WASHINGTON - A U.S. District Court judge in California has dismissed a lawsuit brought by the Riverside County Housing Authority, clearing the way for the Internal Revenue Service to tax holders of bonds sold in conjunction with the $17.5 million Whitewater Gardens black box deal.

Judge Consuelo B. Marshall of the U.S. District Court for the Central District of California in Los Angeles ruled last week that the court does not have jurisdiction in the case, because the authority can use other avenues to block the IRS from collecting $2.25 million in arbitrage profits earned by the authority in the deal.

Her decision also nullifies a preliminary injunction she had granted last year, which had prevented the IRS from taxing the bonds or forcing the authority to rebate the arbitrage profits before the case could be decided, according to Edward Robbins, an assistant U.S. attorney in Los Angeles.

The IRS had notified the Riverside authority in 1991 that it would revoke the tax-exempt status of the Whitewater Gardens bonds if the arbitrage profits were not rebated to the government by late June of that year. The authority responded by suing the IRS to permanently block that action.

In dismissing the case, Judge Marshall cited the arbitrage rebate regulations, under which issuers who believe they have paid too much arbitrage rebate can apply to the IRS for a refund and then sue the agency if the refund is not forthcoming.

As a result of those regulations, "the plaintiff clearly has an alternative remedy" to suing in the district court, Judge Marshall said.

The decision "is an ideal one from our perspective," Mr. Robbins said. The judge's reasoning "was the theory we were arguing all along."

Henry S. Klaiman, a lawyer with Brown & Wood who is representing the housing authority, said he was disappointed by the decision because "the court never got to the merits of the case."

Mr. Klaiman said he believes it is unclear whether the decision lifts Judge Marshall's temporary injunction. The IRS appealed that restraining order to the Ninth Circuit Court of Appeals, which has not yet ruled.

The Whitewater Gardens project is one of 26 deals totaling $1.3 billion that were closed without cash and rushed to market by Matthews & Wright Inc. in the mid-1980s to beat arbitrage restrictions.

The Whitewater deal was closed on Dec. 31, 1985. But the bonds were purchased with checks from an undercapitalized credit union and then temporarily warehoused with an unlicensed offshore shell bank. The bonds were not sold to public investors for cash until Feb. 20, 1986.

The authority and its lawyers say the bonds were validly issued on Dec. 31, 1985, because that is when they were purchased with a check. But the IRS says the bonds were not validly issued until Feb. 20, 1986, because only then did the deal have any economic substance.

The argument that Riverside has an alternative to suing in the district court has also been made by U.S. attorneys in another case. That case, pending in the U.S. District Court for the Eastern District of California in Los Angeles, involves a $29.29 million governmental improvement bond issue that Matthews & Wright underwrote for Galt, Calif., in 1986.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.