Bond insurer Ambac Assurance Corp. remains at risk after the Internal Revenue Service filed an amended complaint last week to retrieve more than $700 million of tax refunds.
Ambac’s rehabilitation plan, which would unfreeze $60 billion worth of toxic assets held in a walled-off account, was approved by local courts on Jan. 25. The plan could be severely impaired if the IRS wins, on appeal, the right to seize Ambac’s assets.
The IRS claims that Wisconsin-based Ambac Assurance — which had $313 million of cash in the middle of 2010 and whose parent is bankrupt — has obtained a “completely unprecedented” order from state courts that prevents the IRS from retrieving federal taxes.
“The state court lacked any jurisdiction, authority, or right to issue the Nov. 8 injunction,” lawyers for the IRS said to Wisconsin’s Western District Court on Feb. 11, referring to an order granting state courts exclusive jurisdiction over Ambac’s rehabilitation. “Those orders were and are null and void as a matter of federal law.”
The IRS is seeking to assess whether Ambac improperly received a tentative $708 million tax refund in 2008. If it finds the refund was improper, it could declare a “deficiency” and place a levy on the company’s liquid assets to satisfy the tax obligation.
Ambac’s regulator, the Wisconsin insurance commissioner, has demoted any potential tax claims to its walled-off account and obtained approval from state court to give it exclusive jurisdiction over the matter.
The IRS claims in its amended complaint that the Dane County, Wis., court violated the sovereign immunity of the United States by claiming such jurisdiction over Ambac’s federal tax liabilities.
It said the order violates the Anti-Injunction Act, which explicitly states that “no suit for the purposes of restraining the assessment or collection of any tax shall be maintained in any court by any person.”
The IRS said Wisconsin courts “substantially interfered” with internal revenue laws, causing “irreparable injury” to a $700 million tax liability “that may be rendered uncollectible except from the nonexistent assets of the segregated account.”
The risk for Ambac is that the massive tax claim could force the insurance commissioner to rehabilitate the entire company. That would trigger a default, forcing Ambac to pay the mark-to-market value of contracts, which were valued at $3 billion in October.
The IRS tried in January to move the Dane County case to federal court. It hoped to persuade the federal authorities that it has a right to collect owed taxes regardless of how the Wisconsin insurance commissioner restructured the company.
A federal hearing on Jan. 12 considered two items: the commissioner’s motion to remand the case back to state court, and the IRS’ motion to dissolve the order that gave state courts exclusive jurisdiction over the matter.
The federal court held that it lacked subject-matter jurisdiction over the rehabilitation proceeding.
It also said it lacked jurisdiction to decide the IRS’ motion to dissolve a ruling, which is prohibiting the agency from initiating a lawsuit against Ambac and preventing it from placing a lien on the insurer’s assets.
Unimpeded by the IRS claim, Ambac’s rehabilitation plan for its segregated account was accepted Jan. 25 by a Wisconsin state court.
The rehab plan calls for Ambac’s most toxic assets to receive 25% of their claims in cash and the rest in surplus notes bearing a 5.1% coupon and maturing in 2020.
The state court now has jurisdiction to dissolve the IRS’ claims. Ted Nickel, who was appointed Wisconsin’s insurance commissioner on Jan. 3, has asked Wisconsin courts to expedite those hearings.
The IRS called that request “nothing more than an attempt to forestall federal review by obtaining a ruling [in a friendly forum] that could arguably be treated as preclusive by the federal courts.”
It also claims the insurance commissioner earlier sought and obtained exclusive jurisdiction over the case without first notifying the IRS, so it had no opportunity to contest the action.
Once the second-biggest bond insurer and rated triple-A, Ambac ran into serious trouble in late 2007 because of decaying credit quality in its structured finance policies, which included contracts guaranteeing to cover losses on mortgage bonds and credit default swaps.
The company's parent, Ambac Financial Group, declared bankruptcy in November.
David Wallis, Ambac Financial’s chief executive, said Nov. 8 that if the IRS claims were allowed to proceed, it could “seriously jeopardize or completely destroy AFG’s reorganization prospects.”