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Documents Tie German Company to Chinese Subsidiary That Produced Defective Drywall

Documents tie a German company to a Chinese subsidiary that produced defective drywall, but family-owned Knauf Gips says it’s not legally responsible for the millions of pounds of defective drywall that was used to build U.S. homes.

Knauf Gips, a family-owned German company with operations throughout the world, has argued for almost two years that it is not legally responsible for the millions of pounds of defective drywall that one of its subsidiaries in China has admitted exporting to the United States.

But documents filed in Germany and in U.S. courts show that Knauf’s German umbrella company is closely involved in the management of its subsidiaries, including overseeing quality control, finding raw materials and dealing with rising concerns over the defective drywall.

Founded in 1932 by brothers Alfons and Karl Knauf, Knauf Gips – the Knauf group’s gypsum products division – is still owned and operated by the descendants of Alfons and Karl. In 2008, the Knauf group had 331 subsidiaries and 22,000 employees, according to financial documents Knauf filed in Germany in March. Its operations include factories in Iran, Russia, Indonesia and the United States. Last year, the Knaufs ranked 14th on a list of Germany’s wealthiest people published by Manager Magazin, one of Germany’s leading business magazines.

Knauf officials declined to be interviewed for this article. But according to the financial documents (in German), the company’s executive board believes that lawsuits filed against Knauf Gips in U.S. courts “are not enforceable.”

Dozens of companies are being sued for manufacturing the defective drywall that has contaminated thousands of U.S. homes, including Taishan Gypsum Co. Ltd., a company with direct ties to the Chinese government. But Knauf appears to be the largest manufacturer on the list of defendants and is thought to have the deepest pockets. In 2008, the year for which the most recent figures are available, its revenue was more than $6.6 billion, according to its filings in Germany. The revenue of its Chinese subsidiaries, which are also being sued, is only a tiny fraction of that amount. According to the German documents, all of Knauf’s Asia, Middle East and Africa subsidiaries had only $369 million in revenue in 2008.

Knauf says that only one of its Chinese subsidiaries – Knauf Plasterboard Tianjin – produced any of the defective drywall and that it is the only Knauf company that can be held financially responsible.

The bulk of the defective drywall arrived in the United States between 2005 and 2007, at the height of the U.S. building boom. It releases high levels of sulfur gases, which can trigger respiratory problems, erode wiring and and cause refrigerators, air conditioners and other electronics to fail. The Consumer Product Safety Commission, which is leading the federal government’s investigation of the problem, has received more than 3,500 complaints from U.S. homeowners about defective drywall. To repair the problem, the CPSC says, the homes should be gutted and all the drywall and wiring removed.

Shipping records analyzed by the Herald-Tribune in Sarasota, Fla., and ProPublica show that since January 2006, three of Knauf’s Chinese subsidiaries have sent more than 100 million pounds of drywall to the United States under their own names, including about 55 million pounds from the Tianjin plant.

However, Knauf Tianjin also shipped large quantities of drywall to the U.S. under the name of third-party exporter Rothchilt International, so it’s difficult to determine how much Knauf drywall was actually imported into the United States. Knauf officials have repeatedly declined to clarify those details.

According to websites that Knauf maintains for its Czech and Swiss subsidiaries, Knauf bought a Thai company’s stake of the Tianjin plant in 1999. The company that sold the plant to Knauf filed a statement with the Thai stock exchange indicating that the stake was 70.93 percent.

A 2003 book that Knauf published about the firm indicated it owns 100 percent of the other two Knauf subsidiaries that are defendants in the U.S. case.

In a statement to ProPublica and the Herald-Tribune, one of Knauf Tianjin’s American attorneys, Steven Glickstein, stressed the legal separation between the German parent company and Knauf Tianjin.

“It is common for management and employees of the affiliated companies to communicate with each other, to have consolidated financial statements and to have relationships with one another,” Glickstein said. “However, this does not change the fact that each corporation is a separate legal entity, responsible only for its sales and its own products.”

Knauf used a similar argument in 2002, when the European Commission fined it about $108 million (in current U.S. dollars) for conspiring with three competitors to artificially inflate the cost of drywall. Knauf appealed the fine, arguing that Knauf Gips was responsible for the price-fixing, and that Knauf Gips and the Knauf group shouldn’t be considered “the same economic unit.” Last month the European Court of Justice rejected Knauf’s appeal.

