Judge Dismisses O.C. Suit Against Merrill Lynch : Bankruptcy: Ruling may be temporary setback for county, which has until next week to refile $2.4-billion claim.

A U.S. Bankruptcy Court judge on Tuesday dismissed Orange County’s $2.4-billion lawsuit against Merrill Lynch & Co., ruling that the county had not proven that it was the proper party to bring a claim against the Wall Street firm.

But the ruling by Judge John E. Ryan may represent only a temporary setback for the county in its battle to recover its massive investment losses. The county has until next week to refile its suit, showing that it was the actual owner of the securities in the investment pool and thus the rightful plaintiff in the suit against Merrill Lynch.

J. Michael Hennigan, the county’s lead lawyer in the case, said he accepted Ryan’s ruling, but was nonetheless disappointed. He said the judge’s decision could cause another lengthy delay in getting the county’s suit before a jury.

Merrill Lynch’s lawyers were exultant. “A nice day’s work,” said Ronald L. Olson, the Los Angeles lawyer who is defending the lawsuit.

Ryan issued his ruling after an intense 3 1/2-hour legal debate.

In the end, he sided with Olson, who had argued that California law is clear that the funds in the ill-fated Orange County Investment Pool “are trust funds and not the property of the county.” Therefore, county officials cannot sue over them, Olson said.

Merrill Lynch’s lawyers argued that the securities it sold to the pool belonged to about 180 government agencies--not just the county--so any suit for damages must be filed on behalf of all the agencies. Olson said the investment pool was akin to a money market fund, with depositors having the right to withdraw their money on 30 days notice.

Olson accused the county of “trying to manipulate this case into this court.” He referred to an April ruling by Ryan that bankruptcy and federal laws barred him from ruling on the overwhelming majority of the issues raised in the county’s initial suit. Since that ruling, the county has sought to keep the case in Bankruptcy Court by contending that Merrill Lynch had no right to liquidate $1.6 billion worth of county securities once held in the pool’s brokerage account.

Orange County sued Merrill Lynch shortly after declaring bankruptcy Dec. 6, blaming the firm for selling the county risky investments that led to the worst municipal bankruptcy in U.S. history. The suit alleges that Merrill Lynch entered into illegal transactions in violation of state law and that the transactions, particularly so-called reverse repurchase agreements, forced the county to exceed the amount of debt it could legally incur under the state Constitution.

Merrill Lynch sold Orange County 68% of the securities in the $21-billion investment portfolio, the suit maintains, which included $14 billion in securities bought with borrowed money. The county used virtually all of this borrowed money to buy reverse repurchase agreements, a transaction in which the seller often provides both the credit and the securities being purchased.