ORANGE COUNTY IN BANKRUPTCY : County Wins Moral Victory on IOU Case : Courts: Timing scuttles plan--for now--to pay investors with lower-cost triple-A rating bonds.

Orange County won a legal victory Wednesday that will enable it to pursue the cheapest way to repay part of its debts to the cities, schools and special districts that accepted county IOUs in place of a portion of their investment pool deposits.

But timing problems and procedural issues will probably force the county to rely on a more expensive repayment option, at least for a year.

Superior Court Judge James L. Smith ruled Wednesday that the county has an obligation “imposed by law” to issue $275 million in so-called recovery bonds to help repay the nearly 200 local government agencies that had money in the investment pool when it lost nearly $1.7 billion in value and dragged the county into bankruptcy last Dec. 6.

Smith said the county need not submit the proposed bonds to a public vote, rejecting a claim by a county employee that without voter approval the new debt issuance would violate provisions of the California Constitution.

Noting that the two sides disagreed over whether the county’s debts to pool investors were contractual or required to right a wrong, Smith said the case was presented as “sort of an apples-and-oranges situation, [but] I think in fact what we have is a rather interesting fruit salad . . . a mixed bag.”

“Any obligation that resulted from negligent investment is clearly one imposed by law and not by contract,” he said after a short hearing Wednesday morning. “The mere fact that there will be contractual obligations [as well] solved by this device does not require constitutional approval.”

But while Smith’s ruling sweeps away a key obstacle to issuance of the new bonds, routine procedures for legal validation prevent them from being issued for at least another month--too late for the mid-June deadline outlined in the investment pool settlement agreement approved in U.S. Bankruptcy Court.

“There’s some procedural, technical things that need to be resolved. But the substantive legal issue has been resolved,” said Richard Posen, an attorney working for the county.

Assistant County Counsel Laurence M. Watson said the county filed legal papers Wednesday to seek dismissal of the four objections filed last month to the debt issuance. But even if the judge rules in the county’s favor, as Wednesday’s decision would suggest, the proposed bond issue could not be validated before next week. Once the debt is validated in Superior Court, there is a 30-day appeal process before the bonds can be issued.

“We’re not going to go out and issue bonds [tomorrow] because of this, but this is certainly a big step,” added Peter Kenny, the county’s bond counsel. “We’re not there yet. It’s a first hurdle.”

If issued, the recovery bonds would be backed by MBIA Insurance Corp., giving them a triple-A rating that ensures marketability and lowers the county’s cost of issuing them.

The bonds are intended to repay pool investors according to the court-approved settlement agreement: schools got 13%, and non-schools 3%, of their Dec. 6 investment balances in “recovery warrants,” which the county must make convertible to cash by early June.

Because the legal process prevents the insured bonds from being issued in time, the county plans to raise enough cash to redeem the recovery warrants by issuing $325 million in lease-backed certificates of participation, a type of debt that is simpler to issue but harder to sell and therefore could cost taxpayers as much as $8 million a year more than insured bonds.

Christopher Varelas of Salomon Bros., the county’s financial adviser, said officials will have three conference calls this morning with potential buyers of the COPs. The county is planning a “road show” to sell the COPs next week, with one-on-one meetings scheduled with institutional investors in Boston, New York, Chicago and San Francisco.

“I think this is a very strong security,” Varelas said Wednesday.

In a preliminary prospectus for the COPs, the county warns potential investors that it might not be able to repay the debt if a proposed hike in the sales tax on the June 27 ballot fails, and notes that the “full faith and credit of the County has not been pledged” to back the COPs.

Rather, the COPs are supported by a dozen county buildings, including several jail facilities, court complexes and administrative offices. Motor vehicle fees are also being pledged to support the issue.

If the county fails to pay the lease on the buildings--in essence, defaults--owners of the COPs have as their only recourse taking over the buildings.

The prospectus also does not include a current audited financial statement, and contains as a caveat: “Material adverse changes have occurred in the financial condition of the county . . . since June 30, 1994.” The county’s last audited statements are for the fiscal year ending June 30, 1993.

Regarding the risks revealed in the prospectus, Varelas said simply: “It’s called complete and full disclosure.”

County officials said that while Wednesday’s court ruling was a moral victory, it came too late to solve the practical problem of repaying pool investors.

Now, the most likely scenario is that proceeds from the COPs will be issued to repay investors in June, and that insured bonds will be used later to buy out the COPs. Officials hinted that there may yet be some way to get the insured bonds done in time, but refused to provide details.

“It’s very disappointing to have come up with a solution that’s more elegant, and cheaper, and to be foiled solely by the calendar,” sighed lead bankruptcy attorney Bruce Bennett. “But I’m not giving up yet.”