If all goes according to schedule, by the end of March, Hamakua Sugar Company will be but a memory. When Hamakua’s demise is coupled with the less celebrated – though no less significant announcement of the phasing out of sugar operations by the Hilo Coast Processing Company and Mauna Kea Agribusiness, the impact on the economy, society and environment of the entire northeast quadrant of the Big Island is profound.
So far, the measure of Hamakua’s debt has been taken by stacking its assets against outstanding loans. Not included in this calculation are the costs of cleaning up the environmental problems left in its wake. At least one unpermitted landfill exists on Hamakua property. The Western Farm Credit Bank has balked at assuming title to Hamakua’s feedlot, citing concerns over the possible presence of hazardous wastes and other environmental liabilities. In 1991, the Environmental Protection Agency fined Hamakua $447,000 for violating asbestos regulations in the demolition of a sugar-cane boiler. Should asbestos be present in existing boilers, whoever assumes ownership of the mill at Haina may face cleanup costs that exceed the value of the asset.
No details of the federal grand jury investigation into Hamakua’s operations have surfaced yet. As the following report shows, however, the range of possible subjects of inquiry is vast. (For more background on Hamakua sugar, readers may wish to consult the April and May 1992 editions of Environment Hawai’i by scrolling down to their listings in the [url=/members_archives/archives1992.php]1992 Archive[/url].)
A Brief Recap
In 1984, Francis Morgan purchased Hamakua Sugar Company from Theo H. Davies & Co., which had been planning to shut the plantation down. Morgan, who had been an executive with Theo Davies, arranged for a highly leveraged buyout of the company counting on a sharp rise in sugar prices to help pay down the debt. The so-called spike in sugar prices never came, and by 1987, Morgan was having trouble paying the debt on his land. The state Department of Agriculture in 1988 gave Hamakua Sugar a $10 million loan, which went straight to Hamakua’s two chief creditors, the Western Farm Credit Bank and an affiliated agency; the Hawai’i Production Credit Association.
By 1990, the plantation was once more in dire financial trouble. Income was not able to meet operating expenses, much less pay the interest on debt. Hamakua defaulted on a mortgage payment of more than $3 million to Western Farm Credit Bank. With the bank’s blessing, Hamakua made plans to slim down its scope of plantation operations and sell off at two auctions about 5,000 acres of what it called excess lands. Alarmed at the prospect of helter-skelter development along the Hamakua Coast, the state prevailed upon Hamakua to call off its second auction (the first one had been disappointing, in any event) and work with state, county and private planners in developing a master plan for the region. The final document, the Hamakua Regional Plan, called for development of the lands surrounding the rim of Waipi’o Valley and in the area of Kukuihaele into a resort.
In January 1991, Morgan announced he had found a buyer for the resort-designated area. Eugene McCain’s Royal Coast Waip’io Corporation was going to purchase more than 3,800 acres of land, Morgan said, and it would in turn sell 600 of those acres to a Japanese company, Sokan-Hawai’i, Inc. Sale price for the 3,800 acres was $99 million.
As a condition of purchase, Sokan insisted upon the developer’s counterpart of a turnkey operation. All permits needed for development had to be in place by the end of 1991 or the sale would not go through. (Sokan’s ongoing efforts to develop a resort at Maui’s Waihe’e Dunes may have been behind this insistence.) Despite the county’s efforts to steamroll approvals, when 1992 dawned, Sokan’s requirement was not met and it indicated that it would not go through with purchase of the 600 acres.
Despite Sokan dropping out, McCain wanted to hold Hamakua to its agreement to selling 3,800 acres. Morgan refused. McCain’s lawyers threatened to sue.
Mounting Debt
Hamakua’s financial condition continued to deteriorate. In late June, the Western Farm Credit Bank and Morgan came up with a tentative agreement to place about 8,400 acres of land in trust, with the intention of selling them to reduce debt, and to restructure the outstanding loans with a new maturity date of July 1, 1995. The bank’s understanding was that this arrangement would be put into effect by September 1, 1992.
