The lessees argue that the lease does not require them to pay P&WV’s legal fees.  The relevant section of the lease, 4(b)(6), states that the lessee is

[R]equired to pay all obligations reasonably incurred by [P&WV] … for … all acts and things necessary or desirable for the protection [of P&WV]’s rights …. pursuant to this Lease, except such obligations … solely for the benefit of its stockholders.

While I’m not an attorney, it seems clear to me that the legal fees Power REIT has incurred to determine its rights under the lease and to protect its interest in the current litigation are both “necessary or desirable” to protect its rights under the lease.  While everything Power REIT does should eventually be for the benefit of its stock holders, that clause is not relevant here because, as P&WV points out in its legal filings, NSC has not historically applied that exemption to paying any of P&WV’s taxes.  These tax payments are also required under the lease subject to the same exemption.

Payment of Taxes

The lease allows the lessees to use the depreciation of the property to reduce their tax bills, so long as they compensate P&WV for the taxes then owed.  Section 4(b)7 of the lease states such taxes (as well as the legal fees discussed above) “shall be paid or discharged by Lessee as and when they become due and payable.”

Rather than paying these taxes for P&WV, the lessees have simply been increasing their “indebtedness” to P&WV, as discussed above, forcing P&WV to pay the taxes out of its own cash.  This is another reason Power REIT argues that the lessees are in default.

Refusal to Allow Inspections

NSC has also refused to allow Power REIT to inspect NSC’s books, despite the fact that section 8(a)3 of the lease seems crystal clear that it should be allowed to do so:

[NSC and WLE] shall permit at any and all reasonable times such person or persons as [P&WV] may designate to inspect the books and records of [NSC or WLE] for any purpose whatsoever.

As far as I can tell, the track inspection Power REIT requested is not required by the lease, but the refusal to allow an inspection of NSC’s books seems sufficient to declare NSC to be in default.

Timing and Likely Outcomes

The case is pending in Federal Court in Pittsburgh, PA.  The litigation is currently in the active discovery phase.  While it’s extremely difficult to predict how long the litigation might continue, and what the cost might be, both parties are asking the court for a summary judgment, which means that there could be a judgment soon after this phase is over.

The various issues that will need to be decided are:

  • Can Power REIT terminate the lease?
  • How should the “indebtedness” in the settlement account be treated?
  • Are the lessees responsible for any of Power REIT’s legal costs?

From reading the filings, it seems to me that WLE and NSC’s strongest argument is that they have been doing things this way for 45 years, and P&WV has never objected before.  Hence, the argument goes, P&WV implicitly agreed to their procedures with its lack of objection over four decades.  Power REIT’s counter is that P&WV was for all intents and purposes a captive of NSC.  NSC controlled PW’s board (WLE’s President was chairman of the board.)  NSC even prepared P&WV’s taxes.   Since P&WV did not have the capacity to object, its previous silence did not constitute assent.

Termination of the Lease

It seems clear to me that WLE and NSC are in default of the lease on several counts, and the lease  is quite clear that there is no remedy once a default has occurred.  That said, the court might still decide that the possibility of economic disruption  would be too great if Power REIT were allowed to completely revoke the lease, and so might simply change the terms of the lease, or order that they negotiate a new lease that the court deems fair.

Any of these outcomes would most likely be favorable to Power REIT, since the current lease has no provision for inflation, past or future, and the current rent is far below a market rate.  The worst-case scenario for Power REIT would be if the court were to rule in WLE and NSC’s favor, and re-affirm the status quo.

If the court finds the lease in default, then WLE or some other railway will need to renegotiate a lease with Power REIT.  Given the fact that the current lease is 50 years old and has no inflation adjustment, it seems reasonable to expect that any new lease would be considerably more lucrative for Power REIT than the old one.  It’s also worth considering that the rail in question lies on top of the active Marcellus Shale natural gas play.  While the environmental impacts of shale gas drilling are in question, the impact on rail usage are not: shale gas drilling requires incredible volumes of water, sand, and drilling chemicals to be hauled, and rail is far more economical for moving bulk goods than roads.   Any new market lease would probably be worth many times the $915,000 per year ($0.55 per PW share) paid under the old lease.

Indebtedness

The lease does not define the terms of the “indebtedness” represented by the almost $16 million in the “settlement account,” and is silent on when the indebtedness is due.  PW argues that because the lease is silent on the matter, the money is payable on demand.

Even if Power REIT is not able to demand the money immediately, the lease caps the settlement account at five percent of P&WV’s assets, which, depending on how assets are valued, is almost certainly less than $1 million.