Posted On: November 13, 2012

California Securities Lawsuit Claiming Negligent Misrepresentation Over Allegedly Flawed Bond Offering Documents May Proceed, Says District Court

The U.S. District Court for the Northern District of California is allowing a securities lawsuit by an investor claiming negligent misrepresentation over allegedly flawed offering documents in bonds to raise money for a private school to proceed. The plaintiff is Lord Abbett Municipal Income Fund Inc. and the defendants are board of trustee members of the Windrush School.

Per the court, the defendants authorized the California private school to seek financing for the renovation and expansion of its facilities through the issuance of $13 million in bonds, which took place pursuant to a July 1, 2007 indenture between Wells Fargo Bank NA (WFC), serving as indenture trustee, and California Statewide Communities Development Authority, as the bond issuer. (Per the indenture terms, the trustee was the bondholders’ representative.) The bonds were secured by a mortgage on the facility and repayment was to be made through gifts, tuition, and grants. Lord Abbett bought more than $9 million of the bonds.

Now, the New Jersey-based mutual fund is contending that the bond offering documents left out key information about Windrush’s ability to pay back the bonds. For example, Windrush allegedly was reliant upon Making Waves Foundation, a charitable organization that historically puts 10-15 kids at the school every year, to pay it a substantial tuition for each student. Lord Abbett, however, claims that even before the bonds were issued the defendants had already found out that the charitable group was going to open its own school and would no longer be sending kids to study at Windrush and that this would cause lose the latter to not just lose the substantial tuition subsidies but also have to compete with Making Waves for state funding. Despite allegedly knowing that the loss of tuition for so many students would reduce Windrush’s revenue, making it harder for the school to pay back the bonds, the defendants did not make this known on the bonds’ official statement. When Windrush found that it could not make an interest payment that was due in July 2011, it filed for bankruptcy protection.

Lord Abbett filed a securities case asserting one claim of negligent misrepresentation based on the Making Waves facts non-disclosure. The district court did not dismiss the action.

While the defendants had argued that Lord Abbett’s contention for negligent misrepresentation had been released due to a settlement agreement between Windrush and the trustee as part of the school’s bankruptcy and, per the indenture terms, the trustee maintains “broad authority” to make and settle all claims for bondholders, the mutual fund claimed that the indenture places a limit on the authority of the trustee to act for the bondholders and this claim of negligent misrepresentation is beyond that authority’s scope.

The court rejoined that the “indenture is ambiguous” about the Trustee’s authority because it is susceptible to interpretations by each party. Therefore, it is up to the “trier of fact” as to whether the plaintiff’s negligent representation claim is within the Trustee’s authority, and dismissal, as of now, is not appropriate.

Lord Abbett Municipal Income Fund Inc. v. Asami (PDF)


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