On another front, the state Department of Labor and Industrial Relations was pressuring Hamakua to come into compliance with worker insurance regulations. According to the DLIR, since December 1991, Hamakua had not provided its workers with workers’ compensation, temporary disability and prepaid health care insurance, as required by state law. On August 10, 1992, Nathan Murakami, insurance section supervisor for the disability compensation division of DLIR, wrote Francis Morgan, reminding him that in return for approval of Hamakua’s request for self-insured status in 1990, the DLIR had required a bond or letter of credit for $500,000; an “annual progress report” on Hamakua’s master plans; and a mortgage on “certain fee simple land” with a value of approximately $5 million.
However, Murakami added, “we cannot understand why after repeated requests Hamakua Sugar Company has not provided an explanation or the aforementioned documents.” Murakami closed with a request that the company respond in writing by the end of August. “Failure to respond will result in the recommendation to cancel your self-insurance status,” he stated. When Morgan did respond to the notice, on August 17, he merely informed Murakami of the company’s bankruptcy filing three days earlier and requested “in the meantime … that you continue to preserve our self-insurance status.”
Bankruptcy
The DLIR notice may have been the proverbial straw on the camel’s overweighted back, prompting Hamakua to file for bankruptcy. More likely, however, the timing was coincidental. Bankruptcy court records disclose that on August 13, the day before the bankruptcy petition was filed, Hamakua transferred $130,000 received from sales of Big Island Meat cattle to Hamakua’s own operating funds. The cattle had been collateral for an HPCA loan; the bank had agreed to their sale only to pay down the loan, not for any other purpose.
In Hamakua’s bankruptcy petition, the company sought court approval for further such diversions of proceeds from sales of collateral (so-called “cash collateral”). Rather than Hamakua’s creditors receiving these proceeds, they would be used for operating expenses, subject to court approval. In the meantime, Hamakua told the court, it would work toward developing a financial reorganization plan allowing it to satisfy creditors as well as continue operations. At the time of the bankruptcy filing, Hamakua’s total indebtedness amounted to approximately $131 million – $121 million of which were claims secured by liens, promissory notes, or mortgages. About $107 million was owed to the Western Farm Credit Bank and HPCA (that debt has since risen to more than $110 million); about $9 million was owed to the state. By the end of 1992, Hamakua’s total assets were estimated to be in the range of $120 million.
Western Farm Credit Bank was skeptical that Hamakua would be able to reorganize successfully. According to the bank’s Sanford Davis, Hamakua’s net worth from the time Morgan took over, in 1984, to mid-1992 declined by more than $90 million. When Morgan took over, Davis told the court, the net worth was $22.5 million. By June 30, 1992, the net worth was a negative $67.8 million. In the last two years, income from sale of land amounted to almost $20 million, but rather than proceeds from the land sales paying down debt, Davis noted, they were applied against operating expenses. As a result, Davis told the court, “collateral securing the loans of the Bank and PCA has dissipated… [S]ince January 1, 1989, there has been a total decrease of at least $34.3 million in the collateral securing the loans owed by Hamakua to the Bank and PCA. This is during the same time when the Bank’s loan exposure has increased by $17 million” – primarily as a result of Hamakua’s failure to pay interest.
Pension Shortfall
In 1991, Morgan paid himself a salary of $69,999.96 and paid $70,811.88 to his pension plan. But payments into the pension plans of other company employees were allowed to lag. At the time of its bankruptcy petition, Hamakua owed nearly $7 million to the Pension Benefit Guaranty Corporation, established by Congress to insure private pension funds. If the premiums paid by the member companies to the PBGC fall short, the U.S. Treasury makes up the difference.
Hamakua has two pension plans – one for its union workers, the other for management. Hamakua has not paid premiums on either plan for some time, resulting in the $6.8 million owed to PGBC.
Hamakua’s pension plans were themselves described as underfunded in a financial statement prepared by Price Waterhouse at the end of 1991. According to that statement, pension fund assets of $11.5 million fell short of meeting projected benefit obligations by nearly $4 million.
Bailing Out
As mentioned earlier, the Royal Coast Waipi’o Corporation had threatened legal action against Hamakua for failure to consummate the sale of land around the Waipi’o Valley. Barely two weeks after the bankruptcy court filing, the court approved a settlement of Royal Coast’s claims. Under terms of that settlement, Royal Coast, a Hong Kong-based entity identified as Zecha Holdings Limited, and a Zecha affiliate identified only as Silverlink Holdings Limited, released Hamakua from further claims. In return for that release, and for payment of $150,000 over and above the $6.6 million Royal Coast already paid to Hamakua as part of its option agreement, Royal Coast and Zecha received from Hamakua quit claim deeds to land having a value, according to the settlement, somewhere between $1.5 million and $2.8 million. Altogether, Royal Coast and Zecha took full title to about 39 acres in the Kukuihaele area (including the plantation manager’s house). Royal Coast alone took over Hamakua’s partial ownership interest in several other parcels makai of Kukuihaele.
