BRADENTON, Fla. — Emmet & Co. and First Manhattan Co. have filed suit against Catholic Health East and Merrill Lynch claiming that $132.26 million of escrowed bonds issued by conduit entities in three states were improperly called.
CHE in March gave bondholders a choice: accept a tender offer at 101 or submit to mandatory redemption at par. Those who accepted the tender offer had to agree to a waiver giving up certain rights, and were told that tendered bonds would remain outstanding.
The bonds, issued by conduits in Pennsylvania, Georgia and Florida, were escrowed to call. The dispute is not about the fact that the bonds were called.
The procedure to take out the bonds violated the indenture, which required redemptions of less than all of the bonds in a single maturity to be performed "by lot" or random selection, according to New Jersey-based Emmet & Co. president Christopher Emmet, who said about half his broker-dealer business specializes in escrowed bonds.
Emmet held $460,000 of the bonds called by CHE. First Manhattan, an investment management firm in New York, held $19.73 million of the CHE bonds.
"If they would have just called the bonds we wouldn't object," Emmet said. "We're just objecting to the method that they called the bonds."
Emmet claimed that about 70% of the bonds were tendered, and remain outstanding, while the rest of the bonds were subject to redemption.
"In my opinion, it was a very devious transaction and pretty clear cut," he said. "We believe it's an illegal call."
Catholic Health East does not comment on pending litigation, said its attorney, Richard Schwed, a partner at Shearman & Sterling LLP.
In notices to bondholders, the multi-state health care provider said the bonds were called or tendered to restructure its financings and save money.
The bonds subject to the dual-call procedure by CHE consisted of $65.93 million issued by the Allegheny County Hospital Development Authority in Pittsburgh for Mercy Health System Inc. in 1996; $33.44 million issued by Tampa, Fla., on behalf of the Allegany Health System for St. Mary's Hospital Inc. in 1993; and $32.99 million issued by the Fulco Hospital Authority in Georgia on behalf of Saint Joseph's Hospital of Atlanta.
On March 28, CHE gave notice to the escrow agent and trustee — Bank of New York Mellon — that it intended to restructure the bonds and redeem them at par, or 100. On March 29, CHE announced its tender offer for a 1% premium along with notices of the redemption call for all of the bonds.
"We acted at the direction of Catholic Health and in accordance with the governing documents," BNY Mellon spokesman Kevin Heine said.
CHE was created in 1998 through the combination of three large systems and then issued debt to finance defeasance of its predecessors' bonds.
"Interest rates have declined significantly since the bonds were issued and we now have the opportunity to reduce our ongoing borrowing cost," the system said in a notice to bondholders.
CHE said it could save more money by repurchasing the bonds through a tender offer than calling them for redemption.
"These savings will support our efforts to keep health care services affordable," the notice said.
Hawkins Delafield & Wood LLP, which served as bond counsel on the transactions, provided CHE with an opinion stating that the dual-call procedure was permitted under the indenture and the escrow agreement.
CHE, in court documents, said that it did not intend to resell the tendered bonds on the open market as Emmet contends.
"It has entered into an agreement to sell the tendered bonds to Merrill Lynch at par as part of a 'total return swap' transaction," said a court statement filed by Randal Schultz, CHE's vice president of capital strategy and management.
Merrill Lynch, through parent Bank of America spokesman Bill Halldin, declined to comment.
"Nothing in the indenture or any other document provides that CHE cannot couple a redemption notice with a tender offer," CHE court documents said. "Moreover, the purpose of the 'by lot' provisions is satisfied by the … transaction because all current shareholders are treated equally. Every bondholder is being presented with the same offer."
The documents also state that "the argument that CHE must immediately redeem the bonds that are tendered in the tender offer (i.e. purchase its own bonds from itself) makes no sense."
Emmet said the waivers bondholders had to accept to tender their bonds were an attempt to circumvent the indentures. Those who tendered their bonds had to "waive any and all inconsistent provisions of the prior bonds" as a result of implementing the tender offer, according to call documents.
"By virtue of these waivers, CHE purports to exclude the tendered (but still outstanding) bonds from the requirement that partial redemption be performed 'by lot,' " Emmet's lawsuit says. "But a waiver of rights by less than all bondholders … is simply insufficient to exempt any bonds — whether tendered or not — from the requirement that partial redemptions be performed on a randomized basis, i.e, by lot."
The random selection of bonds "was put in place to protect all bondholders (including plaintiffs) from self-dealing redemptions that … seek to benefit only one class of bondholders to the detriment of other bondholders," the suit said.
Schultz's statement to the court said that "a tender offer allowing bondholders to opt out of redemption calls by tendering their bonds has occurred at least 50 times in the municipal bond markets. To my knowledge, no bondholder has challenged this procedure."
Emmet, in an interview, questioned Schultz's number, and said he's concerned that the dual-call scenario using escrowed bonds will be replicated. He said he only heard of one prior occasion where escrowed bonds were subjected to the joint tender and redemption call process.
"It's been done with non-escrowed bonds, quite often, which is not a problem because those deals can make tender offers," he said. "I've had conversations that lead me to believe that other investment firms on Wall Street are talking to other hospital systems."
Emmet said he wants his challenge adjudicated. "If the judge says you can do that, fine," he said. "If the judge says you can't do that, it won't be done any more."
Emmet's lawsuit is currently before the U.S. District Court for the Southern District of New York. CHE and Merrill Lynch attorneys have said they plan to file motions to dismiss the case. Emmet's attorney plans to file a motion for summary judgment on their claim for breach of contract against CHE.