Verizon Knifed It in the Back, Fairpoint Says, Calling $2.5 Billion Spinoff & Merger a Fraud

      CHARLOTTE, N.C. (CN) - FairPoint Communications claims it went bankrupt due to a "disastrous 2008 spinoff and merger" with "telecom behemoth" Verizon, which transferred its northern New England "antiquated landlines and DSL technology that was already disfavored by customers and expensive to maintain" to FairPoint, while grabbing the lion's share of the loan money it raised for the deal, to spend on newer technologies for Verizon.
     FairPoint says it took on $2.5 billion in debt, while Verizon waltzed with $1.6 billion in cash and promissory notes. As a result, FairPoint "paid a princely sum for a collection of inferior assets that had no future," while Verizon kept its most advanced business products and business customers, FairPoint says in a lengthy complaint in Mecklenburg County Court.
     Charlotte-based FairPoint provides telephone and Internet services in 18 states, mostly in rural areas.
     The Verizon spinoff made headlines for months in New England, as FairPoint was plagued with service and billing problems. Even customers who were pleased by receiving no bills at all turned sour when they received bills for 6 months or more.
     FairPoint claims that Verizon, the largest telecommunications provider in the United States, caused the bankruptcy of two other companies that acquired Verizon assets.
     Faced with a revolution in the telecommunications industry, with customers switching to wireless, cable broadband and fiber optic cable, Verizon decided to spin off most of its landline assets and raise capital to expand its fiber optic network and other newer technologies.
     The complaint states: "This $2 billion dollar fraudulent transfer suit arises from a disastrous 2008 spin-off and merger (the 'transaction') between FairPoint Communications Inc. ('Old FairPoint'), a small, once well-regarded, North Carolina-based telephone company and a short-lived corporation that telecom behemoth Verizon created for the sole purpose of 'spinning off' certain assets that Verizon considered undesirable - conventional landlines in northern New England.
     "Old FairPoint and the Verizon spinoff entity that was immediately merged into FairPoint, Northern New England Spinco Inc. ('Spinco'), took on an enormous debt load, approximately $2.5 billion, in order to effect this transaction. Old FairPoint received sufficient loan proceeds to pay off its existing lenders and to pay some of the enormous bills incurred in putting the byzantine deal together. But the lion's share of the loan proceeds (principally $1.16 billion in cash) and new promissory notes ($551 million in principal) were transferred or conveyed to Verizon New England which, in turn, passed the money upstream to Verizon. Only 18 months after the transaction closed, the merged entity (the 'combined entity') filed for relief under Chapter 11 of the United States Bankruptcy Code.
     "Some of Verizon's reasons for pursuing the transaction were clear. First, Verizon would rid itself of aging DSL networks in three states that were expensive to maintain and increasingly disfavored by residential and business customers who preferred the speed and reliability of more modern technology like cable broadband Internet and fiber optic cable. Second, the transaction would pay Verizon richly, and Verizon could devote that money to its more profitable technology. Third, Verizon could use a complex 'Reverse Morris Trust' structure for the transaction that would result in the cash passing to Verizon tax-free. Fourth, Verizon could utilize Old FairPoint's appeal as a well-regarded small telecommunications company to assuage, or help to assuage, any regulatory concerns over the transaction.
     "But a key part of Verizon's strategy in luring Old FairPoint into this transaction was not at all apparent until it was too late for Old FairPoint. Verizon structured the transaction so that it could not only continue to compete with the combined entity in the relevant states after the transaction, but also so that it could crush the new competition created by the transaction. Essentially, Verizon did not sell a stand-alone business to Old FairPoint. It sold a collection of low-margin assets in Maine, Vermont and New Hampshire (the 'Spinco assets') with two critical components missing.
     "One of those components was the growing part of the ILEC (defined below) business: Internet protocol-based business products targeted at business customers. That was a growing and profitable market segment that Verizon was able to exploit post-transaction, while the combined entity was not. Instead, Verizon transferred to the combined entity only the shrinking part of the business: antiquated landlines and DSL technology that was already disfavored by customers and expensive to maintain. The other missing component consisted of the IT networks and back office functions that were essential to billing customers, servicing customers, and collecting payments. Instead, Verizon offered an expensive and inadequate transition services contract, so that the combined entity would have to pay dearly for essential services after the transaction closed while creating its own operations at huge expense and with little relevant experience. Without those two components, Old FairPoint paid a princely sum for a collection of inferior assets that had no future." (Parentheses in complaint).