From language in the settlement, it would appear that Royal Coast and Zecha anticipate development of an AmanResort on the makai lands. If the resort is in business by September 1, 1997, and if Hamakua or any successor owner builds a makai golf course, guests of AmanResort are to have access to 16 rounds of golf per day.
Pheasant Ridge
As grim as Hamakua’s proceedings are, at least one party, developer Sheldon Zane, seems to have cause to cheer.
As Environment Hawai’i reported in May 1992, the Pheasant Ridge Corporation, a company headed by Zane, purchased from Hamakua Sugar in February 1990 a one-half undivided interest in a large lot in Honoka’a. The parcel was (and remains) in cane, but since 1982 about 43 acres of it have been in the Urban land use district.
There was nothing tentative about the sale. Pheasant Ridge gave Hamakua a down payment of $790,000 and a note of slightly more than $2 million to cover the balance outstanding. Hamakua in turn assigned the mortgage to Western Farm Credit Bank and the state of Hawai’i’s agricultural loan division as junior secured creditor.
Apparently, Pheasant Ridge desired its money back – and the lawyers for Hamakua were ready to go along. In a filing with the bankruptcy court made January 6, 1993, Hamakua lawyers Ivan Lui-Kwan and Presley Pang asked the court’s approval for returning land ownership to the status quo ante (that is, with Hamakua holding undivided title and the bank and state having first and second liens on it). The bank agreed, so long as it and the Hawaii Production Credit Association received cloudless first and second liens on the property as they had before the sale to Pheasant Ridge.
According to Lui-Kwan and Pang, “after the undivided one-half interest … was transferred to Pheasant Ridge, the overall land use plan for the Hamakua Region changed.” Areas designated for urban growth were “not where anticipated by Hamakua and Pheasant Ridge. Because the primary purpose for the conveyance of [the parcel] was defeated by the Hamakua Regional Plan, Pheasant Ridge, Hamakua, and the affected mortgages agreed to unwind this portion of the transaction.”
Hamakua proposed to give Pheasant Ridge a site for a water tank (Pheasant Ridge needs this as a condition of developing other property it has in the Honoka`a area), in return for which Pheasant Ridge agreed to reduce the amount owed as a refund of its down payment by $337,500. Hamakua then would give Pheasant Ridge a promissory note for $86,000 (the down-payment balance of $452,500; plus credit for interest – accrued at 10 1/2 percent per year – since January 31, 1992; plus about $86,000 for “amounts expended by Pheasant Ridge for preliminary engineering work and preparation of preliminary subdivision plans”). Cash for the refund of the down payment, Lui-Kwan and Pang say, is to come from proceeds from the sale of other Hamakua lands.
Lui-Kwan and Pang stated this agreement would be in the benefit of the estate of Hamakua Sugar “because it will avoid the expense, delays, and uncertainties of litigating potential rescission and damage claims resulting from the redesignation of urban zoning in the November 1990 Hamakua Regional Plan.”
On January 19, the agreement was approved by the bankruptcy court judge.
Not So Lucky
Arthur Herbst Jr. and Thomas Bearden have not fared quite as well as Sheldon Zane. In 1990 Herbst and Bearden purchased several parcels from a group of investors headed by Viking Properties, Inc., which had in turn purchased the parcels from Hamakua in late 1989.1
Among the parcels they purchased was one containing eight houses in what is called the Kaia’akea Camp. The houses have running water, but the source is a spring on land that continues to be owned by Hamakua and which is tentatively scheduled for sale to Savio Development Co.
Now Herbst and Bearden are having difficulty documenting their claim to the spring water. Although Viking did not receive explicit rights to use the water, Herbst and Bearden say that Viking was given a signed statement “by the officer of Hamakua who was most directly involved in the Viking sale” to the effect it would be given such rights.
