John Hancock Life Insurance Co. today asked a federal judge to force Hoosier Energy Rural Electric Cooperative to post an additional $20 million in escrow as the utility continues to challenge a $125 million claim against it by the New York-based insurer.

Attorneys for Bloomington-based Hoosier, meanwhile, said the legal battle that erupted with Hancock last year has severely depleted its liquid reserves and downgraded its credit ratings, and that dire financial consequences could result.

U.S. District Court Judge David Hamilton may issue a decision on the request early next week in a case involving a deal Hoosier entered into seven years ago with Hancock. Hoosier leased its Merom Generating Station in Sullivan County to Hancock, and Hoosier leases portions of the station back from Hancock.

The 2002 deal amounted to a giant tax break for Hancock and netted Hoosier $20 million in cash.

Hoosier filed suit last October, winning a temporary injunction to block Hancock from collecting on a $120 million claim involving the complicated lease-back scheme.
Hoosier said it has never missed a lease payment to John Hancock, but Hancock asserts the utility is technically in default because a firm guaranteeing Hoosier’s lease payments, Ambac, suffered a credit downgrade during the nation’s credit crunch last year.
 
Hoosier, which generates and transmits electricity to 17 rural electric cooperatives in 48 Indiana counties, couldn’t line up a replacement firm fast enough for Hancock and still struggles to do so.

But Hoosier is under a year-end deadline to find a replacement or face the prospect of paying Hancock $125 million – nearly 25 percent of its annual operating revenue.

On Sept. 17 the U.S. District Court of Appeals for the Seventh Circuit, in Chicago, affirmed a preliminary injunction Hoosier sought against Hancock—but only through year-end.

“The longer this impasse continues, the more the balance of equities tilts in favor of John Hancock,” wrote Seventh Circuit Chief Judge Frank Easterbrook.
Hancock’s attorneys, at today’s hearing in Indianapolis before Judge Hamilton, seized on remarks by Easterbrook that $22 million in liquid security Hoosier pledged while the case is being decided “do not cover John Hancock’s exposure.”

“They [Hoosier] can go out and borrow a reasonable amount,” Matthew Herrington, an attorney for Hancock, told the court.
But Hoosier’s attorney, Reed Oslan, of Chicago law firm Kirkland & Ellis, scoffed at the suggestion, saying Hoosier’s “dismal” financial situation would make borrowing daunting, at best.

Oslan told the court Hoosier’s liquid reserves have dropped precipitously, to $115 million, from $208 million last fall. What money is left is dedicated to operating needs. The utility’s credit rating “has been downgraded to one level above junk status,” Oslan added. “In short, we are in a liquidity crisis.”

In his argument against Hoosier having to post additional security, Oslan testified that Hancock had this year effectively retained hundreds of millions of dollars in additional security interest in Hoosier under a trigger in the original lease-back default agreement.

That trigger gives Hancock second mortgage collateral in not only the Merom plant but also several of the utility’s other generating plants.  He estimated Hancock’s interest as high as $1.75 billion.

Hancock’s Herrington, however, reiterated the Seventh Circuit’s remarks that Hancock should be entitled to liquid security. “Do we get security or do we [just] get the right to sue?” said Herrington.

In another argument against ordering Hoosier to post additional security while the case plays out, Oslan cited legislation pending in Congress that seeks to protect struggling utilities and transit systems in a similar predicament.  If enacted, Hancock and other firms that structured lease-back deals would pay a stiff tax designed to discourage them from collecting default payments.

In fact, last December, Sen. Max Baucus (D-Montana) mentioned the predicament Hoosier Energy faced, citing Hancock’s attempts to collect on  technical default. Baucus noted that the Internal Revenue Service found such lease-back deals essentially to be “sham” tax shelters and called them “among the most egregious abuses of the tax law.“

Oslan accused Hancock of trying to reap an enormous windfall by squeezing from Hoosier tax benefits it cannot legally obtain through the tax code.
But Judge Hamilton chuckled at Oslan’s argument.

“There are a lot of things pending before the (U.S.) Senate that aren’t necessarily moving,” said Hamilton. “I’m not given to placing much weight on pending legislation.”

The lease-back tax-shelter deals, known as “lease in/lease-out” or “sale-in/sale out” transactions, have burned a number of utilities and government agencies, including more than 25 city-transit agencies such as St. Louis’ Metro system.

Hoosier serves rural electric cooperatives in counties including Bartholomew and Johnson and Shelby, involving 800,000 residents and businesses in a 15,000-square-mile area.

“It’s not John Hancock’s desire in any sense that Hoosier gets to the liquidation scenario,” said Herrington.

But Hancock won’t get its $125 million if Hoosier can line up a replacement this year for Ambac.