3.31 Sale of Marystown Shipyard Facilities. Introduction

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1 Introduction Prior to the sale of the shipyard operations, Marystown Shipyard Limited and Vinland Industries, [A Limited Partnership] operated facilities owned by Newfoundland Ocean Enterprises Limited (NOEL). All three companies are 100% owned by the Government of Newfoundland and Labrador. Operations at Marystown were reported through Marystown Shipyard Limited, with fabrication operations being reported through Vinland Industries, [A Limited Partnership]. All significant capital assets at the facilities were owned directly by NOEL rather than by the operating entities. Government s involvement with the Marystown shipyard facilities began in 1966 with the construction of the shipyard. The shipyard became operational in 1968, with the fabrication/offshore service facilities being added in 1993 at Cow Head. Both facilities are utilized for construction of new vessels. Shipyard operations include main hull assembly as well as repair and refit work. The fabrication/offshore service site is used for assembling deck houses and superstructures for new vessels as well as fabrication, repair and service work for offshore semi-submersible rigs, most notably relating to various projects connected with Hibernia development, including work related to the Gravity Base Structure, commonly referred to as the GBS. In the fall of 1996, Government decided to divest itself of the facilities at Marystown and Cow Head. We were informed that a divestiture information package was prepared and distributed to several companies in the international steel fabrication sector. In June 1997, Friede Goldman International Inc. expressed interest in purchasing the facilities and on 24 September 1997, a Memorandum of Understanding was signed between Government and the company specifying the basic outline of an agreement by which the Province would sell the facilities. On 22 December 1997, an Asset Purchase Agreement was signed between Government and a new company, Friede Goldman Marystown Ltd., later renamed Friede Goldman Newfoundland Ltd.(FGNL), transferring all of the facilities assets to this company in exchange for 1,000 of its common shares. The net book value of the assets as disclosed in the audited interim financial statements of Newfoundland Ocean Enterprises Limited as at 31 December 1997 was $61 million ($86 million cost less accumulated depreciation of $25 million). On 1 January 1998, a Share Purchase Agreement was signed between Government, Friede Goldman Marystown Ltd., Friede Goldman Canada Inc., and Friede Goldman International Inc., to sell all shares of Friede Goldman Marystown Ltd. to Friede Goldman Canada Inc. for $1. Auditor General of Newfoundland 381

2 Scope and Objectives Our objectives were to determine the extent of government s financial investment in the shipyard and to determine whether the provisions of the Asset Purchase Agreement and the Share Purchase Agreement are being complied with. Conclusions Based on historical information provided by the Department for 1966 through 1994 and through a review of the consolidated financial statements of Newfoundland Ocean Enterprises Limited for the years ended March 1995 through March 1999, government assistance to the Marystown shipyard facilities since 1966 totalled approximately $115 million in capital and operating grants, and $70.9 million in a loan guarantee which was assumed as direct debt of the Province in March As well, as part of the sales agreements, the Province maintained performance guarantees, which as at 31 March 1999 totalled approximately $43 million. Friede Goldman Canada Inc. did indemnify Government relative to contracts it had assumed for which Government had performance guarantees in place. It also released Government relative to Government guarantees on contracts it had assumed between Marystown Shipyard Limited and an affiliated company. Not all the conditions included in the sales agreements have been met. In particular, reports relating to man hours of work for the calendar year 1998 and net after tax profits for the 12 months ending March 1998 were not submitted in accordance with agreement provisions. The report relating to man hours of work for 1998, due to be submitted by 28 February 1999, was never submitted although a Cabinet Committee was provided with this information verbally by company officials in March The report to indicate the net after tax profits, due to be submitted by 30 June 1998, was not submitted until May The Share Purchase Agreement does not require that information provided by Friede Goldman Newfoundland Limited on man hours be audited or otherwise independently verified. The Agreement does provide that the company must retain related information and that Government and its representatives shall have access to such information upon reasonable request and on reasonable notice. Discussions with the Department indicated that the unaudited information provided by the company for 1998 was never verified by Government. The sales agreements do not require Friede Goldman Newfoundland Limited to meet any employment or other requirements after the term of the agreements has passed, which is 31 December As well, there is no provision for assets, recorded at a cost of approximately $86 million at the time the agreements were signed, to return to the Province in the event the company does not comply with the agreements or if the company decided to divest itself of the facilities. In minutes of a Newfoundland 382 Auditor General of Newfoundland

