SAN FRANCISCO (Reuters) - A California community college district is suing JP Morgan Chase (JPM.N) over the bank’s efforts to enforce an exotic financing contract agreed in 2006 when interest rates were much higher than now.
Peralta Community College District filed suit in state court on Monday, asking the court to declare the 2006 contract void and unenforceable, according to the suit, which estimated the contract is now worth between $3 million and $4 million.
JP Morgan declined to comment on the suit.
“JP Morgan Chase’s plan would wrongly shift savings from interest rate declines away from taxpayers and to JP Morgan’s bottom line,” said a spokesman for the community college district, located in the San Francisco Bay Area.”
The dispute centers around a type of refinancing known as a “cash-out refunding,” when a bond issuer raises enough new cash to retire outstanding bonds, plus extra funds.
In this case, PCCD arranged a transaction connected to a 2002 bond issue. It worked with Bear Stearns, which was later bought by JP Morgan.
As part of PCCD’s financing deal, it agreed to give Bear Stearns an option that would allow Bear Stearns to require PCCD to issue new debt to replace its 2002 bonds. The bank, not the college, would benefit from any drop in interest rates.
Bear Stearns paid $550,000 for the option, according to the suit.
JP Morgan, acting as the successor to Bear Stearns, notified PCCD on June 13, 2012, that it planned to exercise its option.
But PCCD is firing back, saying honoring the option would be unconstitutional.
PCCD bases its argument on a 2009 opinion by then-Attorney General Jerry Brown, who wrote that refinancing bonds at above-market rates deprives taxpayers of the full benefits of refinancing. Such a move would violate California’s constitutional debt limit and its constitutional cap on taxes, he wrote.
After that opinion, school districts in California stopped using cash-out refundings. And toward the end of 2009, PCCD refinanced many of the underlying 2002 bonds.
Separately, the city of Oakland is trying to get out of payments currently amounting to $4 million annually it owes to Goldman Sachs (GS.N) because of an interest-rate swap it agreed to 15 years ago.
The suit involving PCCD and JP Morgan is Peralta Community College District v JP Morgan Securities, in Superior Court in the State of California, Alameda County, case no. RG12 643254.
Editing by Eric Meijer