     FairPoint claims that "Verizon took advantage of delays in gaining regulatory approval for the deal to cannibalize business customers. It stopped performing even routine maintenance and upkeep on the assets that Old FairPoint was to acquire. Verizon also failed to disclose crucial changed facts. Going into the deal, Verizon and Old FairPoint both understood that landlines were losing a long-term battle with cell phones. Nonetheless, money can be made even in a declining market, and Old FairPoint had a successful record with rural landlines. But Verizon failed to disclose, whether because of Verizon's functional abandonment of the assets or otherwise, that the landlines Old FairPoint had committed to buy via the transaction were now losing customers at a much faster rate than the numbers on which Old FairPoint had based its projections. Verizon went to great efforts to keep these and other awkward facts under wraps. Even during the period after signing but before closing, Verizon prohibited any contact (save for a single welcoming speech) between Old FairPoint executives and their prospective new employees.
     "For its part, a blend of naïveté and optimism pushed Old FairPoint into the transaction. By the time of the closing (defined below), due to the crushing expense of trying to build complex operational support for the aging landline business it was going to acquire, Old FairPoint had become so strapped for cash that it could not even cover closing costs without help from Verizon. Old FairPoint executives, committed to taking on management responsibilities for a merger partner more than seven times its own size, while simultaneously shouldering a $2.5 billion debt, saw the writing on the wall, but believed Old FairPoint was trapped. The company had no chance given the hand it was dealt by Verizon. Old FairPoint was either insolvent or sliding over the edge into insolvency even before any money changed hands." (Parentheses in complaint).
     FairPoint says it had no reliable financial information about the assets it acquired from Verizon and no experience in the wholesale market, which represented part of the merger assets.
     What's more, FairPoint says, "Verizon not only made no effort to assist Old FairPoint but stood silent knowing Old FairPoint's projections for the Spinco assets were inconsistent with Verizon's projections."
     And, though FairPoint tried to walk away from the deal three times, Verizon "was 'relentless' in its pursuit of Old FairPoint," the complaint states.
     FairPoint adds: "Even without a complete understanding or appreciation of the facts, the stock market's verdict was that Old FairPoint was getting the short end of the stick. From the date the transaction was announced to the day after the closing, FairPoint's common stock price lost over 63 percent of its value. At the same time Verizon's stock rose."
     The transaction added $1.4 million customers for FairPoint, increasing its customer base by about 746 percent, according to the complaint. But Verizon refused to transfer its IT system to FairPoint and restricted FairPoint's access to its prospective employees, former Verizon personnel who could facilitate the transition and serve FairPoint's new customers, until after the transaction was completed, FairPoint says.
     It claims that the deal left FairPoint and the merger entity undercapitalized and unable to pay their debt.
     FairPoint filed for bankruptcy in October 2009, 18 months after the merger with Verizon, then reached a deal with major lenders to restructure its debt and lower it by $1 billion to be converted into common stock.
     FairPoint adds: "Verizon's strategy worked. Today, Verizon has a landline business in just eleven states and Washington, D.C. These locations represent some of the best ILEC [incumbent local exchange carrier] markets in the country. All of these geographic locales have high population densities, lowering the cost to service these homes. Verizon has retained its landline business in eight of the top ten markets measured by per capita income, seven of the top ten markets measured by median household income, and, most importantly, eight of the top ten markets measured by population density."
     FairPoint seeks damages for fraudulent transfer under state and federal laws.
     Its lead counsel is Jonathan Sasser with Ellis & Winters of Raleigh, assisted by co-counsel from Houston and New York, N.Y.
     Named as defendants are Verizon Communications, Nynex Corp., Verizon New England, Cellco Partnership dba Verizon Wireless and Verizon Wireless of the East.
     Verizon told Courthouse News that it plans to "vigorously" contest the "meritless" lawsuit.
     "FairPoint Communications' 2008 acquisition of Verizon's northern New England wire-line operations occurred after thorough due diligence on the part of FairPoint and its lenders and lawyers, as well as extensive review and approvals from telecommunications regulators in Maine, Vermont and New Hampshire," Verizon spokesman Bob Varettoni said in a statement. "The claims now raised by the litigation trust two years after FairPoint's bankruptcy wrongly blame Verizon for financial losses suffered by sophisticated lenders that resulted from operational, financial and other difficulties encountered by FairPoint after the closing of the acquisition, and not from actions by Verizon."