3 Ocean Enterprises Limited/Marystown Shipyard Limited Board meeting held 5 September 1997, it was noted with respect to a discussion held with the Cabinet Committee established to oversee the divestiture, that The Cabinet Committee wants the terms of guaranteed employment extended beyond 3 years and wants to incorporate language covering the return of the assets to the Province in the event of certain occurrences. This was never included in any of the Agreements. A divestiture information package was prepared and distributed to several companies in the international steel fabrication sector. While the Department did provide a copy of the divestiture information provided to the potential proponents, we were advised that no formal record existed as to whom the divestiture information was provided and the evaluation process followed for any proposals which may have been received. Detailed Findings Financial Information Figure 1 provides an overview of consolidated financial information for Newfoundland Ocean Enterprises Limited for the four years ending prior to the shipyard sale, from March 1994 through March 1997, and for the most recent two year ends subsequent to the sale. Figure 1 As indicated in Figure 1, the company reported significant losses for each of the years ended March 1994 through March Consolidated Financial Information Newfoundland Ocean Enterprises Limited Years Ended March ($000) Year Total Assets Total Liabilities Deferred Government Assistance Total Equity (Deficiency) Total Revenue Total Expenses Other Losses Net Loss 1994 $ 79,777 $ 41,821 $ 50,661 $ (12,705) $ 33,831 $ 48,445 $ (1,362) $ (15,976) ,383 76,203 49,405 (29,225) 73,387 89,907 0 (16,520) ,225 63,413 46,552 (39,740) 42,799 53,314 0 (10,515) ,744 75,663 43,191 (45,110) 21,083 26,453 0 (5,370) ,381 72,024 0 (70,643) 66,260 69,268 (22,525) (25,533) (238) Source: Audited financial statements Note:The other losses classification in 1998 relates to losses on sale of the Marystown facilities as disclosed in the audited financial statements Auditor General of Newfoundland 383

4 Government Assistance Government has provided considerable assistance to the Marystown facilities. This assistance took the form of capital and operations grants totaling $115 million and the assumption of the company s long-term debt of $70.9 million in March As indicated in Figure 2, Government provided guarantees to applicable banks as security to finance losses and working capital deficiencies through bank indebtedness and long-term debt and performance guarantees for major capital contracts. Figure 2 provides an overview of the history of these guarantees since 1992, as disclosed in the Public Accounts of the Province. Figure 2 Government Guarantees Newfoundland Ocean Enterprises Limited Years Ended 31 March ($ Millions) Approval Date Corporate Guarantee Performance Guarantee 1992 $ $ Source: Public Accounts of the Province 384 Auditor General of Newfoundland

5 Figure 3 provides an overview of assistance provided by Government as reflected in historical information provided by the Department for 1966 through 1994, and the audited consolidated financial statements of Newfoundland Ocean Enterprises Limited for the three years ending prior to the shipyard sale and for the two years ended since the sale. During the year ended March 1999, Government assumed NOEL s debt, in the amount of $70.9 million, which had been secured by a Government guarantee. Divestiture In January 1997, Cabinet authorized the Minister of Industry, Trade and Technology to provide a clear mandate to the Board of Directors of the Marystown Shipyard Limited to pursue the divestiture of that Crown corporation under general direction from Government. The direction was to include: forming an ad hoc committee of Ministers, with whom the Board could confer with and seek policy direction from; Figure 3 Government Assistance Newfoundland Ocean Enterprises Limited Years Ended March ($Millions) Year Capital Grants Received Operations Grants Received Bank Indebtedness Guarantee Long Term Debt Guarantee Assumption of Bank Debt Total Grants N/A N/A Source: Government s records and Audited financial statements of NOEL Auditor General of Newfoundland 385

6 targeted investors to be limited to national and international companies with the financial capability and market access in appropriate sectors to operate the shipyard as a going concern, with prolonged discussions to be limited to proponents prepared to put forward a detailed business plan for operation of the yard in the long term; a purchase price in the order of $25 million to be used as a starting point for discussion with potential buyers; proposals involving the purchase of either of the shipyard or the Cow Head facilities to be given due consideration; designation under the Province s EDGE legislation to be seriously considered for activities not deemed to have a competitive impact on other Newfoundland entities; new owners shall be exempt from any environmental liability associated with the current operation; if required, a commitment shall be given to potential new owners that no financial assistance will be provided by the Province toward the establishment, acquisition, or expansion of substantial competing facilities; additional costs associated with travel, professional fees and other expenses associated with the divestiture effort, up to a total of $250,000 shall be approved on a case by case basis, with the yard s line of credit and the corresponding loan guarantee from the Province to be increased to accommodate these additional costs as necessary; final decisions with respect to divestiture to be made by Cabinet; and an appropriate communications strategy relating to divestiture to be developed. Government struck a committee, comprising the Premier, the Minister of Finance and President of Treasury Board, and the Ministers of Mines and Energy, Industry, Trade and Technology, and Works, Services and Transportation, to negotiate all issues with respect to the divestiture of the shipyard facilities, including the completion of a divestiture agreement. 386 Auditor General of Newfoundland

