Company controlled by InterOil CEO files 'bad faith' bankruptcy; Mulacek dumps nearly $1.5 million in stock 2 days before filing for federal protection; tries to derail civil fraud case that seeks up to $1.3 billion in damages and could be 'devastating' to InterOil

William Lobdell

A company controlled by Phil Mulacek, chief executive officer of InterOil Corp. (NYSE: IOC), filed a "bad-faith" federal bankruptcy in December in an attempt to derail a potentially massive civil judgment in a fraud case against him and companies he controls, according to court documents filed in Houston.
Less than a month after the filing, federal Judge Marvin Isgur in Houston ruled that Nikiski Partners—a corporation whose $2 million investment in a used oil refinery gave birth to InterOil, one of Wall St.’s high-flying stocks in 2009—had filed the bankruptcy in “bad faith.” (Read transcript here.)
Two days before filing for bankruptcy, Mulacek, through his holdings in   Nikiski Partners, dumped nearly $1.5 million worth of InterOil stock, according to the Canadian Securities Commissions. The insider transaction was filed 40 days after it took place.

Since InterOil evolved from Nikiski and a web of other companies in the mid-1990s, Nikiski’s sole function has been to passively hold investment units that can be ultimately converted to InterOil stock.
InterOil, an oil and gas business founded in 1997, is one of the more controversial companies on the New York Stock Exchange. InterOil’s boosters claim the company has discovered gas fields in Papua New Guinea that will soon be commercially viable and drive the stock as high as 300 (it closed at 70.89 Thursday and had been one of 2009’s high-flying stocks).
Even Shia LaBeouf, who stars in the upcoming "Wall Street" movie, touted the stock to a journalist by texting: "IOC's momentum is major, and it will surprise to the upside."
Critics point out that InterOil has not produced any commercial gas or oil after spending hundreds of millions of dollars, drilling test wells for seven years, and publishing a flurry of optimistic press releases.
In the bankruptcy filing, Nikiski Partners declared $71.5 million in assets and just $5,751 in debts, but argued it needed bankruptcy protection so the 5-year-old civil case could be swept into federal bankruptcy court to avoid a judgment that would be "devastating," as Mulacek termed it, to InterOil stock--Nikiski's only asset.
About 20 of the original investors in Nikiski Partners are plaintiffs in the lawsuit (Todd Peters, et al. v. Phillipe Mulacek, et al.), and they allege that Mulacek diluted their investment shares by falsifying records, giving away for free 25% of InterOil stock to a “shadowy” Bahamian company secretly owned by Mulacek’s grandfather, and ignoring “crippling conflicts of interest” in order to benefit family, friends and himself.
In court filings, the defendants in the suits—Mulacek and the companies he controls, including InterOil—deny the allegations in the Peters lawsuit, calling them frivolous and arguing, among other things, that the statue of limitations has run out on the claims.
The Peters plaintiffs are asking between $275 million and $1.3 billion in damages. The case, which makes derivative or stockholder claims, is scheduled to go to trial in early May.
In the bankruptcy papers, Mulacek also moved to keep under seal all information relating to InterOil because testimony and exhibits would be introduced “that will show how certain events impact the value and volatility of InterOil stock [and publication] of this … in itself unnecessarily create[s] volatility in InterOil’s stock prices.”
And at one point during the Dec. 18 hearing, Mulacek wanted the courtroom cleared before he continued his testimony. The judge elected to put some of his testimony under seal. (You can read the transcript here.) Here's part of the argument to keep portions of Mulacek's testimony secret.

MR. WOOD: We had the president and -- excuse me -- the CEO and chairman of InterOil that’s about to get on the stand and testify. He also happens to be our principal [of Nikiski Partners] and that’s why he’s testifying. He’s going to testify about the negative effect the derivative claims could have against InterOil ...

