SAN FRANCISCO — A California community college district is suing JPMorgan over the firm’s alleged effort to enforce a contract resembling the “cash-out” bond refundings deemed illegal by the state attorney general several years ago.
The Peralta Community College District said it filed the suit after the firm asked the district to reissue bonds at a higher-than-market rate to comply with a contract made in 2006 with Bear Stearns, which was absorbed by JPMorgan in 2008.
“We are asking the court to block J.P. Morgan Chase’s effort to create profit for the bank at the expense of taxpayers,” the Oakland-based district said in a statement.
The district said the “forward bond purchase contract” with Bear Stearns is invalid because in 2009, California’s then-attorney general, Jerry Brown, issued an opinion calling cash-out refundings illegal according to the state constitution because additional principal they generated amounted to new general obligation debt, something that would require voter approval.
JPMorgan declined to comment on the lawsuit.
The lawsuit said JPMorgan told the district it expects to make $3 million to $4 million on the transaction. Bear Stearns paid Peralta $550,000 up front in 2006 to enter into the deal, according to the lawsuit, which was filed Monday in Alameda County Superior Court.
Past cash-out refunding deals in California mainly involved school districts. Schools would sell bonds at a premium above par value by offering higher-than-market interest rates to refund GO debt that was originally issued when interest rates were higher.
By offering higher than market rates, which were lower than the rates on their outstanding debts, districts garnered extra proceeds without exceeding the par amount approved by voters.
The technique required districts to maintain the property tax rate that supported the original bond, whereas a pure economic refunding would allow the tax rate to be lowered.
Following Brown’s decision, cash-out refundings dried up.
“It had a chilling effect,” said Robyn Helmlinger, an attorney with Squire Sanders specializing in municipal finance, about Brown’s opinion. “I think they have pretty much gone away.”
However, deals completed before Brown’s opinion remained legal obligations of the school districts because none were challenged during the 60-day validation period in state law.
Since Peralta’s arrangement is tied to a contract, rather than a bond deal, and many of the bonds have already been refunded, the situation appears to be less cut and dried.
When Peralta entered into the forward bond purchase contract with Bear Stearns, the suit said, the district agreed to give Bear Stearns the ability to call for a cash-out refunding on $25.8 million of outstanding GOs issued in 2002 that were subject to redemption. The district would then issue new, noncallable bonds with the same maturities and interest rates as the refunded bonds and sell them to Bear Stearns for the same price.
After Brown’s opinion and the demise of Bear Stearns, the district in late 2009 refunded the bonds, except for $8 million of 2032 maturity bonds, without taking any cash out, allowing for lower tax rates, the lawsuit said.
In June, JPMorgan asked the district to issue new bonds to replace the 2032 bonds at interest rates in the forward bond purchase contract, which are much higher than current rates, according to the court document. JPMorgan also asked Peralta to make up for the bonds refunded in 2009 by refunding other outstanding bonds and then reissuing them at interest rates higher than the current market, according to the lawsuit.
The district has asked the court to void the contract because it would force them into a deal similar to a cash-out refunding that would be just as unconstitutional.
A court date has yet to be set for the suit.