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1998 Annual Report

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                            ITEM 3. LEGAL PROCEEDINGS
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LITIGATION
     Subsequent to an understanding reached in December 1998, SSCC and SNC
entered into a Settlement Agreement in January 1999 to implement a nation-wide
class action settlement of claims involving Cladwood'r', a composite wood siding
product manufactured by SNC that has been used primarily in the construction of
manufactured or mobile homes. The class action claimants allege that Cladwood'r'
siding on their homes prematurely failed. The settlement was reached in
connection with a class action pending in King County, WA and would also resolve
all other pending class actions. The Superior Court of Washington has
preliminarily approved this settlement and will hold a fairness hearing on the
settlement in May 1999. Pursuant to the settlement, SNC has agreed to pay $20
million into a settlement fund, plus up to approximately $6.5 million of
administrative costs, plaintiffs' attorneys' fees, and class representative
payments. The Company has established reserves that it believes will be adequate
to pay eligible claims; however, the number of claims, and the number of
potential claimants who choose not to participate in the settlement, could cause
the Company to re-evaluate whether the liabilities in connection with the
Cladwood'r' cases could exceed established reserves.
     In April 1998, a suit was filed against Stone in Los Angeles Superior Court
by Chesterfield Investments L.P. ("Chesterfield"), and D.P. Investments L.P.
("DPI"), alleging that Stone owes such parties approximately $120 million
relating to Stone's purchase of common stock of Stone Savannah River Pulp &
Paper Corporation ("SSR"). In 1991, Stone purchased the shares of common stock
of SSR held by Chesterfield and DPI for approximately $6 million plus a
contingent payment payable in March 1998 based upon the post-closing performance
of the operations of SSR from 1991 through 1997. Stone has concluded a
settlement of the case with DPI, which had a 30% interest in the contingent
payment. Chesterfield is continuing to pursue the case as to the remaining 70%
of the contingent payment. Stone disputes Chesterfield's calculation of the
contingent payment, and is vigorously defending the litigation. The case is
currently set for trial in the second quarter of 1999. Stone believes that
existing reserves will be adequate to cover the amount of any adverse judgement
in this matter.
     In May 1998, four putative class action complaints were filed against
Stone, JSC and the individual directors of Stone in the Delaware Court of
Chancery, which were consolidated into one action captioned as In Re Stone
Container Shareholders Litigation. The complaint alleged, among other things,
that the directors of Stone breached their fiduciary duties to Stone's
shareholders in connection with the Merger by failing to undertake an
appropriate evaluation of Stone's net worth as a merger/acquisition candidate,
actively evaluate the proposed transaction with the Company and engage in an
auction with third parties in an attempt to obtain the best value for Stone's
shareholders. In August 1998, the parties entered into a memorandum of
understanding setting forth the terms of the proposed settlement of the matter,
subject to certain conditions, including the plaintiffs' counsel conducting
confirmatory discovery and approval by the Court of Chancery. In addition, the
defendants have agreed not to oppose an application by plaintiff's counsel to
the Chancery Court for fees and expenses in an amount not to exceed $650,000,
which would be paid by Stone.
     In October 1998, two holders of Stone's Series E Cumulative Convertible
Exchangeable Preferred Stock (the "Series E Preferred") filed a complaint
against Stone in the Delaware Court of Chancery alleging that Stone violated its
Certificate of Incorporation by failing to call a meeting of Series E Preferred
stockholders for the purpose of electing two directors by those stockholders.
The plaintiffs also alleged that in connection with the Merger, Stone sought to
change the rights of the holders of Series E Preferred without a two-thirds
class vote of such stockholders and that such stockholders should have been
entitled to vote with respect to the Merger. The plaintiffs' request for a
preliminary injunction was denied by the Court in November 1998. A separate
complaint against Stone was filed by a Series E Preferred stockholder purporting
to constitute a class action on behalf of all Series E Preferred stockholders.
These actions have been consolidated and now also include SSCC as a defendant.
In March 1999, Stone entered into a stipulation of settlement (the "Stipulation") 
with the plaintiffs in furtherance of a prior memorandum of understanding to settle
these cases. As a result, Stone designated two named individuals to serve on the
Board of Directors of Stone, and agreed, among other things, to nominate and
solicit proxies for their election by the holders of Series E Preferred at Stone's
Annual Meetings of Stockholders for so long as the dividends on the Series E
Preferred are more than six quarters in arrears. In addition, the Stipulation
contains an agreement by Stone not to oppose an application by plaintiffs' counsel
for fees or expenses in an amount not to exceed $215,000, which would be paid by
Stone. This settlement is subject to court approval, and a hearing for such purpose
has been scheduled in May 1999.