7 There was no determination of the value of the assets that would be sold in the event that the divestiture proceeded. A divestiture information package was prepared and distributed to several companies in the international steel fabrication sector. While the Department did provide a copy of the divestiture information provided to the potential proponents, we were advised that no formal record existed of to whom the divestiture information was provided and the evaluation process followed for any proposals which may have been received. We were informed that in June 1997, Friede Goldman International Inc. (FGI) expressed interest in purchasing the facilities. On 24 September 1997, a Memorandum of Understanding was signed between Government and FGI, specifying the basic outline of an agreement by which the Province would sell the facilities. Under the Memorandum, Government agreed to: incorporate a new company to which assets and uncompleted contracts would be transferred, in exchange for all issued and outstanding shares of the new company. All shares of the new company were then to be transferred to Friede Goldman International Inc. or its subsidiary; provide EDGE status for the new company; consult with the chief executive officer of the new company regarding the impact of any future Government investment in competing operations; and maintain certain performance guarantees for ongoing contracts. In exchange, Friede Goldman International Inc. agreed to: maintain a minimum of 1.2 million man hours per year for the calendar years 1998, 1999 and 2000 and in default be required to pay Government $10 million, $5 million and $5 million respectively; pay 50% of any net after tax profit of the facilities to Government relating to the year ended March 1998; Auditor General of Newfoundland 387

8 complete specified upgrades and repairs and invest an intended $5 million to $15 million in capital improvements; and provide Government with at least 90 days notice of any intended cessation of operations. On 22 December 1997, an Asset Purchase Agreement was signed between Government and Friede Goldman Marystown Ltd., later renamed Friede Goldman Newfoundland Ltd. (FGNL), transferring all of the facilities assets to FGNL in exchange for 1,000 of its common shares. FGNL is the new company envisaged in the Memorandum of Understanding. Included in the Agreement is a provision for working capital being available to FGNL at closing of at least $2.5 million. As soon as practicable after closing date, FGNL was to arrange for the completion of an audit, for the purpose of determining the accuracy of the calculation of the $2.5 million adjusted working capital required to be transferred to FGNL on closing. Any difference was to be paid or recovered by the applicable party with provision made for resolution of any dispute through arbitration. The Agreement contained provisions as outlined in the Memorandum of Understanding with respect to Government providing EDGE status and consulting with the chief executive officer of FGNL regarding the impact of any future Government investment in competing operations. On 1 January 1998, a Share Purchase Agreement was signed between Government, FGNL, Friede Goldman Canada Inc.(FGCI), and FGI, to sell all shares of FGNL to Friede Goldman Canada Inc. for $1. The Agreement contained the same provisions outlined under the Memorandum of Understanding with respect to minimum man hour requirements, payment of net after tax profit of the facilities relating to the year ended March 1998, completion of specified upgrades and repairs and investment in capital improvements, and provision to Government of at least 90 days notice of any intended cessation of operations. With respect to performance guarantees by Government on ongoing projects, the Memorandum of Understanding provided for the maintenance of performance guarantees with the exception of guarantees for projects with FGI affiliated companies. The Share Purchase Agreement provides that FGCI would indemnify Government with respect to all ongoing projects with the exception of one with an affiliated company, Government s guarantee for which would be released. The Share Purchase Agreement also provides time frames for the completion of various provision requirements. Within 90 days subsequent to 31 March 1998, FGNL was to deliver to Government an audited statement setting out the calculated net after tax profit, with any related payment to be made by no later than 31 May As well, within 60 days subsequent to each calendar year end for 1998, 1999, and 2000, FGNL is 388 Auditor General of Newfoundland