“The companies belonging to the Knauf family constitute an economic unit,” the Court of Justice said. “Knauf Gips KG should be considered to be responsible for all the activities in the Knauf Group.”

Attorneys representing U.S. homeowners have argued in a court filing that the European ruling “makes it abundantly clear that Knauf Gips controls all of the Knauf entities.”

Ulrich Börger, who practices international law in Hamburg, Germany, for New York City-based Latham & Watkins, said that “often American plaintiffs’ attorneys gladly try to implicate parent corporations because they have the deeper pockets.” But to succeed, the plaintiffs’ attorneys “have to prove concrete misconduct by the parent corporation,” said Börger, whose firm is not involved in the drywall litigation.

Dan Harris, an attorney with Seattle-based Harris & Moore, which represents clients in both China and the U.S., said attorneys for the plaintiffs must determine “who made the big decisions? Who made the decision as to what would go into the drywall, China or Germany? Who made the decision with respect to testing that would be done on drywall to make sure it didn’t have problems?”

Isabel Knauf, a granddaughter of one of the founders and manager of Knauf’s operations in the Mediterranean and Asia, addressed quality control when she spoke at a 2007 conference in the city of Tianjin in 2007. “Quality in all Knauf manufacturing facilities in Asia will be rigorously controlled according to the strictest standards set up by our HQ in Germany,” she said, according to a press release that Knauf issued in Chinese after the event.

Ervin Gonzalez, a Florida attorney who represents some of the U.S. homeowners, said Knauf, a “multibillion dollar corporation, has tried to shy away from their responsibility. But we have the evidence that the parent is responsible for the Chinese company.”

It will be up to Judge Eldon E. Fallon, who is presiding over a multidistrict lawsuit in federal court in New Orleans, to determine whether the German parent or the Chinese subsidiary is financially liable for the drywall problem.

If the Chinese subsidiary alone is held responsible and refuses to pay, then the attorneys could move to seize the company’s U.S. assets. But after the drywall incident, Knauf Tianjin stopped doing business in the U.S., and it has no assets here to seize. That would leave the attorneys with the option of trying to collect in China, where U.S. judgments are rarely honored. Or getting the judgment enforced in a country where Knauf Tianjin does have assets. Or suing again – this time in China.

“None of these options are easy,” Harris said. “Knauf China could argue that you can’t sue us here, because you are already suing us in the U.S.”

The process would be far simpler if Fallon decides the German parent is liable. Knauf would still be able to argue that the U.S. court doesn’t have jurisdiction to force them to pay – but the plaintiffs would then have the option of asking a German court to enforce the judgment. According to Börger, if a German judge decides that the U.S. judgment was “issued in a fair trial, it can be enforced.” He said that process would take six months to a year.

Jörg Schanow, a member of the Knauf executive board who also serves as the company’s general counsel, declined to speak with ProPublica, saying he could not discuss matters that are subject to ongoing litigation.

But in December 2009 Schanow told the Frankfurter Allgemeine Zeitung, a leading German newspaper, that “whoever says the products are causing sickness claims something wrong or imagines it.” And in February 2010, he told the German business magazine WirtschaftsWoche that “Knauf KG is only mentioned in the complaint because of its financial power.”

First Complaints

In 2005, building material suppliers in the United States ramped up their importation of Chinese drywall to help rebuild the Gulf Coast after Hurricanes Katrina and Rita. By 2006 the demand for drywall was so high that Knauf began searching for new sources of raw materials for its factories.

“Those efforts were successful and the new suppliers now are serving the Knauf board factories continuously and with increasing amounts,” Knauf said in financial statements for the Knauf umbrella company, filed in Germany in 2008 for the year 2006.

Millions of pounds of Knauf drywall went to Banner Supply, one of Florida’s biggest drywall distributors. When Banner started getting complaints about the drywall from builders and installers in early November 2006, Banner contacted Mike Norris, Knauf Tianjin’s general manager, through its importer.

On Nov. 7, 2006, Norris received an e-mail from a Knauf Tianjin employee warning him that Knauf’s drywall could affect “thousands of houses.”

Norris quickly e-mailed five Knauf officials, asking how he should handle the problem.

“Any ideas on how I can resolve this I am getting a very slow reaction from Germany,” Norris asked. “It looks like it is going to get VERY nasty and expensive.”