On January 11, 1993, Christopher Yuen, attorney for Herbst and Bearden (as well as a member of the state Board of Land and Natural Resources), filed a motion in bankruptcy court seeking the court’s permission for Herbst and Bearden to sue in state court to resolve the question of water rights. No ruling had been made by the time Environment Hawai’i went to press.
The State’s Stand
Of the $10 million the state lent to Hamakua Sugar in 1988, Hamakua Sugar has paid off just $1 million in principal. That is not the company’s only debt to the state.
In October 1992, the state Department of Labor and Industrial Relations filed a complaint against Hamakua stemming from its failure to meet worker insurance overages mandated by state law. The first cause of action concerned workers’ compensation insurance, not provided since January 1, 1991; the second concerned temporary disability insurance, also not provided since at least January 1, 1991; and the third concerning Hamakua’s failure to provide prepaid health care coverage since at least January 1, 1991. The DLNR asked for an injunction against Hamakua doing any further business in the state until it came into compliance and for civil penalties to be calculated at the rate of $11 per employee per day, with a starting date of January 1, 1991. (With Hamakua having employed about 600 employees for most of the intervening time, the civil penalties amount to more than $6 million.)
Hamakua did not respond to the complaints within the required time. The next action taken was by the state, which dropped two of the three causes of action, citing in part Hamakua’s “failure to respond” to the original complaint. When the deputy attorney general handing the matter, Leo Young, was asked why the second and third causes of action were withdrawn by the state, he stated he “was not at liberty to disclose the state’s legal strategy.” Young was also asked why Hamakua’s failure to respond should evidently count in its favor, when common sense would seem to regard failure to respond as strengthening the state’s case rather than weakening it. Young answered by involving a desire on the state’s part to “protect a way of life” on the Hamakua Coast.
In November, the state dipped into its Special Compensation Fund to pay workers’ compensation claims filed by Hamakua workers. At the time, the state assured taxpayers that the $200,000 or so paid out (so far) would be repaid. Payments of about $22,000 per week have continued since then.
But promises of repayment were premature. For this to occur, the bankruptcy court would have to approve the workers’ compensation payments as administrative costs, as thus given priority claim on estate assets (as, for example, is given to Hamakua’s lawyers).
On January 14, a hearing was held on the state’s request to have the workers’ comp expenditures treated as an administrative expense. Judge Lloyd King denied it.
According to Gary Hamada, administrator of the Disability Compensation Division, the draw-down on the Special Compensation Fund made to pay workers’ compensation benefits to Hamakua workers could eventually be as high as $6 million.
Big Island Meat
In 1986, Hamakua Sugar began operating a feedlot and slaughterhouse on 68 acres of coastal land it owned at Pohakuhaku (slightly north and west of Pa’auilo). In more than six years of operation, the feedlot, known as Big Island Meat, never turned a profit. Its very best year was 1989, when net losses amounted to $573,000. In the first half of 1992, net losses totaled $454,000.
Hamakua agreed with the bank that the feedlot operation should be shut down and was in the process of selling its livestock to pay off the HPCA loan when it went into bankruptcy. At the time, it was also negotiating to sell the feedlot.
The sale was put off by the bankruptcy filing, but negotiations continued. By mid-November, Hamakua was proposing an arrangement under which Hawai’i Beef Packers, Inc., would operate the feedlot and slaughterhouse under lease. Western Farm Credit Bank, however, as the ultimate landlord, objected to the arrangement. According to documents filed with the bankruptcy court, the bank was worried about potential liability with respect to hazardous materials, possible nuisances, and water rights. In early December, in consideration of the bank’s concerns, the bankruptcy judge withheld approval of the proposed lease.
That did not spell the end of the matter. On December 18, the Board of Land and Natural Resources was presented with a proposal to have the state accept a license to operate Big Island Meat from Hamakua Sugar, and, once in possession of the license, issue a sub-license to Hawai’i Beef Packers. According to the submittal to the Board by the Division of Land Management, the bank was willing to agree to an arrangement that provided for state involvement.
That submittal stated further that the license arrangement was part of a larger strategy for the state to protect its $10 million stake in Hamakua Sugar. If Hamakua were forced to liquidate, the submittal states, “then there exists a possibility that the state of Hawai’i may acquire fee simple ownership of the feedlot and slaughterhouse facility.. [O]wnership of these lands, together with any improvements located thereon, would be transferred to the state of Hawai’i as partial compensation for Hamakua Sugar’s outstanding loan principal balance owed to the state” Department of Agriculture.
