* Ambac sues to block IRS seizure of $700 mln tax refunds
* Ambac in accord with IRS on enforcement notice
* Ambac filed for Chapter 11 on Monday, has 3rd-qtr profit (Adds quarterly results, paragraphs 8-9)
By Jonathan Stempel
NEW YORK, Nov 9 Bond insurer Ambac Financial Group Inc ABKFQ.PK has sued the United States to block a seizure of $700 million of tax refunds that it said could destroy its ability to reorganize in bankruptcy court.
The company said the Internal Revenue Service has been examining and may seek to recoup the refunds, which relate to losses that Ambac suffered from credit default swaps that insured municipal, corporate and asset-backed debt.
Ambac is seeking a court order letting it keep the refunds, and declaring it has no tax liability from 2003 to 2008.
"Ambac's ability to reorganize successfully will be jeopardized or destroyed" if the refunds are seized quickly, Peter Ivanick, a partner at Dewey & LeBoeuf LLP representing Ambac, wrote in Tuesday's complaint.
IRS questions concerning Ambac's accounting for the refunds and for $7.3 billion of operating losses it hoped to use to offset future taxes were among the reasons Ambac filed for bankruptcy on Monday, sooner than expected, court papers show.
At a court hearing, lawyers for Ambac and the IRS said they reached an accord under which the agency would not take any enforcement action contrary to any state court injunction, absent five business days notice.
"Our goal here, at all costs, is to protect the insurance company," said Martin Bienenstock, another Dewey & LeBoeuf partner representing Ambac, at the hearing.
Separately, Ambac said third-quarter profit fell 97 percent to $76 million, or 25 cents per share, from $2.19 billion, or $7.58, a year earlier, reflecting lower unrealized gains from a portfolio of credit derivatives.
Net premiums fell 40 percent to $143.1 million, and Ambac ended September with a $1.22 billion shareholder deficit.
Ambac was once the second-largest U.S. bond insurer and guaranteed payments on more than $550 billion of debt.
The New York-based company collapsed after suffering huge losses from its guarantees on risky mortgages and other debt.
Ambac filed its Chapter 11 petition after failing to agree with creditors on a "prepackaged" bankruptcy to allow a quick restructuring. It filed the petition and the IRS complaint in the U.S. bankruptcy court in Manhattan.
Shares of Ambac now trade on the Pink Sheets, where they were quoted as closing down 7.7 cents, or 33.4 percent, at 15.3 cents, Reuters data show. The shares had closed Monday at 52 cents on the New York Stock Exchange.
At Tuesday's hearing, U.S. Bankruptcy Judge Shelley Chapman approved a series of motions that companies routinely request after seeking bankruptcy protection. Another hearing has been scheduled for Nov. 30.
SEIZURE COULD CAUSE BIG DEFAULTS
In its lawsuit, Ambac said seizing the tax refunds would allow the IRS "effectively without warning" to tie up assets in affiliates that did not seek bankruptcy, including the Ambac Assurance Corp operating unit.
It said this could cause Wisconsin Insurance Commissioner Sean Dilweg, who oversees that unit, to take steps that could lead to defaults by issuers of $20 billion of asset-backed notes that the unit insured.
Ambac essentially stopped writing new business in 2008 after major credit agencies took away its "triple-A" rating.
Larger rival MBIA Inc (MBI.N) also lost its triple-A rating in 2008. Assured Guaranty Ltd (AGO.N), backed by billionaire investor Wilbur Ross, is effectively the last insurer still writing new municipal bond business.
MBIA on Tuesday posted a third-quarter loss that was 71 percent smaller than a year earlier. [ID:nSGE6A80QN]
In March, Dilweg seized $64 billion of Ambac's worst assets and put them in a segregated account. A court hearing on a proposed rehabilitation plan is scheduled for Nov. 15.
The bankruptcy case is In re Ambac Financial Group Inc, U.S. Bankruptcy Court, Southern District of New York, No. 10-15973. The lawsuit is Ambac Financial Group Inc v. U.S. in the same court, No. 10-04210. (Reporting by Jonathan Stempel in New York; Additional reporting by Kim Dixon in Washington, D.C., and Tom Hals in Wilmington, Del.; Editing by Maureen Bavdek, Dave Zimmerman, Tim Dobbyn and Steve Orlofsky)