First American Corp. could wind up with little to show for bankrolling the growth of the title and escrow subsidiaries of Mercury Companies Inc. to the tune of nearly $100 million during the housing boom.

First American is writing off its investment in Mercury, which it had last valued at $37.3 million, after a judge declined to block the sale of Mercury’s Colorado title operations to rival Fidelity National Financial Inc.

First American Corp. could wind up with little to show for bankrolling the growth of the title and escrow subsidiaries of Mercury Companies Inc. to the tune of nearly $100 million during the housing boom.

First American is writing off its investment in Mercury, which it had last valued at $37.3 million, after a judge declined to block the sale of Mercury’s Colorado title operations to rival Fidelity National Financial Inc.

First American’s write-down dented the company’s second-quarter earnings, which the company had originally estimated at $42 million in a preliminary earnings report (see story).

In a regulatory filing, First American said its investment in Mercury is "permanently impaired," contributing to a reduction in net income for the quarter, to $19.6 million.

First American remains embroiled in a legal dispute with Mercury over nearly $100 million in financing it provided to the Colorado-based company in the last eight years.

In recent months Mercury — which expanded rapidly during the boom with the backing of First American — has shut down operations in five states, and on Aug. 5 reached a deal to sell its remaining title and escrow operations in Colorado to Fidelity (see story).

First American claims that under an 8-year-old agreement governing its initial purchase of preferred stock, Mercury agreed not to dispose of "all or any significant part of its property or assets" without written approval from First American.

"Mercury has stunned First American by breaching that agreement in the most egregious way imaginable," lawyers for First American said, in seeking an injunction last week to block the sale of Mercury’s Colorado title and escrow operations to rival Fidelity.

Just as First American was finalizing months of negotiations to acquire Mercury’s Colorado operations in exchange for forgiving $20 million in debts, First American’s motion said, "Mercury abruptly agreed to sell those operations to First American’s biggest competitor, Fidelity National Financial Inc.," for $5 million.

According to the American Land Title Association, the top five title insurers, with 93 percent of the $14 billion U.S. market in 2007, are First American (30 percent), Fidelity (26 percent), LandAmerica Financial Group (19 percent), Stewart Information Services Corp. (12 percent) and Old Republic International Corp. (5 percent).

Mercury claimed its Colorado subsidiaries — Security Title, First American Heritage Title, Title America and United Title — controlled a 30 percent share of the state’s title insurance business. First American, which had a longstanding agreement to be Mercury’s exclusive underwriter in Colorado, stands to lose all of the business the companies generate.

Kevin Lagerwey, head of mergers and acquisitions for First American, said in an affidavit that Fidelity "will undoubtedly seek to terminate or erode First American’s underwriting relationship with the Mercury subsidiaries … and terminate other First American companies’ business relationships with the Mercury companies in favor of Fidelity’s own companies’ offerings."

Injunction denied

At an Aug. 6 hearing, Judge John Kane of the U.S. District Court for the District of Colorado denied First American’s request for an injunction blocking the sale of Mercury’s Colorado subsidiaries to Fidelity, which had been announced the previous day.

Although Kane declined to stand in the way of the transaction, First American could take other legal action in an attempt to undo the sale or recover damages from Mercury and Fidelity.

According to court documents, Fidelity paid Mercury $1 million on Aug. 5, placed another $4 million in an escrow account, and took operational responsibility for Mercury’s Colorado subsidiaries including payroll.

First American claimed that as a major Mercury shareholder, it had the right to weigh in on major corporate transactions.

"The bottom line is that First American, in providing Mercury nearly $100 million of financing over this decade, bargained for and obtained the rights to approve, and reject, any Mercury proposals to sell significant assets," First American argued in its motion.

First American says it provided more than $97 million in financing to Mercury, including $22 million in between 2000-05.

The loans to Mercury began with the forgiveness of $5 million in past-due underwriting remittances in 2000, First American said, in exchange for 5,000 shares of nonvoting preferred stock in Mercury.

The preferred stock agreement stipulated that Mercury would not "acquire any business entities, wind up, liquidate or dissolve its affairs or enter into any transaction of merger or consolidations" — or "sell, lease or otherwise dispose of … all or any significant part of its property or assets without the written consent" of First American.

Mercury maintained that because it disclosed its intent to discuss a sale of its subsidiaries to Fidelity, and First American "made it absolutely clear that it would not consent," that Mercury complied "with the substance of the preferred stock agreement."

