MARTINEZ, Calif. — Bad legal advice turned a straightforward refunding deal into an expensive mess, a California school district contends in the lawsuit it filed against Orrick, Herrington & Sutcliffe LLP, its bond counsel on the transaction.
The West Contra Costa Unified School District brought a $57.9 million general obligation refunding to market in September 2009 as part of a deal that also included $104.9 million of new-money GOs.
But the deal nearly came apart between the pricing and the closing after broker-dealer Kinsell, Newcomb & DeDios Inc. asserted its ownership of the redemption rights to bonds being refunded. KND bought those optional redemption rights from the school district in 2002, the school district said in its complaint against attorney John Hartenstein of Orrick and Orrick, filed in Contra Costa County Superior Court.
KND went to court seeking a restraining order to block the refunding deal from closing.
"The district's attempt to 'redeem' the bonds is no more enforceable than the proverbial efforts to 'sell' the Brooklyn Bridge by those who did not own it," KND's attorney Mark Sgarlata wrote in a letter to Hartenstein. The letter was attached to KND's request to block the closing of the bond transaction, which was filed Sept. 11, 2009, the Friday before the closing scheduled Monday, Sept. 14.
To prevent a restraining order from blocking the closing, the district agreed to buy the optional bond redemption rights back from the firm for $3.5 million. The district had received $550,000 from KND for the redemption rights in 2002.
It's a high price the district believes it would not have had to pay had it received better advice from Orrick, the nation's top-ranked bond counsel by volume, the district claims in the lawsuit. No trial date has been set for the lawsuit, which was filed in January 2010 in Contra Costa County Superior Court.
"We believe strongly in our position that Orrick lawyers performed in the best interest of the client, and the facts will prove that during the trial," Orrick spokesman David Schaefer said in an e-mail statement. "The firm stands behind its lawyers, and we intend to vigorously litigate this case."
KND probably did not intend to hold the bond redemption rights for seven years or longer when it bought them in 2002, said Sheri Gamba, the district's associate superintendent for business services.
"Based on the intent of the paperwork we looked at, it was the intent of KND to turn around and market those redemption rights immediately," said Gamba, who didn't work for the district when KND purchased the bond call rights from the district.
The West Contra Costa transaction appears to have been intended as one of a series of forward-delivery advance refunding deals KND did with small- to medium-size California school districts between 1993 and 2003, a technique that drew scrutiny from the Internal Revenue Service. The IRS contended the deals had problems with bond and escrow security pricing.
The IRS ultimately agreed to a 2008 settlement with KND, in which the firm agreed to pay $5 million to the IRS, and the IRS agreed to close 26 examinations covering about $800 million of debt without declaring any bonds taxable.
Jeffery Kinsell, the firm's executive vice president, was not available for comment either by telephone or e-mail.
In a 2007 interview with The Bond Buyer, Kinsell said the deals were structured to provide the districts with cash-flow savings even though the refundings did not provide present-value savings. He said the districts also benefited by receiving the proceeds from selling the bond call rights.
In its complaint, the district said there are solid legal grounds on which it could have argued that KND's purchase of the bond call rights was void from the outset under California law.
By following Orrick's advice, the district contends it was unable to pursue those arguments. Instead, it put the district in a position of having to comply with KND's demands in order to close the bond deal on schedule, or face potentially serious legal consequences for botching the refunding.
"Had defendants advised the district of the impact of the Kinsell purchase contract on the 2009 refunding bonds transaction, the district could have sought the necessary declaratory relief to assure itself and potential future investors in the district's 2009 refunding bonds that the Kinsell purchase contract had no impact on the district's ability to proceed with a refunding of the prior bonds," the complaint noted.
KND had been in contact with the district to discuss its redemption rights in February and March 2009, and West Contra Costa officials made Orrick aware of those discussions, according to the complaint. Despite that knowledge, the district said Orrick allowed the refunding deal to move beyond a point of no return, forcing the district to pay a high price to KND so the deal could close after the pricing.
"Not having been made aware of the impact of the Kinsell purchase contract until after issuance of the 2009 refunding bonds and on the eve of the payoff of the prior bonds, the district was forced to buy back the Kinsell purchase contract so as to permit the completion of the 2009 refunding bonds transaction," the complaint said.
The school district — struggling with a tight budget — had to fund the payment to KND out of its general fund, Gamba said.
"It's always difficult to have to make those kinds of payments," she said.