New Fraud Charges In Quick Flip Case

Private equity firms sometimes sell a portfolio company several months or a year after acquiring it, but the buyout that sparked the lawsuit at the center of the case in Manhattan federal court involves a company that was resold in seven hours.

The case was brought by a subsidiary of Switzerland-based Pala Investments over the purchase of industrials firm Norcast Wear Solutions Inc. Pala sold Norcast Wear to New York-based Castle Harlan Inc for $190 million in July 2011, but several hours later Castle Harlan sold it for about $217 million to Bradken Ltd of Australia. Bradken and Castle Harlan had a long history of doing deals together.

Pala cried foul, and through its Norcast S.AR.L. subsidiary slapped Castle Harlan last year with a fraud and breach of contract lawsuit.

Pala argues that it sold Toronto-based Norcast under false premises. It contends that Bradken, as a competitor of Norcast, knew it would have to pay more for the company than a financial investor like Castle Harlan, so Bradken conspired with the private equity firm to buy it at a lower price.

“Castle Harlan merely was a puppet and Bradken its puppeteer,” the amended complaint, filed May 7, states. It says Norcast “would have insisted on a higher price and more favorable terms of sale had it known” it was selling Norcast Wear to Bradken.

Norcast S.AR.L. recently brought in Richard Werder and David Orta of Quinn Emanuel Urquhart & Sullivan to represent it in the case, replacing Scott Balber at Cooley. Court papers outlining the attorney switch did not indicate why the change was made, and the two firms declined to comment.

Timothy Nelson and Scott Musoff of Skadden, Arps, Slate, Meagher & Flom are representing Castle Harlan. They did not respond to requests for comment.

Castle Harlan spokesman Mike Millican declined to comment on the lawsuit. However, in a statement issued at the time of the deal, Co-President Howard Morgan said that the firm and its Australian affiliate, CHAMP Private Equity, have partnered with corporate co-investors, including Bradken, many times.

“As private equity lead investors, we enabled these corporations to participate in investments that for many reasons they couldn’t or didn’t want to lead at the time,” the statement said. “In several instances the corporate partner decided to own the business outright, and we at Castle Harlan saw immediate value-added from the partner and the possibility of a long-term strategic fit.”

In its revised complaint, Norcast S.AR.L. includes more detail on Castle Harlan’s interaction with Bradken, thanks to findings in a 118-page ruling in March in a parallel case in Australia against Bradken. In that case, Judge Michelle Gordon awarded Pala $22.4 million in damages, a decision that Bradken is appealing. Castle Harlan is not a defendant in that case.

The new lawsuit in New York federal court includes additional claims of fraud, as well as claims of unjust enrichment, tortious interference and negligent misrepresentation. The lawsuit seeks at least $26 million in compensatory damages and restitution, plus punitive damages, which Norcast S.AR.L. was not seeking in the initial complaint.

The original U.S. case was brought in New York State Supreme Court. It was removed to federal court by Castle Harlan, which is seeking to compel international arbitration in the matter. A trial date has not been set.

In recent years, private equity firms have faced increased scrutiny for trying to keep deal prices down.

The most notable example is a civil antitrust lawsuit brought in 2007 accusing 11 large firms, including Bain Capital Partners and The Blackstone Group, of colluding to drive down purchase prices between 2003 and 2007. In a victory for the buyout firms, a federal judge in Boston significantly narrowed the case in March.

Castle Harlan is a relatively smaller player in private equity, having raised $6 billion since former Donaldson, Lufkin & Jenrette chief executive John Castle co-founded it in 1987. Some of its better-known investments have included Morton’s Restaurant Group Inc and lawn and garden product maker Ames True Temper.

Among the many details culled from the recent Australian ruling, the new complaint by Norcast S.AR.L. includes the judge’s determination that Castle Harlan engaged in “misleading or deceptive” conduct in the deal. The Australian ruling cites evidence from the case suggesting that Castle Harlan’s Morgan told people involved in the initial transaction that Castle Harlan had no plans to sell Norcast to Bradken.

In one exchange included in the ruling, former Norcast Chief Operating Officer Richard Wilson was said to have asked Morgan if Castle Harlan was planning to quickly sell Norcast to Bradken, as it had previously done with another company. According to Wilson, Morgan described the earlier deal, for a company called AmeriCast, as an exceptional situation, but did not directly answer the question.

“Bradken submitted that Morgan did not directly respond to Wilson’s questioning and, in that sense, he told no untruth,” the judge wrote in the Australian ruling. “I reject that submission.”

Morgan said in an email to Reuters that these comments were taken from internal Norcast reports representing the company’s view of the exchanges, that Castle Harlan was not a party to the Australian proceeding and that no one from his firm testified in the case. He declined to comment further.

Another finding by the Australian court suggests Castle Harlan co-founder Leonard Harlan had concerns about the entire deal. Bradken Chairman Nick Greiner reported to a colleague that Harlan “was obviously concerned to ensure that (Castle Harlan) did not run any significant reputational risk” from the transaction, according to an excerpt of the exchange included in the ruling.

Greiner and Harlan did not respond to requests for comment.

While U.S. District Judge Paul Crotty, who is presiding over the New York case, may read the Australian ruling, it will likely have little impact on a U.S. trial, said John Donovan, a partner and corporate litigator at Ropes & Gray who is not involved in the Norcast case.

“The judge will want to hear actual evidence of what happened, not some court’s conclusion, particularly since Castle Harlan was not a party to the Australian litigation,” Donovan said.

Bernard Vaughan, a former senior editor at Buyouts, is a correspondent for Reuters in New York.