GM Asks Partial Refund on Hughes Aircraft Deal : Contends That Problems Were Minimized During 1985 Negotiations That Led to $5.2-Billion Merger
General Motors is entering secret arbitration to reduce retroactively the $5.2-billion price it paid to acquire Hughes Aircraft in 1985, claiming that it has sustained tens of millions of dollars in unexpected losses on troubled government contracts held by Hughes during the merger, The Times has learned.
GM is seeking restitution from the Howard Hughes Medical Institute, a wealthy research organization that was the sole owner of the Los Angeles-based aerospace firm until it sold Hughes Aircraft to GM for a combination of cash and securities.
Although GM knew at the time that Hughes was facing serious problems on a number of military programs, the auto maker apparently now believes that their severity was minimized by the medical institute or by Hughes officers, including then-Chairman Allen E. Puckett, according to Hughes officials.
Legal Battle Sparked
The largest single loss was an estimated $180-million penalty imposed on Hughes in connection with a large Navy contract for a communications system. The contract was terminated by the Navy in November, 1985, after Hughes was unable to develop adequate technology for the system. The Navy contract was canceled one month before GM completed its acquisition of Hughes in December, 1985, but the penalty against Hughes was not set until April, 1986, according to Navy documents.
The dispute has set off a potent behind-the-scenes legal battle, focusing on a high-powered arbitration panel composed of former Atty. Gen. Griffin Bell, former Atty. Gen. Nicholas Katzenbach and Robert Bork, the conservative jurist whose nomination to the U.S. Supreme Court was rejected by the Senate last year.
The relationship between GM and the institute, which became one of GM’s largest shareholders when it sold Hughes Aircraft, has grown increasingly tense throughout the dispute. The medical institute owns 76% of General Motors “H” class shares--the stock created in the Hughes acquisition--worth nearly $3 billion.
“It doesn’t exactly please GM that it has essentially had to sue one of its largest shareholders,” said one source knowledgeable about the affair.
Relationship in Question
“GM has no comment,” GM spokesman Jim Crellin said when asked about the arbitration. Hughes officials also declined to comment, as did Puckett.
Medical institute spokesman Robert A. Potter declined to comment in detail on the arbitration, saying only, “It is a current process. All of the trustees are aware of the situation.”
Potter disputed the reports that relations have soured between GM and the medical institute, saying, “It is a business relationship, but it is a good business relationship.”
But other sources said the relationship is becoming strained. GM made financial guarantees on the value of the 100 million shares of “H” class stock it issued to the medical institute when it acquired Hughes. Those shares are thinly traded, and if the institute attempts to sell any significant number of them, the stock price could drop precipitously. GM could have to make good on its guarantees, at a cost of up to $2 billion.
The contract that has formed the basis of GM’s demand for a reduction in the price of Hughes was for development of the Joint Tactical Information Distribution System or JTIDS. The sophisticated system was intended to provide Navy aircraft with voice and data communications that would be jam-resistant and secure.
However, the Navy terminated the Hughes contract in November, 1985, claiming that the firm had defaulted on its obligations and was unable to fulfill the agreement.
JTIDS (pronounced jay-tids) had already undergone serious delays and the contract had been converted two years earlier from a fixed-price to a cost-plus type of agreement. Even with the additional money and time, Hughes was finding it difficult to complete the work.
“It was a crisis situation where threats were brought from both sides,” said retired Navy Rear Adm. Stuart Platt, now a private business executive in San Francisco. “Reputations of powerful people and big money were at stake. The whole issue had reached a boiling point.
“We saw a worse case than Hughes, and in the long run the losses were a lot worse than we thought,” Platt added in a telephone interview.
Settlement in Early ’86
Puckett, who was then Hughes’ chairman, and John Lehman, then the secretary of the Navy, negotiated a settlement of the program in early 1986, just weeks after the $5.2-billion acquisition of Hughes was completed on Dec. 20, 1985. The agreement between Puckett and Lehman was finalized in a legal document titled simply, “Aide-Memoire,” signed April 30, 1986. The Times obtained a copy of the agreement under the federal Freedom of Information Act.
The deal provided that Hughes would not be held to specific monetary damages on the JTIDS program itself and that the official record would be revised to show that Hughes did not default on the contract.
In exchange, Hughes agreed to major reductions in prices on three other large Navy weapons systems--the Phoenix missile, the radar system for the F-14 jet fighter and a satellite communications system known as Leasat.
The aide-memoire provides, for example, that Hughes would sell the Navy 530 Phoenix missiles at a unit cost of $650,000 in fiscal years 1985 and 1986. That compares to the previously negotiated 1984 price of $894,340, according to the document. The total price reduction amounted to $244,340 per missile or $129.4 million for the two years.
Although the agreement does not put a total cost on the penalties imposed on Hughes, an authoritative military source said it amounted to as much as $180 million, assuming that the government took advantage of all of the provisions allowed in the agreement. That estimate was confirmed by a second source knowledgeable about the agreement.
Whether GM was aware of the potential for losses on JTIDS is unclear. GM officials, including Executive Vice President Donald Atwood, were aware of the cancellation but may have thought that the government would cancel the program without penalizing Hughes. Atwood did meet with Navy officials in 1985 but apparently was not involved in the final negotiation of the penalty, according to Navy officials.
Lehman reportedly insisted to subordinates that he wanted Hughes to bear a substantial penalty for failing to deliver the JTIDS, part of his policy of getting tough with defense contractors. Hughes had told the Navy that it was technically unable to develop the system at a reasonable price under its “cost-plus” contract.
‘Reflections Between Mirrors’
“Lehman was the man in the driver’s seat,” retired Vice Adm. Glenwood Clark Jr. said in a recent telephone interview. Clark was chief of the Space and Naval Warfare Systems Command, which was the military department developing JTIDS for the Navy. He described the contract termination as “a fairly convoluted process,” since the penalty was imposed in the form of reductions in the prices of other weapons.
“The agreement can be characterized as reflections between mirrors,” Clark said in the interview. “It would be difficult to . . . (put a) value on the settlement. It involved negotiation of a number of contracts and you can’t really say what it cost because you don’t know what it would have cost otherwise.”
Nonetheless, the settlement was a burden on Hughes, and in turn on General Motors. Moreover, it outraged many executives inside Hughes because the financial penalty fell on divisions that had played no part in the JTIDS program and saddled otherwise healthy programs with unexpected costs. But JTIDS was not the only troubled contract that has left GM with a loss.
Hughes has also experienced overruns on a fixed-price contract for the Command, Control and Intelligence System (CCIS) that Hughes’ Ground Systems Group in Fullerton is building for Norway, according to a Hughes official. Estimates of overruns on that program amount to as much as $50 million.
In addition, Hughes had to write off more than $100 million in administrative expenses at its Fullerton operation when it discovered in 1987 that its inventory was overvalued and its overhead costs had been underestimated, according to informed sources.
Meanwhile, teams of attorneys for GM and the medical institute have taken up residence at Hughes’ Los Angeles headquarters, going over reams of corporate records, according to one Hughes executive.
