JPMorgan Files Counterclaim in Alabama School Swaption Case

BRADENTON, Fla. - JPMorgan has filed a counterclaim for $122 million plus expenses and legal fees in the federal case brought by the Alabama Public School and College Authority, which is seeking to void a swap option it entered with the investment banking firm.

The APSCA last October sought a declaratory judgment as to whether a swaption it entered in 2002, and amended in 2003, was a legal hedging agreement 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. The case originally surrounded a single swaption, but now has grown to include four swaptions that JPMorgan has now terminated.

The firm said last Thursday when it filed the counterclaim that the swaptions were entered into for hedging purposes, that New York State law governs the interpretation of them, and that the APSCA has defaulted on them.

"JPMorgan's answer was filed recently as required by the court's schedule for this case, along with its anticipated counterclaim for the termination value of the swaptions," Alabama's acting finance director, Bill Newton, said in an e-mail. "The case is proceeding as we expected."

The case centers around four swap transactions giving JPMorgan the options to enter into future interest rate swaps. The parties first entered into the agreements on March 13, 2002. They were based on 70% of the London Interbank Offered Rate, and the authority received an up-front payment of $11.3 million.

In January 2003, the four agreements were amended to revise the floating-rate option to 67% of Libor and to provide the APSCA with an additional up-front payment of $1.3 million.

JPMorgan exercised its first option on one of the swap agreements in June 2008, which would have required the authority to issue variable-rate refunding bonds by Nov. 1.

Besides an unstable and unfavorable bond market at the time, lawyers for the authority determined that the swaption agreement was not "normal," state officials said when the suit was filed in October.

It claimed that APSCA could realize virtually no savings from entering the swap partly because of the nontraditional way the exchange of payments was structured. The complaint also alleged that the swaption was not documented in accordance with Alabama law.

JPMorgan denied the claims in the court papers filed last Thursday. And in the counterclaim, the firm outlined subsequent events of default that began when the bank and the authority were to start exchanging payments in May of this year.

"Since this action was commenced, APSCA has defaulted on its obligations under the swaption transaction that is the subject of its complaint and three similar swaption transactions entered into with JPMorgan," the investment bank said. "APSCA has defaulted on its obligations ... by failing to make scheduled payments in accordance with the terms of the agreement between the parties."

JPMorgan said it tried but was unable to verify wiring instructions to transmit its swap payment to the authority, which failed to make its first payment of $17.66 million to JPMorgan.

The firm said it received a letter on March 24 from the authority stating: "Because APSCA has challenged the validity of and enforceability of [the first swaption], it does not intend to accept any payments from JPMorgan Chase while the case remains pending."

JPMorgan said the default gave it the right to proceed with early termination of the swap agreements for a fee of $122 million plus interest, legal fees, and expenses.

U.S. District Judge Keith Watkins recently ordered the authority and JPMorgan to conduct settlement negotiations and to consider mediation. If those fail, Watkins said he would begin a trial in Montgomery, Ala., on Oct. 4, 2010.

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