First American loaned Mercury an additional $17.6 million in 2003 and 2004, the company’s lawyers said. With Mercury expanding rapidly during the housing boom, Mercury and First American "began discussing larger contributions to Mercury’s finances," lawyers for First American said.

The discussions culminated in a June 2006 preferred stock agreement in which First American provided $75 million in cash to Mercury in exchange for 75,000 shares of nonvoting preferred stock.

First American claims that Mercury was obligated to convert its preferred stock into Class A common shares with voting rights if Mercury did not redeem the shares by Sept. 30, 2007.

As the housing boom waned and home sales dwindled, the nature of Mercury’s financing agreements with First American changed from "voluntary to involuntary," First American said.

"Mercury ceased making preferred stock dividend payments; it defaulted on its promissory notes, and its operating subsidiaries … breached their obligations to remit premiums" owed, First American claims.

First American said months of negotiations with Mercury culminated on Aug. 4, when Mercury and First American agreed that First American would acquire Mercury’s Colorado operations in exchange for forgiving Mercury’s $20 million debt.

In seeking a temporary restraining order blocking the deal, First American said that it would ultimately prevail in its arguments that Mercury was required to seek its approval, and that allowing Fidelity to move forward with the acquisition would lead to "irreparable harm."

"If Fidelity’s deal remains in place, it will be immediately performed, the Colorado operations will be integrated into Fidelity, and it will be impossible to unscramble the egg," First American argued.

Mercury’s view

Mercury’s attorneys responded that any damages First American suffered "were due to its own unrepentant greed, and not to any wrongful action by Mercury." Mercury initially attempted to sell its Colorado operations to First American, "but First American repeatedly refused to pay even a small percentage" of the companies’ fair value, Mercury said in successfully heading off an injunction.

Mercury said its recent troubles were the result of a decision by another of the company’s creditors, Comerica, to call in a $40 million line of credit at the end of July.

Mercury claims it had an agreement to "put," or sell, another 15,000 shares of preferred stock to First American for $15 million, which First American refused to honor when Mercury tried to exercise its put option on May 13. That refusal led to Comerica "sweeping" up $40 million Mercury held in various bank accounts, and forcing it to sell its Colorado subsidiaries, Mercury claimed.

Fidelity stepped in with an offer that was "millions of dollars more than the best offer made by First American," funded the payroll of Mercury’s subsidiaries, and provided closing protection letters First American had failed to provide, Mercury’s lawyers said.

In a signed statement, Mercury Chief Executive Officer Jerrold Hauptman said that on July 25, Mercury "found itself without working capital, numerous checks and wire transfers bounced, and Mercury did not know how it would meet its obligations or conduct business in the immediate term."

After Mercury closed down 161 title and escrow offices operated by Mercury subsidiaries in California, Arizona and Texas on July 29, Hauptman said 27 lenders stopped doing business with Mercury’s Colorado subsidiaries.

It became apparent that the companies "had lost confidence in the marketplace," Hauptman said. "The circumstances were analogous to a ‘run on the bank.’ "

Hauptman said that in an Aug. 1 conversation with First American CEO Parker Kennedy, he offered to sell Mercury’s Colorado subsidiaries in a $1 million stock transaction.

"Mr. Kennedy agreed to pursue a transaction along these lines," Hauptman said in his affidavit, and negotiations on the terms of a sale began that day and continued over the weekend.

The discussions deteriorated, reaching a "nadir" on Sunday evening when First American said it was only interested in acquiring two of Mercury’s four Colorado title subsidiaries, Hauptman said. First American refused to pay cash or make other provisions to pay most of the subsidiaries’ debts, he claimed.

A First American spokeswoman said the company would not comment on pending litigation.

"Minutes after receipt of First American’s predatory offer, we called a Fidelity representative, for the purpose of exploring preliminary interest in acquiring the Colorado businesses," Hauptman said.

Hauptman said that when he informed Kennedy that Mercury was exploring a sale of the Colorado companies to Fidelity, Kennedy said such a deal would be a "disaster," and negotiations with both companies continued.

With an Aug. 6 deadline to meet payroll for employees of Mercury’s Colorado subsidiaries looming, Mercury’s board approved the sale of the company to Fidelity on Aug. 5, Hauptman said, choosing the "financially superior" offer.

***

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