9 to report to Government the actual man hours relating to the preceding year, with any default amount payable to be included with the statement. Under the Share Purchase Agreement, FGI guarantees the performance and related payments of all commitments made by FGCI and FGNL, including the payment of any out-of-pocket costs and expenses reasonably incurred by Government or NOEL and MSL in connection with enforcing commitments made by FGCI and FGNL. Subsequent to divestiture, Vinland Industries, [A Limited Partnership] became essentially inactive with consideration currently being given by Government to having the Corporation dissolved. NOEL and MSL will continue to exist, primarily to facilitate any legal or other issues which may arise with respect to the divestiture. Compliance with Agreements Our review of the requirements set out in the Asset Purchase Agreement and a review of events subsequent to the date of the Agreement disclosed the following: In May 1997, Cabinet had authorized the designation of Marystown Shipyard Limited as an EDGE corporation for the purpose of facilitating its sale to the private sector. Cabinet authorized the designation of FGNL as an EDGE corporation in September As soon as practicable after 31 December 1997, FGNL was to have an audit conducted for the purposes of determining the accuracy of the calculation of the $2.5 million adjusted working capital required by FGNL on 31 December Upon completion of the audit, should it be determined that the amount of working capital required was other than $2.5 million, Government was to pay to FGNL any shortfall, and FGNL was to pay to Government any excess. Payments were to be made within 30 days after the audit was completed, with a further stipulation that in the event of a dispute, the payment would not be required until 15 days after a decision by an arbitrator. In May 1998, the auditors for FGNL reported that the working capital shortfall was $3.809 million, less an advance payment by Government of $905,000, for a net amount due to FGNL of $2.904 million. In the report, the auditors outlined that this amount may be adjusted to $1.534 million depending on the interpretation of whether a long term holdback receivable amount would be included in the working capital calculation. Auditor General of Newfoundland 389

10 In a separate report in August 1998, a private sector auditor engaged by the Department, determined that the working capital shortfall was only $1.973 million, less the $905,000 advance, for a net of $1.068 million. After additional review, the Department s auditor revised the original estimate of $1.068 million to a range of between $1.250 million and $1.300 million. The revision was based mainly on an estimate of the overhead contribution for a major contract. The final settlement amount of $1.260 million was paid in September Our review of the requirements set out in the Share Purchase Agreement and a review of events subsequent to the date of the Agreement disclosed the following: FGCI did indemnify Government relative to contracts it had assumed for which Government had performance guarantees in place. It also released Government relative to Government guarantees on contracts it had assumed between Marystown Shipyard Limited and an affiliated company. These actions were agreed to through a schedule appended to the Share Purchase Agreement. FGNL was to submit a report, in writing, to Government within 60 days after each calendar year end for 1998, 1999, and 2000, setting out the actual man hours utilized for the immediately preceding calendar year. FGNL did not submit a formal report as required under the Agreement. It did, however, in a March 1999 presentation to the Economic Advisory Committee of Cabinet, report that it had maintained the required 1.2 million man hours, consisting of management and labour, and salaried and hourly, for the calendar year Actual hours reported were 1.7 million. It appears uncertain whether the 1.2 million man hour requirement will be met for the calendar year FGNL has advised Government that man hours for the six month period ended 30 June 1999 were approximately 459,000. It is noted that if FGNL is found to be in default of this requirement for 1999, damages in the amount of $5 million will be required to be paid by FGNL to Government. The Agreement does not require that the report on man hours from FGNL be audited or otherwise independently verified. The Agreement does provide that FGNL must retain related information and that Government and its representatives shall have access to such information upon reasonable request and on reasonable notice. Discussions with the Department indicated that the information presented by FGNL was not verified by Government. 390 Auditor General of Newfoundland

11 We were advised that through discussion with FGNL and through its own knowledge of the facilities operations, Government determined that FGNL had upgraded the existing computer system, repaired the synchro-lift and provided other equipment within three months after the Agreement date. As well, in the March 1999 presentation to the Economic Advisory Committee of Cabinet, FGNL reported that it had invested in excess of $8 million in capital improvements, which was within the required investment of between $5 million and $15 million in capital improvements outlined in the Share Purchase Agreement. No further verification was carried out on the reported $8 million in capital improvements. FGNL was to submit a statement to Government within 90 days after 31 March 1998, signed and verified by FGNL and audited by FGNL s auditors, setting out the calculated net after tax profit of FGNL for the 12 months ending March FGNL did not meet the required timeframe. The audited statement setting out the calculated net after tax profit was not submitted until May In the statement, it was reported that the net after tax loss was $1,885,400. Under the Agreement, FGNL was to pay Government 50% of any calculated net after tax profit, therefore, there was no payment to be made. Department s Response Over the years, as detailed in your report, government provided considerable financial support to Marystown Shipyard. Prior to its sale, the Board of Directors implemented a number of strategies to turn the facility around and make it attractive to the private sector since it was a widely held view that the Shipyard could be operated more efficiently and effectively in private hands. The sale to Friede Goldman, then, was the culmination of these efforts. With respect to your comments on proposals from other interested parties, I want to make it clear that the offer from Friede Goldman was the only real expression of interest that we had in the facility. There were preliminary discussions with a major Canadian shipping company, however, there was no proposal or exchange of correspondence. In short, the Friede Goldman offer was the full extent of the private sector interest in the purchase of Marystown Shipyard. Auditor General of Newfoundland 391