MR. FARRELL (attorney for plaintiff Todd Peters): Judge, if I might just address it briefly? The -- I really don’t understand the argument. InterOil has already publicly disclosed in its public filings that this lawsuit, the Peters lawsuit, could potentially, if a judgment were to be entered against InterOil, have a material adverse effect on the company. That’s not a surprise to the investing public. It’s been publicly disclosed. If he’s essentially going to say that on the witness stand, it’s already out there publicly.
MR. WOOD: He’s going to go into great detail, Your Honor.
THE COURT: Well, he’s going to go into detail.
MR. WOOD: What he’s about to say is not public.

The Peters plaintiffs objected to Nikiski’s bankruptcy filing, calling it a “transparent attempt” to delay litigation by forcing the case into bankruptcy court. They said in court papers that it was no coincidence that the filing came one business day before the court-ordered and long-delayed deposition of Ronald Mulacek, Phil’s father, in the Peters’ case.
“Nikiski is a single-asset, passive investment vehicle that is under no financial distress, has no significant creditors, has no employees or ongoing business activities and nothing to reorganize,” wrote the plaintiffs’ attorney in a motion to dismiss the bankruptcy. “… Any concern that the Peters case might have an adverse financial impact on InterOil obviously does not present a valid reason for Nikiski Partners to seek bankruptcy protection … If InterOil thinks it needs bankruptcy protection, then InterOil can make its own decisions for filing for relief.”
Before Peters' counsel was about to make his closing argument at the Dec. 30 hearing, Judge Isgur said it wasn't necessary because he had already made a decision in favor of the plaintiffs.
"I don’t think you can invoke a bankruptcy case if what you’re really trying to do ... is simply to do away with state law derivative claims," Judge Isgur said. "That makes no sense. We would have everybody filing a bankruptcy case just to get rid of a state law minority derivative claimant."
Isgur also said that Mulacek's credibility was "diminished" when the executive argued in court papers that one of the reasons for the bankruptcy was the threat of $42 million in damages from another lawsuit, this one brought in 2006 by InterOil's former chief financial officer. That case had actually been settled before the bankruptcy filing.
"I think it just diminishes his credibility that both [lawsuits] were put out [as reasons for the bankruptcy filing] but only one had any possible validity given that [Paul A. "Andy"] Martin had fully settled," Isgur said.
The bankruptcy was authorized by Nikiski Partners board members Mulacek; his wife, Kathleen Mulacek; and his father, Ronald Mulacek. His wife testified that they spent a total of 10 to 15 minutes discussing the idea before voting to file bankruptcy to protect InterOil stock.
William A. "Trey" Wood, III, attorney for Nikiski Partners, said at the Dec. 30 bankruptcy hearing that InterOil "wouldn't even be able to pay a $50 million judgment" without substantial third-party financing.
"The evidence before this Court was that the judgment against InterOil would be devastating to InterOil and our stock," Wood said.
At an earlier hearing, Wood argued that a large judgment would keep InterOil, which has about $60 million in cash, from raising capital to drill its gas wells ($1 billion), construct a pipeline ($900 million), or build a liquidified natural gas (LNG) plant ($5 to $7 billion) in Papua New Guinea before the gas--if it's commercially viable--could be sold. A verdict favorable to the plaintiffs would also threaten InterOil's licenses for drilling on Papua New Guinea land, according to court testimony.
Nikiski Partners sought bankruptcy protection to push the Peters case into federal court, where it asked Judge Isgur to appoint an examiner who would determine if litigation was in the best interest of Nikiski Partners. The examiner could also make a settlement offer that, if approved by the judge, the investors who sued would be bound to accept but Nikiski Partners could reject, according to Judge Isgur.
On Dec. 30, Judge Isgur ruled the bankruptcy had been filed in bad faith and ordered the Peters suit returned to its state courtroom.
InterOil’s 2009 annual report released earlier this month reported that a favorable judgment from the plaintiffs in the Peters case could result in damages exceeding $125 million. The report doesn’t mention the $275 million to $1.3 billion range that the plaintiffs of the Peters case are seeking in damages--figures Mulacek's attorneys used in the bankruptcy proceedings.
The Peters suit wasn't mentioned in InterOil's annual reports for 2005 and 2006. In 2007 and 2008 annual reports, InterOil mentions the suit but said a judgment for the plaintiffs would have no material adverse impact.
Allegations of self-dealing and secret alliances
The bad-faith bankruptcy also spotlighted details contained in the Peters litigation. Among the allegations:

