COFINA bondholders pursue case against MBIA and Ambac

The bond debts of the Puerto Rico Sales Tax Financing Corporation, better known as COFINA, were restructured in 2019 as part of the territory's Title III bankruptcy proceedings. But holders of COFINA bonds are pursuing a lawsuit against bond insurers MBIA (MBI) and Ambac that challenges how the insurers handled the 2019 restructuring, which wrote down billions of dollars in debt.

The defendants "unilaterally" replaced bondholders' "low risk, highly marketable insured bonds, for which plaintiffs were entitled to receive cash from defendants in the event of a default, with less valuable, riskier, and less marketable financial instruments that had varying yields," the bondholders said in their complaint.

Bondholders Dwight Jereczek and Stanley Elliott filed the suit in February against MBIA Inc. (MBI), Ambac Financial Group (AMBC), Ambac Assurance Corp., MBIA Insurance Corp. and National Public Finance Guarantee Corp. They are asking for the case to proceed as a class action case and for a jury to hear the case.

The suing bondholders said under the plan of adjustment they would be given the choice of either a "reduced, accelerated cash payout (which was less than the value they were entitled to under the [insurance] policies); or (ii) trust certificates for trusts that were less valuable than the insured bonds they originally purchased and worth less than the cash they should have contractually received."

The plaintiffs said the practices breached the insurers' irrevocable promises to make payments to the insured bondholders on time.

MBIA (MBI) and Ambac told the U.S. District Court for Connecticut, where the suit was filed, that the plaintiffs are wrong and made a variety of legal arguments in favor of either dismissing the case or transferring its venue to the United States District Court for Puerto Rico.

In May Ambac and MBIA (MBI) filed motions to dismiss the case and transfer the venue. Since then parties have filed replies and counter-replies and discovery has started but Judge Sarah Russell hasn't ruled on the insurers' dismissal or transfer motions.

In an amended complaint filed in early May the plaintiffs said the terms of the insurance contracts legally barred them from participating in the COFINA restructuring discussions that occurred in 2017 and 2018.

"The insurers knowingly structured the settlement to impair insured bondholders," the plaintiffs said. They acted in "bad faith."

The risks and obligations of MBIA Inc.'s (MBI) subsidiaries NPFG and MBIA Insurance were the responsibility of MBIA Inc. (MBI) and Ambac Assurance was the legal responsibility of Ambac Financial Group, Inc. (AMBC), the plaintiffs said.

The plaintiffs sued for breach of contract, unjust enrichment, bad faith refusal to pay first-party benefits under an insurance contract and, against Ambac, breach of implied covenant of good faith and fair dealing.

The plaintiffs seek damages "in an amount subject to proof at trial," pre-judgment and post-judgment interest on damages, and attorney and court costs. They are represented by Nation's Counsel PLLC based in Washington, D.C. and John Mudd, a Puerto Rico attorney.

The bond insurers said the plaintiffs have all the key facts and legal issues wrong.

Both MBIA (MBI), of which NPFG is a subsidiary, and Ambac Assurance Corp., which was recently sold, are in run-off, managing the remainder of their insurance portfolios. Ambac hasn't written new business since the global financial crisis; NPFG pulled the plug on new business in 2017.

MBIA (MBI) said the plaintiffs assert claims that "(i) have already been decided and cannot now be litigated, (ii) are brought against improper defendants (MBIA Inc. (MBI) and MBIA Insurance Corp.) and defendants over which this court lacks personal jurisdiction (MBIA Insurance Corp. and National), and (iii) are not legally viable."

The plaintiff's suit is "an improper collateral attack on the Title III Court's final and binding order confirming COFINA's plan of reorganization."

While its policies protected holders against nonpayment of principal or interest, they didn't protect holders against losses of prepayment premium, MBIA (MBI) said to the court. NPFG insured nearly $700 million in original principal.