     In June 1998, Stone, believing the allegations to be without merit and
without admitting liability, entered into a consent decree (the "Consent
Agreement") with the Federal Trade Commission (the "FTC"). In pertinent part,
the Consent Agreement requires Stone to cease and desist from "requesting,
suggesting, urging or advocating that any manufacturer or seller of linerboard
raise, fix, or stabilize prices or price levels..." and from "entering into, or
attempting to enter into...any agreement... to fix, raise, establish, maintain
or stabilize prices or price levels...". There are no monetary fines, sanctions
or damages imposed by the FTC in connection with the Consent Agreement; however,
Stone will be required to file certain reports on an annual basis with the FTC
to evidence its compliance with the Consent Agreement. By its terms the Consent
Agreement has also become applicable to SSCC and its other subsidiaries.
     In 1998, seven putative class action complaints were filed in the United
States District Court for the Northern District of Illinois and the United
States District Court for the Eastern District of Pennsylvania alleging that
Stone reached agreements in restraint of trade that affected the manufacture,
sale and pricing of corrugated products in violation of antitrust laws. Stone is
the only named defendant, although the suits allege that other unnamed firms
participated in the purported restraints of trade, and specifically allege, on
information and belief, that JSC also participated. The suits seek an
unspecified amount of damages arising out of the sale of corrugated products for
the period from October 1, 1993 through March 31, 1995. Under the provisions of
the applicable statutes, any award of actual damages could be trebled. The
Federal Multidistrict Litigation Panel has ordered all of the complaints to be
transferred to and consolidated in the United States District Court for the
Eastern District of Pennsylvania. Stone believes it has meritorious defenses and
intends to vigorously defend itself.
     Stone is a party to an Output Purchase Agreement (the "OPA") with Four M
Corporation ("Four M") and Florida Coast Paper Company, L.L.C. ("FCPC"), a joint
venture owned 50% by each of Stone and Four M. The OPA requires that Stone and
Four M each purchase one-half of the linerboard produced at FCPC's mill in Port
St. Joe, FL (the "FCPC Mill") at a minimum price sufficient to cover certain
obligations of FCPC. The OPA also requires Stone and Four M to use their best
efforts to cause the FCPC Mill to operate at a production rate not less than the
reported average capacity utilization of the U.S. linerboard industry. FCPC
indefinitely discontinued production at the FCPC Mill in August 1998. Certain
creditors of FCPC have alleged that Stone and Four M are in default with respect
to their obligations under the OPA. The amount of Stone's liability under the
OPA, if any, is uncertain at this point, although Stone believes that existing
reserves will be adequate to cover the amount of any adverse judgment in this
matter. The failure of Stone, Four M and FCPC to resolve the outstanding
indebtedness of FCPC and the obligations of Stone and Four M under the OPA in
the near future will likely result in litigation regarding the OPA and/or a
bankruptcy proceeding being commenced by or against FCPC.
     The Company is a defendant in a number of lawsuits and claims arising out
of the conduct of its business, including those related to environmental
matters. While the ultimate results of such suits or other proceedings against
the Company cannot be predicted with certainty, the management of the Company
believes that the resolution of these matters will not have a material adverse
effect on its consolidated financial condition or results of operations.
ENVIRONMENTAL MATTERS
     From 1995 to 1998, Federal and State of Oregon authorities conducted an
investigation of potential violations of the Clean Water Act by SNC at its Sweet
Home and Philomath, OR Cladwood'r' manufacturing facilities. In order to conclude
this matter, SNC pled guilty in November 1998 to a one-count felony violation of
the Clean Water Act. Under the terms of the plea agreement, SNC paid a $50,000
fine and paid $7,500 in restitution to each of the Oregon Department of
Environmental Quality and the Western States Project, and the United States
agreed not to bring further criminal charges against SNC for activities that have
been the subject of the investigation.
     In March 1999, management of SNC's Oregon City, OR newsprint mill became
aware of possible alterations by one of its employees of data utilized in
determining compliance with the mill's National Pollutant Discharge Elimination
System ("NPDES") permit. SNC conducted a thorough internal investigation of this
matter, and based on this investigation concluded that such alterations did
occur, and that as a result the mill violated its NPDES permit limits on
suspended solids on several occasions. SNC provided both the EPA and the Oregon
Department of Environmental Quality with a detailed report of its investigation
and it is probable that the agencies will conduct an additional investigation
based on this report. SNC intends to continue to fully cooperate with any such
investigation. While it is too early at this time to predict the potential
consequences of this matter to SNC, it is possible that SNC would be subject to
civil penalties and criminal charges.
     In October 1992, the Florida Department of Environmental Regulation,
predecessor to the Department of Environmental Protection ("DEP"), filed a civil
complaint in the Circuit Court of Bay County, FL against Stone seeking
injunctive relief, an unspecified amount of fines and civil penalties, and other
relief based on alleged groundwater contamination at Stone's Panama City, FL
mill. In addition, the complaint alleged operation of a solid waste facility
without a permit and discrepancies in hazardous waste shipping manifests. At the
parties' request, the case was stayed pending the conclusion of a related
administrative proceeding petitioned by Stone in June 1992 following DEP's
proposal to deny Stone a permit renewal to continue operating its wastewater
pretreatment facility at the mill site. The administrative proceeding was
referred to a hearing officer for an administrative hearing on the consolidated
issues of compliance with a prior consent order, denial of the permit renewal,
completion of a contamination assessment and denial of a sodium exemption. In
June 1998, DEP and Stone reached a settlement in principle pursuant to which DEP
will issue a full operating permit for the mills' wastewater pretreatment
facility and a compliance order requiring the installation and continued
operation of a hydrologic barrier system at two locations on the mill site's
perimeter. As part of the settlement, the parties have also agreed to a
stipulation dismissing the enforcement action with respect to the groundwater
contamination allegations.
