Court OKs University's Case Against JPMorgan

WASHINGTON - Mercer University in Macon, Ga., can continue to sue JPMorgan & Chase Co. to recover the $500,000 it paid to settle Internal Revenue Service yield-burning allegations over $48.4 million of 1991 revenue refunding bonds, a federal court ruled last week.

In a March 26 decision, the U.S. District Court for the Middle District of Georgia in Macon denied the bank's request for dismissal, setting the stage for the two sides to begin trading information in advance of a possible jury trial.

JPMorgan cannot appeal the court's denial of the motion, but has a week to respond to the decision, according to Robert C. Norman Jr., an attorney with Jones, Cork & Miller LLP who is representing the university.

The university alleges in its complaint that Banc One Capital Corp., which merged with JPMorgan in July 2004, engaged in yield-burning, forcing it to pay the IRS under a closing agreement to preserve the bonds' exempt status.

The transaction appears to be one of about a dozen, according to a tax law expert, where the issuer or borrower rather than a bank or broker-dealer settled yield-burning allegations with the IRS.

These transactions were not covered by a global settlement that federal agencies reached with 17 firms in 2000, under which the firms agreed to pay more than $138.3 million to resolve federal yield-burning allegations and compensate issuers for losses in connection with 3,603 advance refundings done for hundreds of state and local governments between 1990 and 1994. The transactions also were not among the roughly 400 additional deals settled between the IRS and about 30 broker-dealers in settlements reached after the large global one, according to sources.

That bonds issued nearly two decades ago are now embroiled in a courtroom battle has drawn the attention of some bond attorneys.

"From a bond counsel standpoint, the fact that those kinds of issues are being batted around 17 years after a deal was done might give them pause," said an attorney who did not want to be named.

The case revolves around $48.4 million of revenue refunding bonds that the Private Colleges and Universities Authority in Georgia issued for Mercer University in October 1991. The deal was underwritten by Wachovia Bank NA of Georgia. Banc One purchased $40 million of Treasury securities and sold them to the issuer for the advance refunding escrow.

The IRS began an audit of the transaction in March 2004 and, in October 2005, sent the issuer a preliminary adverse determination that the bonds were taxable because of yield-burning. The IRS claimed the Treasuries were excessively marked up and that the markups reduced or "burned" the investment yield so that it would not be below the bond yield and generate arbitrage for the issuer.

Fearing that the IRS would declare the bonds taxable, Mercer paid $500,000 to the government under a May 3, 2006 closing agreement with the agency to settle the yield burning allegations.

Mercer, which contended that Banc One had manipulated the price of the Treasuries and therefore caused the yield-burning, claims it asked JPMorgan, which had assumed Banc One's assets, to pursue a settlement with the IRS, but that the bank refused, forcing it to make the payment. According to Mercer, if the IRS had declared the bonds taxable, bondholders would have been exposed to federal income taxes in excess of $5 million.

On June 22 of last year, Mercer sued JPMorgan, seeking damages of at least $615,973 to cover the payment plus interest and legal expenses. The university claimed "equitable indemnity" and charged the bank with fraudulent misrepresentation and concealment.

The equitable indemnity claim stems from a Georgia law that states that a "person who is compelled to pay damages because of liability imputed to him as a result of a tort committed by another may maintain an action for indemnity against the person whose wrong has thus been imputed to him."

But JPMorgan filed a motion to dismiss the lawsuit on July 26, warning: "Left unchecked and extended to its extreme, litigants who are so inclined would be free to act like benevolent 'Robin Hoods,' settling prospective claims in advance of their ever being asserted and, in turn, seeking indemnity from whomever they deem liable."

The bank's statement seems to state the reason why it would spend potentially hundreds of thousands of dollars on legal fees fighting a university that is only seeking $600,000, a relatively small amount, from it.

In its motion, the bank argued among other things that Mercer was not "compelled" to pay $500,000 to settle the IRS' preliminary charges and that, as a result, the bank should not have to reimburse the university for the payment. The bank claimed Mercer should never have settled with the IRS until it received a proposed adverse determination, and that even then, it should have taken steps to fight the IRS charges.

Judge Hugh Lawson disagreed with the bank on all counts. A compulsion to settle does not rely on a formal demand, but rather "turns on whether [the] settlement was made in response to the assertion of a valid legal claim to which the [university] did not have a legal defense," he said in the order. Lawson found the university had the right to settle with the IRS.

The judge said in his ruling that if the court accepted the bank's argument, all future plaintiffs "would be faced with the onerous task of pleading facts that negate the existence of every possible legal defense it may have had to predicate claim."

JPMorgan argued on the one hand, that the IRS' "highly flawed" preliminary determination that the bonds were taxable could have been successfully challenged, and on the other hand, that Mercer should have recognized any fraud that occurred.

The bank said that under the federal tax law a bona fide bidding process for escrow securities, in which at least three arms-length bids are obtained, "presumptively establishes [the] fair market value for those securities." In this case, it said, Arter Hadden Haynes & Miller collected bids from four dealers and the bidder quoting the "lowest total price" was chosen to acquire the Treasuries.

"Additionally, in this case, the IRS was legally bound to accept the Arbitrage Certificate," the bank in its motion, under which the issuer said the bonds complied with arbitrage requirements.

JPMorgan also claimed that Mercer's failure to exercise appropriate diligence in examining the transaction for fraud should disqualify it from seeking recovery of the payment.

"Aside from the plaintiff's conclusory remark that it 'could not have reasonably discovered' the alleged fraud, which is insufficient ... the facts alleged in the complaint tell a different story," JPMorgan told the court.

The bank said that Mercer received written confirmation statements that disclosed the prices if the Treasuries, and that the IRS determined that yield-burning took place with the same information that was available to the university.

"Indeed, the confirmation statements and the New York Times 'quote prices' were all the information that the IRS needed (or, for that matter, had) to reach the initial view expressed in its preliminary letter," JPMorgan said, noting, "that information was available to all the parties equally in 1991 and was obviously sufficient to 'discover' the alleged fraud," the motion stated.

But the court said that this is a matter for a jury to decide. "The issue of a plaintiff's reasonable diligence in discovering the alleged fraud is a question of fact for the jury," the order stated.

JPMorgan also contended that the claim exceeded the statute of limitations for such cases. The bonds were retired in 1995, and normally tax claims must be made within three tax years after retirement. However, the court sided with Mercer, which said that the fraud perpetrated hid the existence of the claim until recently.

Norman said that the university had hoped to reach an agreement with JPMorgan before heading to court.

"We've attempted to resolve it short of filing a legal complaint in court, and [JPMorgan hasn't] really told us anything other than by the motion they filed as their response to the complaint," he said Tuesday.

Officials with JPMorgan declined to comment on the case, as did their attorneys. Besides Wachovia, other firms involved in the transaction included King & Spalding LLP as bond counsel, Arter Hadden Haynes & Miller as special tax counsel, Alston & Bird LLP as counsel for the authority, Martin, Snow, Grant & Napier LLP as counsel for the university, and Kutak Rock LLP as underwriter's counsel.

 

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