AVIV, Israel — A new lawsuit, a failed acquisition bid and the loss of its anchor Israeli Ministry of Defense operating partner are the latest complications confronting ImageSat International (ISI) and its Eros satellite program.

The latest lawsuit, by stakeholders led by Pegasus Capital Advisors, L.P., a New York-based equity investment firm, includes new allegations of conflicting interests, contractual breaches and corporate raiding of ISI by Israel Aerospace Industries (IAI) and Elbit Systems, major shareholders with controlling interest in the commercial satellite firm.

Unlike three pending lawsuits against ISI and majority shareholders, the newest complaint, filed Dec. 15 in U.S. Southern District Court of New York, is not directed at ISI, but IAI and Elbit directors on the ISI board.

In their eight-count, $1.7 billion complaint, plaintiffs – all U.S. investors who put up some 80 percent of the capital used to launch and sustain ISI – repeated earlier claims that IAI and Elbit “raided” the company of customers, cash and business potential in pursuit of competing commercial imaging ventures. But in new allegations, plaintiffs faulted IAI and Elbit representatives on the ISI board for foiling a serious opportunity to sell ISI, and recoup the $91 million that Pegasus and its associated American shareholders invested in the conflict-mired and steadily depreciating firm.

According to the complaint, plaintiffs had contractual rights to demand the sale of ISI once long-held plans for an initial public offering never materialized. Moreover, plaintiffs insisted IAI and Elbit were obligated “to use their best efforts” to pursue the sale of the company, whose value, sources say, has plummeted from some $400 million to $500 million in 2005 to today’s rough estimate of some $120 million.

Although the potential buyer was not identified in the 45-page complaint, both sides confirmed that the potential deal was with Churchill Ventures, a special purpose acquisition company that began negotiating with ISI in March 2008. By August 2008, plaintiffs claim general terms of the proposed sale were approved by the ISI Board.

But “far from using its best efforts, IAI did everything in its power to scuttle the proposed sale and in fact was ultimately responsible for ensuring that the transaction would not move forward,” plaintiffs alleged.

“At the eleventh hour of negotiations, IAI attempted to impose onerous and self-serving conditions upon the sale of [ISI] that had nothing to do with its rights as a shareholder,” plaintiffs claim.

Among the “onerous demands,” plaintiffs said IAI insisted that all ISI minority shareholders now suing the company and majority shareholders release it of some $5 billion in claims and cancel previous exclusivity and first-right agreements between IAI and ISI or its shareholders.

Churchill terminated negotiations with ISI in November and announced, in a Nov. 21 suspension notification, that it would begin the process of liquidating and distributing trust fund proceeds to shareholders. Churchill Chief Executive Christopher Bogart said company founders, rather than investors, would incur losses from the suspension, but that it was “the right thing to do rather than bringing a questionable transaction to the market.”

Although the Churchill announcement never mentioned ISI by name, Bogart confirmed that the Israeli firm was the target of the special acquisition effort. He declined to discuss the matter further, insisting he was bound by nondisclosure agreements with IAI and Elbit.

Lost Anchor Customer

Yet another revelation contained in the new lawsuit – and subsequently confirmed by Israeli defense and industry officials – is the Israeli defense ministry’s decision to terminate its so-called satellite operating partner agreement with ISI. According to the complaint, loss of the Israeli Ministry of Defense (IMOD) as an anchor customer “threatens to harm the Company because, among other things, the Company has touted its significant relationship with the IMOD as a major selling point to other potential customers.”

Moreover, plaintiffs contend that loss of the Ministry of Defense commitment to Eros B allows IAI to operate ministry satellites “in direct competition with ImageSat and in direct contravention of IAI’s and the IMOD’s explicit non-compete and first-right commitments to ImageSat’s investors.”

An Israeli Ministry of Defense spokesman declined to comment on the matter, insisting it is not involved in ongoing litigation. Nevertheless, an Israeli government official confirmed that the defense ministry’s satellite operating partner contract which expired Dec. 31 would be replaced with a “barter-type arrangement.”

Although the government source refused to specify, others here and in the United States said the estimated $10 million annual satellite operating partner deal is being exchanged for a modest arrangement under which the defense ministry will purchase a single orbiting pass per week for an estimated $200,000 per year.

“The bottom line is that IAI is now selling [satellite operating partner] programs and satellite services from what are really [defense ministry] satellites – the TecSAR and Ofeq – in direct competition with ImageSat,” said Steve Wilson, a founding director and minority shareholder in ISI who is leading two outstanding lawsuits against the firm and its majority shareholders.

Wilson and plaintiffs in the latest lawsuit maintain ISI has rights to all commercialization activities associated with IAI-developed imaging satellites, including the defense ministry’s newest TecSAR synthetic aperture radar spacecraft. “Having utilized ImageSat’s cash to enhance their own earth observation commercialization strategy and to further develop their satellite technology, IAI and Elbit now are in the final stages of improperly appropriating ImageSat’s commercial earth observation satellite business,” noted plaintiffs in the Dec. 15 complaint.

Today, said Wilson, ISI has no approved plans for a third satellite and is rapidly losing market value and potential business due to “self-serving manipulations, primarily on the part of IAI, but with active support of Elbit and the IMOD.”

Meanwhile, in light of the latest lawsuit and other pending litigation, Elbit announced Dec. 30 it had struck a deal with IAI holding the state-owned firm responsible “for any losses arising out of any of the foregoing claims or legal proceedings.”

In its announcement of the indemnification agreement, Elbit said it “believes there is no merit or basis to the allegations.” Nevertheless, parties in the disputes said they had been discussing the possibility of dropping claims against Elbit in exchange for its cooperation in ongoing cases against IAI.

“Our interpretation [of the IAI-Elbit indemnification agreement] is that it is a movement to solidify their control of the [ISI] board and to ensure there are no cracks in their positions,” said Steve Baldini, a lead attorney representing plaintiffs in the latest case.

In an interview last week, Baldini said his team invested tremendous efforts for more than a year to resolve outstanding issues with IAI and Elbit representatives on the ISI board. Baldini said his clients in the case filed Dec. 15 include leading U.S. financial institutions and state pension funds representing tens of thousands of U.S. taxpayers.

“Our cardinal interest was getting [ISI] to become a functioning, strong, and dynamic company, which is impossible under the way it’s being run. Frankly, we only filed this complaint when we reached a point where we couldn’t – through other means – change the manner in which the company is being manipulated by majority shareholders and appointees on the board,” he said.

Shimon Eckhaus, chief executive of ISI, was unavailable for comment and IAI declined to respond to circumstances surrounding the scuttled Churchill acquisition or the latest court case.

IAI’s policy is to litigate in court and not in the press … IAI will address each allegation, including those related to the Churchill transaction, at the appropriate time. IAI continues to believe that ImageSat could be a successful company, and would have preferred that Pegasus focused on this goal rather than on a wasteful and misguided lawsuit,” said DoronSuslik, deputy corporate vice president for communications.