     In January 1996, the United States of America filed a suit against Stone in
the United States District Court for the District of Montana seeking injunctive
relief and an unspecified amount in civil penalties based on the alleged failure
of Stone to comply with certain provisions of the Clean Air Act, its
implementing regulations, and the Montana State Implementation Plan at Stone's
Missoula, MT mill. The complaint specifically alleged that Stone exceeded the
20% opacity limitation for recovery boiler emissions; failed to properly set the
span on a recovery boiler continuous emissions monitor; and violated limitations
on venting of an air contaminant by improperly venting non-condensable gasses.
In May 1998, Stone, the United States Department of Justice, EPA and other
intervening parties entered into a consent decree settling this case. In
addition to, among other things, agreeing to certain emissions limitations and
monitoring and reporting requirements, Stone paid a civil penalty of $312,500.
     In September 1997, Stone received a Notice of Violation and a Compliance
Order from EPA alleging noncompliance with air emissions limitations for the
smelt dissolving tank at Stone's Hopewell, VA mill and for failure to comply
with New Source Performance Standards applicable to certain other equipment at
the mill. In cooperation with EPA, Stone responded to information requests,
conducted tests and took measures to ensure continued compliance with applicable
emission limits. In December 1997 and November 1998, Stone received additional
requests from EPA for information about past capital projects at the mill. Stone
is fully cooperating with these requests and has provided significant
information to EPA. EPA representatives have advised Stone that its requests are
part of a nationwide enforcement review of industry's compliance with its New
Source Review rules. The Clean Air Act authorizes EPA to assess a penalty of
$25,000 per day of each violation; however, no penalties have yet been assessed.
If EPA decides to commence an enforcement action to assess penalties in this
matter, Stone intends to vigorously contest such action.
     In April 1998, EPA issued a Notice of Violation ("NOV") to Stone alleging
violations of the particulate emission limits for the No. 6 boiler at Stone's
Coshocton, OH mill. In September 1998, EPA filed an administrative complaint
against Stone formalizing the allegations set forth in the NOV and seeking a
civil penalty in the amount of $102,400. Stone and EPA have settled the matter,
and the penalty in the final consent order was reduced to $68,500.
     Federal, state and local environmental requirements are a significant
factor in the Company's business. The Company employs processes in the
manufacture of pulp, paperboard and other products, which result in various
discharges, emissions, and wastes, and which are subject to numerous federal,
state and local environmental laws and regulations, including reporting and
disclosure obligations. The Company operates and expects to operate under
permits and similar authorizations from various governmental authorities that
regulate such discharges, emissions, and wastes.
     The Company also faces potential liability as a result of releases, or
threatened releases, of hazardous substances into the environment from various
sites owned and operated by third parties at which Company-generated wastes have
allegedly been deposited. Generators of hazardous substances sent to off-site
disposal locations at which environmental problems exist, as well as the owners
of those sites and certain other classes of persons (generally referred to as
"potentially responsible parties" or "PRPs"), are, in most instances, subject to
joint and several liability for response costs for the investigation and
remediation of such sites under the Comprehensive Environmental Response,
Compensation and Liability Act ("CERCLA") and analogous state laws, regardless
of fault or the lawfulness of the original disposal. The Company has received
notice that it is or may be a PRP at a number of federal and/or state sites
where response action may be required, and as a result may have joint and
several liability for cleanup costs at such sites. However, liability for CERCLA
sites is typically shared with other PRPs and costs are commonly allocated
according to relative amounts of waste deposited. Because the Company's relative
percentage of waste deposited at a majority of these sites is quite small,
management of the Company believes, based on current information, that its
probable liability under CERCLA and similar state laws, taken on a case by case
basis or in the aggregate, will not have a material adverse effect on its
financial condition or operations.
     In addition to participating in remediation of sites owned by third
parties, the Company has entered into consent orders for investigation and/or
remediation of certain Company-owned properties. The Company believes that its
potential liability for investigation or remediation for these sites, either
individually or in the aggregate, will not have a material adverse effect on its
financial condition or operations.
     Based on current information, the Company believes that the probable costs
of the potential environmental enforcement matters discussed above, response
costs under CERCLA and similar state laws, and remediation of owned property,
will not have a material adverse effect on the Company's financial condition or
results of operations. The Company believes that its liability for these matters
was adequately reserved at December 31, 1998.
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