Among those who received the e-mail was Isabel Knauf, manager of Knauf’s operations in Asia. The e-mail also went to Frederick Knauf, director of Knauf Trading Shanghai Co. Ltd., another Knauf subsidiary in China.

Isabel Knauf immediately urged Dr. Hans Ulrich-Hummel, Knauf’s head of research and development, to go to Florida, visit some of the affected homes and meet with Salomon Abadi, who owned the company that had brokered Banner's purchase of Knauf drywall.

“I think we need to show our face because this gets out of hand.” Isabel Knauf told Hummel on Nov. 7, after referring to a previous lawsuit against Knauf Insulation, its American-based subsidiary. “Please, pretty please with sugar on it, do this visit!”

Isabel’s sweet tone became sharper the next day.

“We have made it very clear to Soloman (sic) that if anybody wants to sue us, they will have to sue Knauf Tianjin in a Tianjin court,” she said in a note to Hummel, Norris and other Knauf officials. “However, for the reputation of Knauf in the market and to avoid that they sue Knauf’s American entity, we need to show up there and find out what the hell is going on.”

A few days later, Hummel, Norris and several scientists from an Arkansas-based environmental engineering firm flew to Florida and visited homes with Abadi and Banner Supply executives. According to Abadi’s sworn testimony, Hummel was in frequent communication with a “Mr. Knauf” in Germany, whom Abadi described as the “orchestra director.”

Norris also checked in with members of the Knauf family, according to sworn testimony from the Banner executives.

Norris later sent Banner and Abadi the results of the Arkansas firm’s study, which Norris said showed that the drywall didn’t pose a health risk.

In December 2006, Knauf Tianjin and Banner reached a confidential agreement that was revealed in May by ProPublica and the Sarasota Herald-Tribune. Knauf agreed to replace any of its Chinese-made product that Banner hadn’t sold with U.S.-made drywall. In exchange, Banner promised not to sue Knauf. Both parties agreed not to tell the government, media or the public about the deal.

Other documents filed in connection with the federal lawsuit also show that Knauf had financial and managerial ties with its Chinese subsidiaries.

In a 2006 e-mail, Tony Robson, who previously held Isabel Knauf’s position, informed his colleagues that management of the company’s Asian operations was being shifted to the Knauf family’s hands: “As you know the new structure involves the overall responsibility for our gypsum activities in Asia passing from myself to Isabel Knauf.”

Knauf Tianjin has said that it traced the drywall problem to a gypsum mine in China. Gypsum is the white sedimentary rock that is the primary ingredient in some forms of drywall. Knauf Tianjin attorneys said that for some reason gypsum from one mine contained a particularly high concentration of sulfur and that the company stopped using that mine after the problem was discovered.

But neither Knauf Tianjin nor its attorneys have provided documents to support that conclusion. Many of Knauf’s factories, including some in China, also produce drywall made from another form of gypsum, which is produced from coal ash that has been scrubbed from the smokestacks of coal-fired power plants for air pollution control.

Questioned Under Oath

Since the first drywall lawsuits were filed in early 2009, Knauf Tianjin’s attorneys have argued that Knauf Gips should be excluded from the lawsuit – and that Knauf officials in Germany shouldn’t be required to appear as witnesses – because Knauf Tianjin alone is responsible for the defective product.

But earlier this month, Judge Fallon ordered some of the witnesses to appear. He also ordered Knauf to turn over documents that the plaintiff’s attorneys had been trying to obtain for months.

Last week, at least one of the company’s employees flew to New York City and spent two days answering questions under oath from the plaintiff’s attorneys. Fallon issued an order saying information about the depositions could not be made public, so it’s unclear how many people testified or whether Isabel Knauf, who is included on the witness list, appeared.

At Fallon’s urging, the various attorneys involved in the case met on Tuesday to begin discussing a settlement. According to Russ Herman, a New Orleans lawyer who heads the plaintiff’s steering committee, they are negotiating a pilot program that would remediate 150 to 300 homes in the Gulf Coast that were built with Knauf wallboard. Details of the program are still being hashed out, but Herman said it would also involve insurers and suppliers.

Herman said the issue of whether Knauf Gips in Germany will be held responsible for the problem hasn’t been resolved.

ProPublica research director Lisa Schwartz contributed to this report.

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