Reference no: EM131779979

Case - Danle Corporation

Danle Corporation ("Danle"), a public company, conducts business activities primarily related to the design, development, manufacture, and assembly of passenger cars, recreational and sport-utility vehicles, minivans, and trucks. Over the past three years, two claims were filed against Danle by automotive mechanics and surviving family members seeking recovery because of their alleged exposure to asbestos. Danle used asbestos in the manufacturing of brake shoes and gaskets because of its heat resistance.

The following information summarizes Danle's exposure to the two asbestos claims over the past three years. The amount of damages sought in the complaints is considered material to the Danle's financial statements for each period presented. Fiscal Year 2004

In November 2004, Danle was served a complaint in the U.S. District Court alleging that 50 mechanics suffered severe illnesses that led to death or disability as a result of exposure to asbestos from parts manufactured by Danle. The case was brought against Danle as a class-action lawsuit seeking damages totaling approximately $100 million. Danle did not believe the asbestos used in the manufacturing of the brake shoes and gaskets led to the mechanics' illnesses and immediately retained external legal counsel to vigorously defend the claim made against Danle in this complaint. Since this legal matter was in its early stages of discovery and development, Danle determined that the risk of potential loss at that time was remote and no amount of potential damages could be reasonably estimated. Therefore, Danle made no disclosure of the legal matter in its Form 10-K for the year ended December 31, 2004.

Fiscal Year 2005

In October 2005, Danle was served a second complaint alleging an additional 100 mechanics suffered severe illnesses because of exposure to asbestos from Danle's automobile parts. This matter was also filed as a class-action lawsuit seeking damages from Danle totaling approximately $250 million.

The first class-action lawsuit remained in the discovery phase for this entire fiscal year.

In December 2005, evidence was discovered by Danle's external counsel relating to the two lawsuits that led counsel to believe that Danle could potentially, but not probably, be liable for a percentage of recovery sought by the claimants in those matters. External counsel could not estimate the exact percentage of Danle's potential exposure, but believed, on the basis of historical precedence, that the amount of potential loss was less than 50 percent of the amount claimed.

Historical precedence exists related to two similar asbestos lawsuits with claims made against automotive manufacturers that were litigated within the past five years. One of the lawsuits was settled by judgment in court in favor of the mechanics and surviving family members. This lawsuit resulted in the automotive manufacturer remitting payments to the plaintiffs equal to 70 percent of the amount claimed. The other lawsuit was dismissed in court with judgment made in favor of the automotive manufacturer. In this case, the automotive manufacturer made no claim payments to the plaintiffs. The plaintiffs appealed the court's final decision, but the court denied the plaintiff's appeal. After further assessment of the evidence discovered in Danle's two lawsuits, management did not believe that it was probable a loss would occur and could not reasonably estimate an exact amount of the risk of potential loss as a result of the two lawsuits; therefore, it determined that no disclosure of the matters was necessary in its Form 10-K for the year ended December 31, 2005.

First Quarter 2006

No significant developments occurred in the discovery related to the two lawsuits during the three-month period ended March 31, 2006; however, as a result of additional analysis and better information, Danle disclosed the following information in the notes to its consolidated financial statements in Form 10-Q for the quarter ended March 31, 2006.

Note 8 - Litigation

Over the past two years, two class-action lawsuits have been filed against Danle by automotive mechanics seeking recovery. The lawsuits allege that the mechanics suffered severe illnesses as a result of exposure to asbestos that was used by Danle in the manufacturing of brake shoes and gaskets. The lawsuits are seeking compensatory and punitive damages. Because it does not believe the asbestos used in the manufacturing of the brake shoes and gaskets led to the mechanics' illnesses, Danle has retained external legal counsel to vigorously defend the claims made against Danle in the lawsuits. Danle estimates the range of possible loss to be approximately $50 million to $350 million. The recorded reserve balance for these proceedings and exposures as of March 31, 2006, and December 31, 2005, was approximately $50 million and $0, respectively. These reserves represent management's best estimate of the probable loss, as defined by ASC 450-20, Contingencies: Loss Contingencies (FASB Statement No. 5, Accounting for Contingencies).

Second and Third Quarter 2006

No changes in the facts.

Year End 2006

On the basis of developments in the two lawsuits during the year, Danle disclosed the following information within the notes to its consolidated financial statements in Form 10-K for the year ended December 31, 2006.

Note 8 - Litigation

Over the past two years, two class-action lawsuits have been filed against Danle by automotive mechanics seeking recovery. The lawsuits allege that the mechanics suffered severe illnesses as a result of exposure to asbestos that was used by Danle in the manufacturing of brake shoes and gaskets. The lawsuits are seeking compensatory and punitive damages. Because it does not believe the asbestos used in the manufacturing of the brake shoes and gaskets led to the mechanics' illnesses, Danle has retained external legal counsel to vigorously defend the claims made against it in the lawsuits. Danle estimates the range of possible loss to be approximately $200 million to $350 million. The recorded reserve balance for these proceedings and exposures as of December 31, 2006, and December 31, 2005, was approximately $200 million and $0, respectively.

These reserves represent management's best estimate of the probable loss, as defined by ASC 450-20, Contingencies: Loss Contingencies (FASB Statement No. 5, Accounting for Contingencies).

Required:

• Discuss whether you believe the conclusion reached by Danle to omit disclosure relating to the class-action litigation was appropriate for the year ended December 31, 2005.
• If Danle's Form 10-Q for the quarter ended March 31, 2006, were to be reviewed by the Division of Corporation Finance of the SEC, what comments may Danle expect to receive regarding its disclosure in that period? Discuss the basis for the comments you have identified.
• If Danle's Form 10-K for the year ended December 31, 2006, were to be reviewed by the Division of Corporation Finance of the SEC, what comments may Danle expect to receive regarding its disclosure in that period? Discuss the basis for the comments you have identified.