WASHINGTON -- The Riverside County, Calif., Housing Authority asked a federal court yesterday to reconsider requiring it to post a $2.25 million bond needed to trigger a preliminary injunction that would block federal agencies from taking enforcement action against one of the authority's bond issues.
In a motion filed with the U.S. District Court for the Central District of California in Los Angeles, the authority said that it will face "serious potential harm" if the $2.25 million bond requirement is not eliminated or reduced.
Judge Consuelo B. Marshall had issued the preliminary injunction against the agencies last July but said that it would not go into effect until the authority posted the $2.25 million bond. The $2.25 million is the amount of arbitrage that the Treasury Department and the Internal Revenue Service have been seeking from the $17.5 million Whitewater Garden multifamily housing bond deal.
The authority also told the court that the bond requirement will not eliminate a problem with the three-year statute of limitations that the Treasury and IRS will face if they fail to collect the arbitrage and then try to tax bondholders.
Under the statute of limitations, the IRS could only tax the bonds' interest earnings for a three-year period after they were reported on tax returns. The IRS, for example, already can no longer tax the interest earnings reported by Whitewater Garden bondholders in 1987 and 1988. The bonds, which were issued six years ago, are still outstanding and are not to be redeemed until Dec. 1, 1993. The authority said that interest earnings on the bonds probably do not exceed $375,000 in any given tax year.
As an alternative to the $2.25 million bond requirement, the authority asked the court to modify the preliminary injunction so that it would protect only those Whitewater Garden bondholders who agree to waive the three-year statute of limitations. "What we're saying is that the service can protect itself from the three-year statute of limitations in other ways" than the $2.25 million bond requirement, said Henry S. Klaiman, a partner with Brown & Wood, the law firm that represents the authority.
The Riverside County authority filed its motion with the court after U.S. attorneys refused to support the idea of eliminating or reducing the $2.25 million bond requirement. The attorneys, which are representing Treasury and the IRS, rejected the idea in a Nov. 15 letter to the authority.
The authority has contended it could not afford to either rebate $2.25 million of arbitrage profits or post that amount with the court so the injunction could move forward.
The injunction was sought by the authority in a lawsuit filed against the agencies last June. The suit was filed after the IRS said the bonds were subject to arbitrage rebate requirements and that it would tax bondholders if arbitrage from the deal was not rebated to the government.
The IRS said that the even though the Whitewater Garden deal was closed on Dec. 31, 1985, the bonds were not validly issued until Feb. 20 when they were sold to public investors for cash, after arbitrage rebate requirements took effect for multifamily housing bonds.
The authority has claimed that the bonds were validly issued on Dec. 31, 1985, because that was when they were purchased with a check. Under IRS rules and relevant case law, the authority said bonds are "issued" when they are exchanged for a check regardless of whether that check is backed with sufficient funds.
Whitewater Gardens is one of 26 deals totaling $1.3 billion that former municipal bond underwriter Matthews & Wright Inc. rushed to market and closed without cash in the mid-1980s to beat arbitrage rebate restrictions pending in Congress. In these deals, Matthews & Wright purchased the bonds with a check from an undercapitalized credit union and then temporarily warehoused them with an unlicensed, offshore shell bank. The bonds were not sold to public investors until weeks or months later.
The Whitewater Garden deal is a black box deal. In these deals -- so named because the structure is complex and the bond proceeds seem to disappear -- participation interests in the mortgage note to the property being financed were supposed to be sold to third party investors for cash to buy credit enhancement. But in the Whitewater Garden deal, as with many of mid-1980 black box deals, the mortgage note was never sold. The bond proceeds were locked into a long-term guaranteed investment contract and were not available for the apartment project.