WASHINGTON — An investor holding bonds wrapped with insurance from ACA Financial Guaranty Corp. has filed a lawsuit against the moribund insurer, which says it is no longer obligated to pay insurance claims related to the bonds following the issuer’s Chapter 9 restructuring agreement.
The bonds were issued by the Connector 2000 Association, a beleaguered toll road in South Carolina that filed for bankruptcy last year and exited Chapter 9 bankruptcy on April 1.
The ACA-wrapped bonds, which include six series of zero-coupon bonds and one fixed-rate series totaling $51.7 million in face value, were originally insured on the secondary market on June 8, 2001, according to the suit.
James E. Davis of Mississippi filed the suit Friday in the Northern District of Mississippi Northern Division. Davis purchased $100,000 face value of the fixed-rate bonds for $32,900. According to Davis’ brokerage statement appended to the complaint, the bonds have a current value of one cent.
The suit seeks compensatory damages, punitive damages, attorneys fees, and costs. An attorney representing the plaintiff said he is seeking class action status for the suit.
As part of the Connector’s restructuring plan, which reduced the toll road’s outstanding debt to $148 million from $329 million, bondholders were issued new bonds. No bond documents or ratings were needed for the bond exchange.
As a result of the restructuring, “the bonds were exchanged for new obligations of the issuer and were effectively cancelled,” ACA wrote in a letter to bondholders on July 7. “As a result, the bonds are no longer enforceable obligations, and as such, neither is the guaranty obligation originally provided by ACA under the policy.” The letter was included in the complaint.
“Because the original guaranty issued by ACA in connection with the bonds under the policy was not extended under the plan or otherwise to the new obligations, ACA has no further liability or obligation under the policy,” the letter said.
ACA made debt service payments on July 1, 2010, and Jan. 1, 2011, following the Connector bankruptcy filing and before the exchange.
“We pay premiums to purchase insurance so that we can have the peace of mind that, in the event the unexpected occurs, we will not suffer a devastating loss,” said Jesse Mitchell, an attorney with McCraney Montagnet & Quin PLLC who is representing Davis.
A spokesman for ACA wouldn’t comment beyond saying that the insurer — which before the financial crisis was rated in the A category — is continuing to make payments on all its other policies.
The suit argues that “ACA breached the implied covenant of good faith and fair dealing when it inexcusably refused to pay the amounts due for payment under the policies and when it clearly stated that is has no further liability or obligation under the policies ACA’s actions deprived the plaintiffs of the fruits of their agreement with ACA under the policies.”
By saying it is no longer obligated to pay the insurance, ACA’s “conduct is grossly unreasonable,” the suit says.
Zero-coupon bonds typically are bonds sold at a discount that don’t pay interest until maturity. They accrete interest at a rate determined at issuance.
Roughly $134 million of the $200.2 million issued for the connector in 1998 were zero-coupon bonds. Of the $200.2 million, $66.2 million were Series A current interest bonds and $87.4 million were Series B senior zero-coupon bonds. The remaining $46.59 million were Series C subordinate zero-coupon bonds.
ACA, which originally stood for American Capital Access, was launched in 1997 as a single-A rated insurer willing to enhance lower-rated credits traditionally shunned by the triple-A rated credit enhancers. It lost its investment-grade rating after backing billions of dollars worth of exotic products related to mortgages. The insurer is domiciled in Maryland.