• Mulacek, using Nikiski funds, bought a $250,000 piece of used equipment for an oil refinery and later falsely claimed it was purchased for $15 million from Commodities Trading International, an offshore company covertly owned by his grandfather and controlled by him. In exchange for the equipment that CTI didn’t buy, the Bahamian company received 5.1 million shares of InterOil, which have been sold. At the time, it represented about 25% of InterOil stock. If cashed out at its peak, the stock would have been worth nearly $225 million.
• Mulacek had secretly established a Canadian company that was used to divert—in exchange for no consideration—265,000 shares of InterOil to Mulacek and his family members and insiders.
• Mulacek, family and friends were allowed to convert large chunks of their investments into InterOil stock, but the original investors were only able to convert 6.84% of their investment units into InterOil stock.

Documents generated by the lawsuit and bankruptcy filings give details about how a small-time company, originally formed to buy a used refinery in Alaska, evolved into a public corporation with a market capitalization of more than $3 billion.
InterOil’s roots go back to 1994, when Phil Mulacek and his small company, Petroleum Independent & Exploration Corp. (P.I.E.), formed Nikiski Partners to raise $2 million and buy a shuttered oil refinery in Alaska from Chevron.
Mulacek proposed to investors that the refinery could be sold quickly for a profit, moved to a nearby property for continued operations, or shipped to another country—after being fitted with a converter to allow for the manufacturing of unleaded gas.
With the investors’ consent, Mulacek decided Nikiski Partners should keep ownership of the refinery and ship it to Papua New Guinea.
From 1994 through 1997, Phil Mulacek and PIE Corp. obtained additional financing and created new corporate structures through which to pursue the Papua New Guinea option.
Plaintiffs' chart on the formation of InterOil.
Web of companies
Through a web of complex deals and companies—including ones formed in the Bahamas and Cayman Islands—ownership of the refinery was transferred to a number of companies until it ended up property of InterOil, which in 1997 became a public corporation by merging with a shell company on the Canadian Dealer Network.
The original investors said in court papers that they believed their stake in the venture had not been reduced by what they were told were necessary restructuring for “tax and business planning purposes.”
Later, the investors alleged in court documents that they learned a different reason for the maneuvers: to strip them of any power, to dilute their interests, and to enrich Mulecek, his family and friends.
For example, the investors claim in their lawsuit that Mulacek used their investment money to quietly buy a used catalytic reformer for $250,000 that would allow the refinery to convert oil into unleaded gas.
They allege in court papers that in order to gain more control of what was to be InterOil, Mulacek claimed an unaffiliated company called Commodities Trading International had purchased the reformer for $15 million and would exchange the piece of equipment for 5.1 million unrestricted shares of InterOil stock—25% of the company at the time.
Investors alleged that they say they didn’t find out until last year that Commodities Trading International was founded by Mulacek’s grandfather, Maurice Vinson, and controlled by Mulacek, and that Nikiski, with their investment money, had actually purchased the equipment for $250,000.
In their lawsuit, the investors also claim they found out during discovery that “Mulacek and P.I.E. Corp. had secretly established a Canadian company that would be used to divert—in exchange for no consideration—265,000 shares of InterOil to Mulacek and his family members and insiders.”
Favorable treatment?
And, the investors alleged in court papers, Mulacek allowed the selling of InterOil shares for friends, family and himself, but severely restricted the amount of stock the original investors could sell by giving them a variety of different excuses.
Source: Peters lawsuit.
According to legal claims, here’s the breakdown how much of their investment units they were able convert into InterOil stock during the first decade of the venture.

