BRADENTON, Fla. – An appellate court upended a long-running dispute between a Mississippi county and the insurer that wrapped a failed economic development district’s bonds.

The Fifth Circuit Court of Appeals last month overturned a lower court ruling that stemmed from Madison County and Assured Guaranty Corp.’s differing legal opinions over the interpretation of bond documents.

“The contribution agreement was pretty clear that the county’s obligation was limited and conditional,” said John Humphrey, head of the credit research at Gurtin Municipal Bond Management.
“The contribution agreement was pretty clear that the county’s obligation was limited and conditional,” said John Humphrey, head of the credit research at Gurtin Municipal Bond Management.

Since the initial lawsuit was filed in 2013, Madison County has maintained that its duty to backstop a shortfall in debt service owed by the failed Parkway East Public Improvement District only ran for two years if the district didn’t repay the funds.

The appellate court agreed with the county in handing down its 13-page reversal opinion May 31, in a decision that overturned a lower court ruling that favored Assured Guaranty.

“Because the plain language of the contribution agreement conditions the county’s advancement obligation on Parkway East’s performance of its obligations, we reverse and remand for further proceedings consistent with this opinion,” the Fifth Circuit Court of Appeals wrote

The appellate jurists concluded that the contribution agreement unambiguously conditions the county’s obligation to make bond payments on Parkway East’s performance of its covenants, which includes its promise to reimburse the county within two years.

“I think the appeals court was correct in its ruling on what the contract said,” said Copeland, Cook, Taylor & Bush Attorney Bobby Thompson, who represented Madison County.

No petitions for rehearing were filed, and the next step likely will be a status conference on any remaining issues to decide in the case, Thompson said.

The case is back before the U.S. District Court for the Southern District of Mississippi, where Radian Asset Assurance Inc. originally filed it. Radian was subsequently acquired by Assured Guaranty.

The legal dispute is a cautionary tale about the importance of credit analysis and identifying obligors with the ability to control their own destiny, according to John Humphrey, senior vice president and the head of credit research at Gurtin Municipal Bond Management.

“The contribution agreement was pretty clear that the county’s obligation was limited and conditional,” he told The Bond Buyer. “There is nothing wrong with that type of pledge, as long as you recognize it for what it is. I can only speak for us, but when we render a credit opinion, we do so without regard to the presence of insurance.”

Humphrey said the recent round of insurer watch lists and downgrades after the initial near collapse of the industry a decade ago, along with occasional attempts to litigate the contract, are reasons why Gurtin only purchases and holds bonds if the firm can see past insurance to the pledge being made by the obligor to the bondholder.

“A component of the ingrained inefficiency of the municipal market is that people may struggle to determine who is actually standing behind the payment of bonds,” he said in a June commentary about the Madison County-Assured lawsuit. “In this case, some investors may have incorrectly concluded that Madison County was actually standing behind the district’s debt in the same manner as its own debt.”

Gurtin does not believe that the county’s contribution agreement created a general obligation of the county, he said, but it appears to create an obligation.

Humphrey’s commentary pointed out that the nature of the county’s contribution as mentioned in the official statement for the bonds explicitly states that it does not constitute a general obligation.

The OS also includes language that there is no assurance or representation that the county will budget or appropriate funds to make payments under the agreement, he said.

Although some emphasis has been placed on whether the county is required to pay for the bonds beyond two years, Humphrey said Madison County’s case illustrates that when terms and conditions are not specified – or even when they are – “there remains the possibility for filling those blanks with what seems or feels right, rather than acknowledging a blind spot exists.”

“Our view is that a plain read of the contribution agreement shows that bondholders are in fact exposed to the underlying credit quality of the district, and whatever ‘lift’ the county provided in the contribution agreement was limited,” he said.

Madison County created the Parkway East Public Improvement District as an economic development project.

In 2005, the district issued $27.7 million of insured limited obligation special assessment bonds. An additional $3 million of privately placed, non-insured completion bonds were issued in 2008.

The commercial development for the 1,050-acre district never occurred as planned, resulting in a shortfall of assessment payments.

When the district could not pay debt service, Madison County made four contributions to the shortfall between October 2011 and September 2013.

The county stopped payments when the district failed to reimburse the county two years after the first payment was made. No reimbursement payments from the district have ever been made.

In its lawsuit, Assured Guaranty argued that the failure of the district to reimburse Madison County did not excuse the county from its obligation to make debt service contributions as long as the bonds were outstanding.

U.S. District Judge Carlton Reeves agreed with the insurer in an April 20, 2015 ruling.

“The amount of time the district has to reimburse the county is independent of the duration of the county’s duty to make bond payments,” Reeves wrote at the time.

The appeals court sided with Madison County, writing in last month’s ruling that Assured’s argument fell short with regard to the amortization approval certificate signed by the county at bond closing.

“While Assured is correct that the condition of satisfaction language in the certificate must only have related to the covenants Parkway East was able to perform before bond closing, an identical understanding cannot extend to the contribution agreement,” the May reversal opinion said.

None of the post-closing covenants in the contribution agreement could serve as conditions precedent to the county’s obligation to advance payments; otherwise Parkway East could sell land for taxes and not reimburse the county, and take other actions failing to redeem its bonds, and the county would still be required to advance bond payments, the appellate judges found.

On another point, the court said Assured contended that the certificate serves to estop the county from asserting that it is dissatisfied with Parkway East’s performance and suspending bond payments.

“Mississippi’s doctrine of quasi-estoppel precludes a party from asserting, to another’s disadvantage, a right inconsistent with a position it has previously taken,” the ruling said. “Assured’s quasi-estoppel argument is only compelling if the county signed the certificate intending to agree that it was satisfied with Parkway East’s performance of all its obligations under the contribution agreement, including those that Parkway East could not possibly have performed by bond closing.

“Because such an interpretation makes little sense, we hold that the county is not estopped from arguing that Parkway East’s performance was unsatisfactory and suspending bond payments,” the judges wrote.

Gurtin said the case is a reminder that investors need to know exactly what they own, regardless of who the issuer is or what public credit rating it carries.

When Parkway East’s 2005 bonds were issued, S&P Global Ratings assigned an A underlying rating based on the county’s backing.

“A read of S&P’s original report doesn’t describe the nature of the county’s obligation other than a non-specific linkage to the county,” he told The Bond Buyer. “If you simply looked at the rating and read the report…you might walk away thinking the county was backstopping the bonds in full.

“Credit analysis, as we see it, looks at who is making the pledge, what the nature of the pledge is, what circumstances would permit non-payment, and what remedies would be available in that situation,” he said. “Looking at a bond for the presence of insurance and seeing a vague connection to a parent government is not what we would consider fundamental credit analysis.”

S&P currently assigns a D underlying rating to the 2005 bonds as an unfulfilled moral obligation. Its insured rating is AA because of Assured Guaranty’s credit enhancement, which guarantees debt service payments for the life of the bonds.

Since May 2015, payment defaults on the 2005 and 2008 bonds have occurred five times, and the trustee has made five claims on insurance to complete payments on the 2005 bonds, according to a May 4 notice on the Municipal Securities Rulemaking Board’s EMMA filing system.

“Weak, moral obligation-like securities and poorly defined enhancement programs are much riskier than the market seems to believe if one looks at their ratings and how bonds often trade,” Humphrey said. “Madison County is not an isolated case of a weak, ambiguous security turning out to be riskier for investors than they likely imagined.”

Humphrey said other cases similar to Madison County include Rhode Island's near repudiation of 38 Studio bonds and Indiana’s School District Enhancement Program.

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