World Crisis Online

Ambac Financial Group Inc., the bankrupt holding company for a failed bond insurer, won a four- month extension of its time to reorganize after a judge called disputes in the case “ugly” and ordered mediation of a tax dispute between Ambac and the U.S.

U.S. Bankruptcy Judge Shelley Chapman denied Ambac Financial’s request for a six-month extension of its control over a reorganization in Manhattan bankruptcy court today. During a seven-hour hearing as creditors disputed the extension, Ambac Chief Executive David W. Wallis testified that if creditors get their way with tax benefits, it could further harm both the companies and holders of municipal debt.

Creditors said Ambac could run out of money if it gets too much time to reorganize, and accused company executives of having a conflict of interest.

“I’ve never heard of another case where there’s such a long, full bore, all-out ugly hearing,” over a company’s right to control its bankruptcy, Chapman said, calling the case a “hit parade of complexity” for its disputes among creditors, the bankrupt holding company, Wisconsin regulators overseeing its operating unit, and the Internal Revenue Service.

Her ruling will gives Ambac until early July to file a Chapter 11 plan.

Since Ambac Financial filed for bankruptcy, it’s been in dispute with all constituents, including its operating unit, Ambac Assurance Corp., over who gets $7.3 billion in net operating losses to use for tax benefits. The IRS has also challenged claims by both companies to tax benefits.

Sword of Damocles

Creditors committee lawyer Anthony Princi told Chapman that the case could convert to a Chapter 7 liquidation if Ambac doesn’t file a plan sooner than in six months.

“You are waving an enormous sword of Damocles,” Chapman told Princi. “A Chapter 7 won’t happen in this court, you heard it here first.”

Stefan Feuerabendt, a managing director at Ambac’s financial adviser Blackstone Advisory Partners LP also testified today that Wisconsin regulators have a proposed resolution of disputes between the operating company and the holding company that could involve some cash payments to Ambac Financial.

Separately, Chapman ordered mediation with the IRS after hearing from lawyers for the U.S. that a Wisconsin district court lawyer had dismissed a lawsuit brought by the IRS. U.S. lawyer Ellen London said the U.S. would appeal that ruling.

Muni Debt

Ambac Assurance was the second-largest bond insurer before the 2008 financial crisis, when mounting defaults on mortgages swamped the company with claims. It guaranteed around $256 billion of $1.4 trillion in insured municipal debt, according to Bloomberg data. Its bankruptcy, filed Nov. 8, listed liabilities of $1.68 billion.

Wisconsin’s insurance commission, known as OCI, is overseeing the rehabilitation of $50 billion in policies insuring mortgage-backed securities held by Ambac Assurance. Commissioner Sean Dilweg in March 2010 created a segregated account that isolated the worst subprime assets from the rest of the insurer’s business, which was kept out of rehabilitation proceedings.

Creditors alleged in court papers that Ambac could file a reorganization plan today, but is held back by conflicts of interest.

Wallis, issued a subpoena by creditors, testified that if creditors get their request to reorganize by taking all of Ambac Assurance’s $7.3 billion in net operating losses for tax benefits, both companies would suffer.

Receivership

“If all NOLS were to be extricated from AAC, AAC starts paying tax, and that would be to the detriment of policy holders and I think our regulator would be unhappy with that,” Wallis testified. Wisconsin regulators would likely put all of Ambac Assurance, not just its segregated account, into receivership, he said, which would in turn hurt Ambac Financial and holders of insurance for municipal debt.

Princi said the action isn’t likely as it would be too detrimental to the policy holders that Wisconsin regulators want to protect.

Creditors alleged the only reason Ambac Financial doesn’t now file a Chapter 11 plan is that the two companies are conflicted by sharing the same eight directors, which are only paid by Ambac Assurance, as a way to circumvent bankruptcy court scrutiny, creditors said in court papers.

“The debtor has avoided the scrutiny by this court of the appropriateness of the payment of these bonuses, by purposefully not making an application for approval to make such payments,” lawyers for creditors wrote.

Investments

Feuerabendt said in court documents that the company had cash and bond investments worth $70.4 million as of the end of 2010, enough to afford a six-month extension. The company needs to get the consent of OCI to the bankruptcy in order to get post-bankrupt payments from its Ambac Assurance unit, Feuerabendt said.

He declined to testify about specifics of OCI’s offer, and said that the amount of a cash payment “would be better than numbers I described in my affidavit.”

The creditors committee includes The Bank of New York Mellon, as an indentured trustee, Law Debenture Trust Co. of New York, Halcyon Master Fund LP, ValueWorks LLC and One State Street LLC, according to court papers.

The holding company case is In re Ambac Financial Group Inc., 10-15973, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

To contact the reporter on this story: Tiffany Kary in New York at tkary@bloomberg.net.

To contact the editor responsible for this story: John Pickering at jpickering@bloomberg.net.