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Judge Allows Bid to Void Swaption

BRADENTON, Fla. - Using an analogy between "fish and chips" and derivatives transactions to frame his decision, a federal judge weighing the Alabama Public School and College Authority's bid to void a swaption has finally issued his first ruling nine months after the case was filed.

U.S. District Judge W. Keith Watkins last week denied JPMorgan's motion to dismiss the case that was brought last October by the authority. The APSCA sought a declaratory judgment as to whether a swaption it entered in 2002, and amended in 2003, was legal under Alabama law. A swaption gives the bank counterparty purchasing it the option to require a bond issuer to enter into a swap at a future date.

"Fish and chips and derivative transactions: Each has been adopted by the United States from its English heritage," Watkins said in the opening of his distinctive ruling. "One is more appetizing than the other, but this opinion is not about fish and chips. It is about the Alabama Public School and College Authority's appetite for a bad taste of a derivative transaction."

Watkins said the arguments for and against dismissing the case created an "abundance of factual and legal chasms" making it unsuitable to resolve the issues on a motion to dismiss.

At the end of his 47-page analysis, Watkins concluded: "Whether the swaption is void, voidable, or a bad-but-binding deal bought into by the authority is a question not capable of resolution without development of the facts."

JPMorgan spokesman Brian Marchiony said the company declined to comment about the ruling.

Bill Newton, acting director of finance for the state, said in an e-mailed statement: "I am pleased with the court's recent decision. It will permit us to move forward with this case. The state's position has been that the declaratory judgment action was necessary to determine the validity of the original transaction. After the federal court rules on this case, the Public School and College Authority will abide by that ruling, whatever it may be, and will continue to honor its legal obligations."

On Monday, JPMorgan's attorneys filed a motion requesting 30 days, instead of 10, to file their answer to the original complaint, which had never been done because the motion to dismiss was pending for many months. On Tuesday, Watkins granted JPMorgan's request for an extension and ordered the firm's response to the suit to be filed by Aug. 21.

Watkins also ordered the authority and JPMorgan to confer and develop a proposed discovery plan. The case is expected to be set for trial in seven to 10 months.

Last October, the APSCA filed for a declaratory judgment in federal court seeking to void the swaption with JPMorgan, citing a number of reasons why the derivative agreement should be invalidated, including that it was not a legitimate hedging transaction under Alabama law.

The swaption agreement covered $300 million of Series 1998 revenue bonds, $18.4 million of Series 1999A bonds, $250 million of Series 1999C bonds, and $172.7 million of Series 1999D bonds.

In return for total payments of $12.58 million, the authority gave JPMorgan options to enter swap transactions on the bonds at various dates.

At the time, then-Alabama finance director Jim Main said the APSCA would abide by the judge's ruling in the case, which would either require the authority to pay a termination fee or return upfront payments it received from JPMorgan.

In mid-December, JPMorgan filed a motion seeking to have the case dismissed, saying Alabama's suit was "a baseless attempt by a public authority to escape its clear contractual commitments."

The APSCA complaint also alleged that the swaption was not documented or certified by-state officials in accordance with Alabama law.

Watkins, in his ruling last week, said it is troubling that state documents are not available for him to consider. "That allegation begs the question of why the authority has been unable to locate what it contends is the required documentation," Watkins said.

The unresolved case earlier this year caused problems for the APSCA as the May 1 date for it to begin making swap payments approached.

In late March, Standard & Poor's placed its AA rating on the APSCA's bonds on negative watch because of the potential for missing the swap payment. The date passed and no payments were made.

Moody's Investors Service rates the APSCA's bonds Aa2 and did not take any action in response to the missed payment, maintaining a stable outlook on the credit.

On April 29, Standard & Poor's removed the authority's rating from negative watch after receiving an opinion from the APSCA's counsel "to the effect that the authority did not grant or intend to grant, as security for swap payments, a lien on any revenue pledged as security for the bonds," Standard & Poor's analyst Sussan Corson said at the time.

Standard & Poor's did assign a negative outlook to the bonds to reflect continued uncertainty about the federal court case.

The APSCA in June failed to receive any competitive bids for a $284.8 million current refunding deal. And it only got one bid for a $39.6 million new-money piece that didn't meet bid parameters, financial advisers said.

Some market participants said it was a difficult market the day of the sale and they were under the impression that Standard & Poor's still had the APSCA on negative watch for a downgrade due to the pending federal lawsuit.

The deal has not been brought back to market.

JPMorgan notified the authority that May 13 would be the early termination date for all of the swaptions and calculated the termination fee at $122 million, according to bond documents for the failed sale.



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