ORANGE COUNTY IN BANKRUPTCY : Judge Rejects Debt Rollover; Pact Goes Back to Drawing Board

A federal judge surprised lawyers for Orange County and its creditors Friday by trashing their proposal to extend $975 million in short-term debt for one year.

U.S. Bankruptcy Judge John E. Ryan said the agreement was far too broad and should be revised to address only the narrow problem of avoiding default on notes coming due this summer.

“It’s like a train with four cabooses,” the judge said of the agreement that would have validated millions of dollars in debt owed vendors, employees and long-term bondholders, in addition to rolling over the notes.

“You only need one caboose to take care of the train’s maintenance requirements,” Ryan said. “I think that by adding the cabooses and telling the court that this is an all-or-nothing consideration, you’re putting yourself in the position of getting nothing.”

Upon hearing Ryan’s comments, dozens of attorneys and financial advisers that had packed the courtroom for the hearing huddled in impromptu negotiations, passing cellular phones among themselves and spinning off into scores of side conversations.

The lawyers agreed to spend the weekend rewriting the proposal and to return to Ryan’s courtroom Tuesday morning to seek approval of a far-narrower rollover plan that would simply extend the maturities on the short-term notes without conferring rights on other creditors.

Vendors, employees and long-term bondholders--whose debts had been validated and granted post-bankruptcy interest under the original proposal--will likely be left out of the new deal.

“There are many very divergent interests in this case. An attempt was made to accommodate all those interests,” said Robert J. Moore, the lead attorney for the creditors committee that crafted the original deal. “Now an attempt will have to be made to accommodate them separately.”

Bruce Bennett, the county’s bankruptcy counsel, said that despite Ryan’s harsh blow to the overall proposal, he was happy that the judge seemed ready to support the narrower notion of rollover. That is a key plank of the county’s recovery effort intended to avoid default and prevent the county’s bruised reputation on Wall Street from further injury.

“We are obviously not going to be able to solve all the problems we set out to solve,” Bennett said, sighing. “The county’s central problem is the summer debt maturities. It does sound like the county will leave Tuesday’s hearing with the solution to those problems.”

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Those involved said the terms of the basic note extension probably will not change. According to the deal, the maturities on five note issuances would be extended to June 30, 1996. Investors would be paid about 75% of their current interest rate monthly during the year, then receive the balance of the interest--plus 95 cents for every $100 invested--next June.

What will probably disappear is the debt validation that accompanied the rollover provisions.

The old deal included a promise from the county that it would not try to repudiate the debts it owes vendors, employees and bondholders under a provision of the California Constitution that prohibits payment of debt from one fiscal year with revenue earned in another. It also provided for the accrual of interest on debt owed vendors and employees.

But attorneys for several short-term noteholders, as well as investors in the county’s failed investment pool, argued that vendors, employees and long-term bondholders should not receive benefits based on sacrifices being made by other constituents, namely those holding short-term notes.

“A compromise implies that something is given up by both parties . . . and you move to the middle,” said Jean Morris, a lawyer representing four groups that hold $175 million in taxable notes. “There doesn’t really seem to be anybody other than the short-term noteholders being asked to give anything.”

Ryan agreed, prompting celebration among bondholders and investors in the county’s failed investment pool, who had filed at least a dozen separate objections contending that the rollover went too far toward categorizing claims against the county.

The pool investors have long lambasted the proposal as a “Christmas tree” on which the county creditors tried to hang piles of extra lights and ornaments. Ryan’s caboose analogy was more than close enough to satisfy them.

“That’s called a home run,” Jon Schotz, financial adviser to the pool participants, said after the hearing.

“They tried to do too much, please too many people and do it at our expense, so we had to fight,” added Patrick C. Shea, the pool investors’ lead attorney. “We are not going to sweep into this [deal] a bag of prizes for everybody else.”

But groups that had supported the original rollover now may contest the debt-extension in court Tuesday.

“This course is awful for the county,” said Richard Marshack, who represents vendors owed about $100 million. “While it might aid in providing some stability in the financial markets, it will cause great uncertainty to those who provide goods and services to the county.”

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Marshack vowed to file an objection to any rollover that cuts his clients out. If nothing else, he said, he will protest the passage of a deal without the proper legal notice, since the deal likely to be unveiled Tuesday will be far different from the one creditors were warned about before Friday’s hearing.

Mary Ann Schulte, chair of the vendors’ subcommittee, warned that without the protections proposed in the original deal, vendors providing everything from trash disposal to flood control will up their fees, costing the county as much as $100 million in penalties over the next five years.

“The fear that vendors have of not being repaid is very great,” she said. “Many of the vendors will react by not doing business with the county any more.”

Attorneys for the vendors, employees, short-term noteholders and long-term bondholders adjourned from Friday’s court hearing to a nearby law office to hammer out a deal, but spent much of the afternoon arguing over interpretations of the judge’s comments.

They plan to meet this morning with Bennett, and to open the discussions up to pool investors in the afternoon. Most expressed confidence that a new deal would be cut by Monday.

If Ryan approves the rollover after Tuesday’s hearing, individual noteholders will have until July 7 to accept it. If more than 90% vote Yes, it will affect all noteholders; if between 50% and 90% give it the nod, it will affect only those accepting it.

“The true import of the judge’s ruling,” Bennett joked as he left the courtroom, “is my weekend is trashed.”