At the Board meeting, testimony was presented raising the same concerns that the bank had earlier expressed regarding potential liability that easily could exceed the value of the land. Nonetheless, the Board approved the license arrangement.
Board action may have come too late to prevent at least a temporary closure of Big Island Meat. In late December, Hamakua announced it was laying off feedlot employees. However, Environment Hawai’i has learned that the state continues to express an interest in acquiring the 68-acre feedlot site as well as the entire 500-acre parcel of which it is a part. The Pohakuhaku land would be combined with fee-simple interest in Waipi’o Valley rim lands, giving the state the buffer around the valley that it has long expressed an interest in acquiring. In addition, the state wants to take over ownership of Hamakua’s irrigation system so that any future agricultural operations along the Hamakua Coast can be assured adequate water.
Clean Water Issues
Hamakua Sugar discharges wash water from its sugar mill into the Pacific Ocean, pursuant to a National Pollutant Discharge Elimination System permit. For many years, however, its compliance with permit terms has been sporadic. In February 1991, the state issued an administrative notice of violation against Hamakua, citing seven months in which the company’s discharges exceeded permit limits. With penalties of up to $10,000 a day, the potential fine could run as high as $2 million. There has been no resolution of the Department of Health’s notice of violation to date, although at the time of bankruptcy filing, Hamakua said it owed the Washington, D.C., law firm representing it on this and other environmental matters $118,233. No potential liability resulting from the DOH notice of violation was listed, although potential liability to the Environmental Protection Agency of as much as $1 million was cited.
For two years, Hamakua and Hilo Coast Processing have shared an annual $3.2 million grant from the federal Department of Housing and Urban Development. The grant, whose stated purpose is job protection, is in fact to offset part of the costs of treating cane wash water before discharge.
In November of 1992, HUD asked the Department of Business, Economic Development and Tourism to demonstrate the grantees’ compliance with the Clean Water Act. With both companies winding down, discharges have been well within limits. With both companies winding down, in fact, the need for the federal assistance seems to be moot. Still, a spokeswoman for DBEDT said the state had applied for an extension of the HUD grant for a third year. A decision on the matter was pending in Washington, she said.
Grand Finale?
At press time, it would seem that Western Farm Credit Bank and the Hawai’i Production Credit Association are close to working out an agreement with Hamakua Sugar. Terms call for the bank to begin foreclosure on Hamakua’s properties (a process estimated to require at least six months’ time). Following foreclosure, the bank would apparently do whatever is required to convert the land to cash sufficient to cover its outstanding loans. (That could entail development or efforts to rezone lands as well as simple sales.)
The state and other creditors have not been included in the bank’s proposed settlement. However, if the state can cut a deal on the side with the bank for the feedlot land and Waipi’o Valley rim area, it seems likely the bankruptcy court would approve it.
Any land deal with the state will probably satisfy only the agricultural loan. Over and above that are the claims of the state for expenditures from the Special Compensation Fund, penalties for Clean Water Act violations, and the near-certain costs of cleaning up environmental or health hazards on lands abandoned by Hamakua and taken over by the state. In addition, should the state receive ownership of Hamakua’s irrigation system, permanent repairs to a collapsed tunnel at the back of Waipi’o Valley may be expected to cost in the neighborhood of $1 million, according to Hamakua’s filings with the state Commission on Water Resource Management.
Finally; there are the costs associated with mass unemployment in the Hamakua area. Unemployment costs are only the most readily identifiable. Other costs already covered by the state include special counseling services (provided by the Department of Health) and ongoing workers’ compensation payments. Should the Department of Health assume operation of Hamakua’s medical clinic, that would represent yet another drain on state resources.
1 It may be worth noting that among the investors were David W. and Shirley A. Larsen. In the late 1970s and 1980s, David Larsen played a prominent role in consolidating the property in Ka`u where Charles Chidiac later proposed to build the Hawaiian Riviera Resort. See “[url=/members_archives/archives_more.php?id=626_0_33_0_C]Ghosts of Speculators Past Stalk Land Proposed for Resort[/url]”, Environment Hawai`i, July 1991.
Volume 3, Number 8 February 1993
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