• Phil Mulacek: 64.6%
• APRI (a company run by Gaylen Byker, a close associate of Mulacek): 35%
• Pierre Mulacek (Phil’s brother): 28.6%
• Ronald Mulacek (Phil’s father): 27.5%
• Christian Vinson (Phil’s brother-in-law): 21.26%
• Kathleen Mulacek (Phil’s wife): 20.8%
• Michelle Vinson (Phil’s sister): 14.45%
• Five Sterling (Phil’s family partnership): 12.47%
• Original investors: 6.84%

According to Peters’ amended lawsuit, “The primary focus of the investors’ original lawsuit was to obtain access to the partnership books and records of Nikiski Partners.”
'Serious wrongdoing'
But “an initial round of discovery in the Peters case revealed evidence of serious wrongdoing by the general partner of Nikiski Partners [P.I.E] and others … the allegations of wrongdoing relate, in significant part, to the creation of a public company called InterOil Corporation and the misappropriation of shares in InterOil.”
Since lawsuit was filed, all Nikiski Partners—except plaintiff Todd Peters and his parents—were allowed in 2008 or 2009 to exchange a substantial portion of their units for shares of InterOil, according to legal papers. Preventing Peters and his parents from cashing out their investment by selling InterOil shares is “blatantly discriminatory treatment to punish him for having filed this lawsuit,” Peters' attorney wrote.
In 2008, Mulacek attempted to lessen the liability of the Peters' suit--which at the time had only one plaintiff, Todd Peters--by getting other original investors to sign a retroactive release that held him harmless for past acts and urged the state court to dismiss the lawsuit, according to Thomas M. Farrell, attorney for Peter.
"He got virtually every one of the limited partners to sign such a document because he told them the case was a lie," said Farrell during the bankruptcy proceedings.
Farrell said Mulacek filed a motion for summary judgment, arguing that the vast majority of limited partners didn't want the derivative case to go forward. But then Farrell said he started to dispose the investors.
Farrell said in court that during a deposition, "I said, 'Well, did Mr. Mulacek tell you these facts and did he show you these documents?'
"And they said, 'No.'
"I said, 'If you'd known that, would you have signed this release?'
They said, 'No.'
"And then virtually without fail, I finish a deposition and the next day they call me and they said, 'Can I join the law[suit] and can I revoke this consent that Mr. Mulacek got me to sign?'
"That's how I ended up with 46.1 percent of the limited partners in this case."
After Ferrell added about 20 new plaintiffs to the suit, he said Mulacek tried another tactic to stop the litigation. Ferrell said that Mulacek told each Nikiski investor that Aster Capital, an "independent, third party unafflilated with Mr. Mulacek," would pay 1.25 shares of unrestricted InterOil in exchange for each restricted Nikiski unit.
Ferrell said about 40 percent of the investors took the offer, none of them his clients. But then Aster Capital, holding the majority stake in Nikiski Partners, asked that the Peters case be dismissed, Ferrell said.
The attorney said he didn't find out until Mulacek's Dec. 17 deposition that Aster Capital only put up one share of Interoil for each Nikiski investment unit, and that Mulacek contributed the additional .25 share of InterOil.
"They concocted this deal so they could now come either to State Court or to this Court and say, 'A majority of these people don't want [the Peters' case] to go forward,' " Ferrell said.
InterOil insider transactions
In the past 16 days, there's been several InterOil insiders dumping their stock. Five directors or officers have dumped nearly $10 million worth of stock, according to documents filed with the Canadian Securities Commissions.
On March 5, Director Edward Nicholas Speal sold 30,000 shares at 63.8593 for $1,915,779.
On March 10, Director Gaylen J. Byker sold 30,000 shares at $69.25 for $2,077,500.
On March 16, President and COO William Jasper sold 30,000 shares at $67.47 for $2,024,100.
On March 17, Director Roger Grundy sold 25,000 shares at $66.39 for $1,659,750.

On March 18, Director Christian Vinson sold 30,000 shares at $68.50 for $2,055,000.
Disclosure: Because of the facts uncovered in this story, William Lobdell has taken a short position in InterOil. Lobdell can be contacted at william@ibizreporting.com.