The court-approved plan of adjustment gave NPFG-insured bondholders two options: first, to receive new Puerto Rico bonds plus cash payments from NPFG, which were projected to provide bondholders a 100% recovery; or they could keep their original insured rights through trust certificates, MBIA (MBI) told the court. After the plan went into effect, NPFG upheld these obligations, MBIA (MBI) said. The plaintiffs fail to say which option they chose to take.

In the bankruptcy proceedings leading up to the plan's enactment, the bondholders were fully apprised of the deal's terms and had the right to appear in the case, MBIA (MBI) said.

Finality to bankruptcy proceedings is a critical legal principle and the plaintiffs are trying to undo the COFINA restructuring, MBIA (MBI) told the court.

MBIA (MBI) argued the Connecticut court doesn't have jurisdiction over cases against it or Ambac. The actions took place in Puerto Rico and the companies have only a tenuous connection to Connecticut.

MBIA (MBI) argued that because the holders could elect an option to continue to get the same treatment as they would from the original COFINA bonds, they have no basis for a claim for a breach of contract.

MBIA (MBI) asked the court to dismiss the complaint. MBIA (MBI) is represented by Weil, Gotshal & Manges LLP attorneys in New York and Florida.

Ambac made similar arguments. Ambac quoted the COFINA confirmation order, where Judge Laura Taylor Swain said, "The treatment of Senior COFINA bond claims (Ambac) under the plan [of adjustment] is not inconsistent with the Ambac Insurance Policy."

Ambac, like MBIA (MBI), said if the Connecticut court thinks the case should continue, it should transfer to the bankruptcy proceedings stemming from the Puerto Rico Oversight, Management and Economic Stability Act, handled by Swain in the Puerto Rico District Court.

The COFINA plan explicitly said those bondholders who elected to take the commutation option of new bonds and cash from Ambac "shall be deemed to have released Ambac from its obligations," Ambac pointed out.

Because PROMESA says all cases related to the Puerto Rico bankruptcies must be transferred to the Puerto Rico District Court, the case must be transferred there, Ambac said. Ambac is being represented by a Finn Dixon & Herling LLP attorney in Connecticut and Milbank LLP attorneys in New York.

Ambac, insured $808 million in COFINA zero-coupon capital appreciation bonds, with the first payments due in 2046.

In the plaintiff's response to Ambac, they said, "this complaint is not about the actions of Puerto Rico. It focuses on the actions of defendants."

In response to Swain's confirmation-order-statement that those choosing the commutation option released Ambac, the plaintiffs said it "belittles the fact that Ambac, not plaintiffs, voted for the plan since they did not have the right as per the policy to do so." A Supreme Court ruling last year said a claim can't be extinguished without the consent of those affected.

"The complaint is not a collateral attack on the plan of adjustment," the plaintiffs said. "None of the causes of action presented in the complaint deal with the plan, but rather Ambac's duties and responsibilities towards plaintiffs as per the insurance contract."

The plaintiffs said Ambac conspired with Connecticut-based MBIA (MBI), which constitutes sufficient minimum contact to establish the Connecticut court's jurisdiction. Additionally, the proposed class of litigants will include Connecticut residents.

"Plaintiffs allege that defendants entered into contracts which obligated them to pay if certain events transpire," the plaintiffs said. "These events then indeed transpired[;] the defendants did not pay. Defendants ? failed to perform and plaintiffs suffered financial harm."

The case shouldn't be transferred to the Puerto Rico District Court because the case isn't about the plan of adjustment, the plaintiffs said.

In MBIA's (MBI) 10-Q quarterly financial report for the quarter ending June 30, it said other than the Title III bankruptcy proceedings in the Puerto Rico Electric Power Authority bankruptcy, "There are no material legal proceedings pending or, to the knowledge of the company, threatened, to which the company or any of its subsidiaries is a party." MBIA (MBI) didn't respond to a request for comment.

Ambac disclosed the case in a its 10-Q filing.

On Tuesday COFINA 5s of 2058 priced at 95.2 cents on the dollar, according to S&P Global Market Intelligence.