By Stephen Nellis Friday, November 18th, 2011

[EDITOR’S NOTE: This story was updated and corrected at 1:45 p.m. on Nov. 21. Scroll to the bottom for the correction.]

The State Compensation Insurance Fund and the region’s biggest private company are taking off the gloves in a fight over a $50 million fraud judgment.

At issue is whether an $80 million dividend paid to the owners of Santa Barbara-based Select Staffing in 2007 can be unwound to resolve claims that Select underpaid its premiums and defrauded the fund.

On Nov. 7, the State Fund, which has $20 billion in assets and is the largest provider of workers’ compensation insurance in California, took the unusual step of filing a civil Racketeer Influenced and Corrupt Organizations Act claim in U.S. District Court in Los Angeles. The lawsuit alleges the $80 million payout to Select CEO Stephen Sorensen was made when Select was insolvent or caused the company to become insolvent — and therefore unable to pay the $50 million jury award won earlier in a state court.

In response, Sorensen said the lawsuit is an attempt by the State Fund to cover for a costly procedural mistake. Its big jury award is against Select Personnel Services, a relatively small and legally isolated subsidiary of Koosharem, the umbrella parent corporation that Select, now with $1.8 billion in revenue, has used to carry out its growth-through-acquisition strategy.

The newest lawsuit names Sorensen personally, as well as Koosharem, several members of Select’s corporate staff, and Sorensen’s family trust and holding company.

“We have multiple companies. If you look at the size of the company during the time the alleged wrongdoing took place, it was less than a seventh the size of the company now,” Sorensen told the Business Times in a interview. “We were a California company then, and now we do business all over the U.S. The notion that [the State Fund] should be able to get all of our companies, all of our brands — it just doesn’t seem right.”

State Fund officials said the firm cannot comment on ongoing litigation. In August, the State Fund won a state court victory in San Francisco on allegations that Select tapped another staffing firm to improperly lower its workers compensation premiums. A jury found that Select had underpaid by $30 million and awarded $2 million in punitive damages and $18 million in accrued interest.

Select is appealing that judgment. In most cases, a defendant can post a bond to satisfy a judgment while appeals unfold. However, Sorensen said that Select has been unable to obtain a bond for the judgment because it is so large. That opened the door for the State Fund to take action to collect even as appeals are pending.

The allegations relate to an $80 million transfer back when Select was expanding through nine-figure mergers and the credit markets were generous.

In 2007, Select inked a leveraged recapitalization with Bank of the West and its parent, Bank Paribas, for $400  million with the option to borrow up to $200 million more when acquisition opportunities came up.

The deal included an $80 million dividend to Sorensen. But because the company was so heavily leveraged, the payout was structured as a loan to Par Alma Alliance, a limited liability corporation controlled by Sorensen’s family trust.

The details of the deal came to light in 2009, when Select briefly considered going to public to help pay down about $200 million of its then $535 million in debts. Public filings at the time said that Sorensen had drawn about $70 million on the loan, then put back $33.5 million. At the time of the proposed deal, Sorensen was trying to secure forgiveness on a balance of up to $74 million, cementing the payment.

“When we got into the fine print of it, the lending community decided that rather than have it be an outright check to me, they’d rather it be a loan,” Sorensen told the Business Times in 2009. “I got the dividend in 2007, but during the recession I’ve actually had to put a lot of money back into the company.”

The State Fund filed civil claims under the RICO Act. The law is more commonly known to the public in its application to criminal cases, often cropping up as a center piece in mob family shows such as “The Sopranos.”
RICO cases can be filed at the state or federal level and are among a range of options available to a creditor that believes it won’t be repaid because assets have been transferred away from a debtor to keep them safe from a creditor’s hands. At a consumer level, the classic example is couple that transfers its house to a child just before filing bankruptcy in attempt to save the home from being taken over by creditors.

Courts have the power to unwind such transactions under several statutes. The RICO laws are a powerful way to do so, but require a higher legal bar than a fraudulent transfer alone.

Darrel Menthe, a partner in Culver City-based Miller, Miller & Menthe who has written on civil RICO cases and reviewed the State Fund case at the Business Times’ request, said the fraudulent transfer portion of the State Fund’s allegations is relatively straightforward. If the State Fund can show that Select wasn’t able to repay its debts before or because of the payout, that courts could uphold the claim.

But Menthe said it will be more difficult for the State Fund to prove that the claims should be brought under RICO statutes and that Select will likely challenge the pleadings.

He said State Fund’s lawsuit does not appear to bring substantial new facts to the case, but rather seeks to gain federal jurisdiction over the judgment and bring in new defendants.

“To the extent we’re talking about the same basic facts, that’s going to be hard,” Menthe said. “Sometimes people file RICO suits to paint their adversaries in a bad light.”

[CORRECTION: A previous version of this story misstated the amount of the punitive damages in the jury award against Select Personnel Services as $20 million. In fact, the jury awarded $2 million in punitive damages and $18 million in accrued interest.]