Documents detail sale to IWIF; Purchase of company made to avert lawsuits, lawyers say; $2.6 million payment found; Contract extension not advised by board, session notes showed


When the board of the state Injured Workers Insurance Fund (IWIF) voted by phone April 22 to buy the assets of a private company for $6.5 million, the two-page news release touting the sale told only a small part of the story.

What was unsaid was that the sales agreement followed a series of nasty legal threats, and that it was the culmination of a highly unusual relationship between the public agency and a private contractor.

A review by The Sun of records obtained under the state public records law and interviews with IWIF board members and officials show:

The agreement included an unusual provision eliminating the threat of personal libel and slander suits against the same board members who voted on the sale.

An additional payment of $2.6 million was approved with the purchase, boosting the cost to more than $9 million.

An audit shows that IWIF paid $2 million to the former owners of Statutory Benefits Management Corp. (SBMC) for an agreement not to compete against IWIF for business in other states. IWIF was created to serve Maryland companies and cannot sell its insurance in other states.

In a series of interviews, board members and IWIF's legal counsel acknowledged that a key element of the overall agreement with SBMC was a five-page document, finalized May 12, in which SBMC owners agreed to drop a series of threatened multi- million-dollar legal claims against IWIF and its board members.

Created in 1914 by an act of the General Assembly, IWIF is governed by a board appointed by the governor. It sells workers compensation insurance to private businesses.

Lawsuits avoided

IWIF and its lawyers say that, without the overall settlement, including the $9 million payment, the agency faced the nearly certain prospect of a long and costly legal battle from SBMC and its former owner, Louis J. Nicholas.

"It was clear to me there was going to be a lawsuit," said David M. Funk, a private attorney who advised IWIF on the sale. "This was a very real threat. There were a lot of bad things about to happen."

Nicholas agreed to an interview on the negotiations, but later canceled it.

Additional payment made

The records reviewed by The Sun show that in addition to the publicly disclosed purchase price of $6.5 million, IWIF agreed to pay SBMC another $2.6 million for services the firm had provided to IWIF since June 1996.

The documents show that the additional $2.6 million was included as part of the original purchase price of more than $9 million under a preliminary agreement dated April 30. But after an audit set SBMC's assets at only $6.5 million, the $2.6 million was redefined and listed as a payment for services rendered.

Clause to 'not compete'

The records also show that the audit by Arthur Andersen LLP credits $2 million of the $6.5 million total for an agreement by SBMC owners not to compete with IWIF for business in other states. IWIF was created to provide workers' compensation insurance to Maryland companies and cannot legally sell the product out of state.

Asked to explain the "noncompete" agreement, IWIF officials acknowledged they can't sell insurance outside Maryland, but said there were plans to sell computer software used to handle workers compensation claims to other states. IWIF paid for the software and allowed SBMC to use it during the contract. Records provided by IWIF show two prior efforts to sell the software were unsuccessful.

Auditors also were apparently uncertain about the $2 million figure. A footnote to the report states, "If covenant not to compete is not contained in the purchase agreement, this amount will be allocated to excess of purchase price over fair value of assets."

Threats against board

Funk said SBMC's attorneys were threatening to initiate personal legal actions against board members because, under state law, IWIF itself is immune from most legal claims.

In a letter to an IWIF official, Nicholas complained of "legal foot dragging" and added that "someone needs to be hit over the head with a public baseball bat to get everyone's attention. Wake up before they throw you under the bus."

Funk and IWIF board chairman Daniel E. McKew, the letter's recipient, also stressed that the agency was under a rapidly approaching deadline to select a new managed care contractor or find a way to take that operation in-house. SBMC's contract expired June 30.

Changing relationship

The relationship between IWIF and SBMC dates to 1996, when the state agency issued an invitation for private firms to submit proposals to provide managed-care services. Eventually, in a decision sparking prolonged internal debate and a critical review by an outside auditor, IWIF threw out all the bids only to negotiate a $21 million agreement with SBMC.

Late last year, after public disclosures about the original SBMC contract, the IWIF board voted to reject a proposal to extend the SBMC contract for another year, ordering the staff to put the pact out to bid.

The disclosures about the original contract award, including excerpts from the critical audit report by Ernst and Young and quotes from the minutes of IWIF board executive sessions, triggered an angry war of words and a series of legal threats from Nicholas and his attorneys.

Session minutes revealed

In a letter dated Feb. 28, SBMC's legal counsel demanded payment from IWIF of more than $24.5 million, including $10 million for defamation and $3 million for "interference with a business relationship." SBMC lawyers said that release of the executive session minutes was a violation of state law.

According to his letters, Nicholas was particularly incensed over a comment made by McKew at an open board meeting Nov. 24, 1998, in which McKew stated that the IWIF board should not go along with a staff recommendation to extend SBMC's contract.

"There's been a black cloud over this contract," said McKew. "It seems to me the prudent thing to do would be to remove it and put some integrity back into the agency."

So serious were the threats of legal action that two board members critical of SBMC, Louise T. Keelty and Joseph M. Coale III, hired attorneys. The board later voted to reimburse the two for more than $2,000 in legal expenses incurred as a result.

Noting the Nov. 24 statement, Nicholas wrote that McKew either was the "pawn" of fellow board members or "you purposely and maliciously made statements which you knew were unsupported by the E & Y [Ernst and Young] report, were in fact untrue and which you knew would cause damage to my company and me in dollars and reputation."


McKew said he did not see a conflict in voting for an agreement that included provisions ending the threats of litigation against himself and other board members.

"The personal side of this never influenced my vote," said McKew. "I don't think there was a conflict -- but I can't tell you I didn't grit my teeth paying this premium."

Coale and Keelty, who is no longer on the board, declined to comment.

Funk said that because of the legal threats, he felt it would have been negligent on his part not to include in the agreement language to protect board members from the threatened action.

Deteriorating service

Those threats came, records show, at the same time that IWIF managers were reporting a continuing deterioration in the services being provided by SBMC. By early March, the backlog of claims from injured workers had grown to more than 7,500, and IWIF began offering overtime to its employees to help eliminate the deficit. IWIF even turned to a temporary employment agency, Free State Adjusters, for additional help.

In memos to SBMC, IWIF officials said they believed SBMC was not living up to its contract and threatened suit for breach of contract.

Funk and McKew said the settlement was the best available option. They noted that SBMC had never collected the full $21 million authorized under the 1996 contract and that old claims handled by SBMC were not covered by the 1996 contract.

"We were really solving two problems," Funk said.

Pub Date: 10/05/99

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