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J.P. Morgan Chase & Co. isn’t in the habit of backing energy trading futures contracts with billions in loans. But for a blue-chip customer it was wooing, the House of Morgan paid up. Now, six weeks after that client, Houston-based Enron Corp., filed for bankruptcy, Morgan is in a heated court battle with Enron’s insurance companies over which institution is liable for nearly $1 billion the bank lost when those contracts weren’t fulfilled. If the bank wins and the insurers are on the hook, the bank would halve its $1.9 billion total estimated loss on Enron. J.P. Morgan made $965 million in loans to an Enron subsidiary that was backed by insurance company promises, or collateral, in the form of surety bonds. The 11 insurers — including Hartford Fire Insurance Co., St. Paul Fire and Marine Insurance Co. and Safeco Insurance Co. — aren’t paying. They claim the futures contracts may be fraudulent, if they ever existed. The case, now in U.S. District Court in New York, illustrates not only the complex and risky entanglements Enron engaged in, but also how integral its bankers were to its operations. “We have to brace ourselves for what’s shaping up to be protracted litigation,” said E. Reilly Tierney, an analyst with Fox-Pitt, Kelton Inc. in New York. “The impact would be significant if they recover (or lose) that amount.” A spokesman for J.P. Morgan declined comment, as did the bank’s attorneys in the case, Donald Bernstein and Nancy B. Ludmerer of Davis Polk & Wardwell in New York. But sources close to the bank acknowledge the agreement between Enron, Morgan and its insurers was not typical for the bank, nor is the practice of backing huge energy trading contracts. The impact of its Enron relationship already has been substantial. On Dec. 19 the bank shook up Wall Street by saying it may classify the nearly $1 billion it believes it is owed as “nonperforming” assets and would take a charge of more than $200 million in the fourth quarter. Results for the quarter will be announced next week. Despite a looming writeoff, J.P. Morgan’s risk management chief, Marc Shapiro, remained defiant. “We believe we will be paid,” he said. But Shapiro’s tone notwithstanding, the bank’s “body language” suggests they don’t expect to collect completely on the bonds, said one analyst who asked not to be identified. “I don’t sense there’s going to be any kind of full repayment [to J.P. Morgan].” Meanwhile, the potential losses to the insurers are substantial enough to catch the attention of ratings agencies. Standard & Poor’s analysts Thomas Upton and Fred Sklow say they are studying the case to determine if the insurers will be weakened should they be forced to pay in the case. A.M. Best Co. and Fitch are in the early stages of taking similar action, according to their spokesmen. A court filing by St. Paul Cos. on Dec. 21 hints at how the insurance companies will defend themselves. It claims that the futures contracts “were not intended by the parties to be fulfilled as actual supply contracts, but, instead, were intended to provide a mechanism to obtain surety bonds to secure loans to be made to Enron in the guise of forward supply contracts.” In other words, Enron and the bank made it appear the surety bonds were insuring the performance of contracts, when they would really be more like loan guarantees. Attorneys at Kronish Lieb Weiner & Hellman, the New York law firm for St. Paul, could not be reached for comment. Other insurance company attorneys declined comment or could not be reached. A source familiar with creditors’ issues in the Enron bankruptcy said that the bond arrangements between J.P. Morgan, Enron and the insurance companies are not unique to Enron and are in place with other energy traders. “It’s not unusual at all,” he said. “But Enron is Enron.” The dispute could clarify what has been a gray area of contract and insurance law as energy trading has developed into an important adjunct to the financial markets. Surety bonds are a kind of quasi-insurance used as protection for businesses as disparate as construction to derivative contracts. A surety “is a form of insurance … [but] it’s just barely a form of insurance,” in the words of Kent Keller, an insurance coverage specialist at Barger & Wolen in Los Angeles. As a result, disputes over whether surety bonds are regulated as insurance or simply as contracts have been common, added Barry Leigh Weissman, a Los Angeles-based attorney with Squire Sanders & Dempsey. Copyright (c)2002 TDD, LLC. All rights reserved.

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