Form 906	 	 
	(Rev. August 1994)	Department of the Treasury — Internal Revenue Service	 


 


Closing Agreement on Final Determination


Covering Specific Matters


_________________


 


Under section
7121 of the Internal Revenue Code: ___________________________________________________


 





	Ambac Financial Group, Inc., EIN: 13-3621676, One State Street Plaza, New York, NY 10004, (the “Taxpayer”), on behalf of itself and as agent for the members of the Ambac Financial Group, Inc. and Subsidiaries consolidated group,







 (Taxpayer’s name, address, and identifying number)


 


 


 



 


and the Commissioner of Internal Revenue (“Commissioner”)
make the following agreement (the “Closing Agreement”):


 


WHEREAS, Ambac Financial Group,
Inc. (“AFGI”) is entering into this Closing Agreement on behalf of itself and as agent of all the members of the Ambac
Financial Group, Inc. and Subsidiaries consolidated group with which it filed consolidated federal income tax returns, as their
common parent, for the taxable years ended December 31, 2003, December 31, 2004, December 31, 2005, December 31, 2006, December
31, 2007, December 31, 2008, and December 31, 2009 (collectively, the “2003 through 2009 Tax Years”), and the taxable
year ended December 31, 2010 (the “2010 Tax Year,” and together with the 2003 through 2009 Tax Years, the “Applicable
Tax Years”);


 


WHEREAS, Ambac Assurance Corporation
(“AAC”) is a subsidiary of AFGI, and AAC, through its wholly owned limited liability company, Ambac Credit Products
LLC (“ACP”), entered into certain credit default swaps (the “CDS Contracts”)1 with third parties;


 


WHEREAS, the Taxpayer claimed
operating losses attributable to the CDS Contracts for certain of the Applicable Tax Years (“Disputed CDS Losses”)
as set forth in Table 1 below, and claimed net operating loss carry-forwards attributable to the CDS Contracts (after taking into
account premiums received on the CDS Contracts) in certain of the Applicable Tax Years (“Disputed Carry-Forward NOLs”)
as set forth in Table 2 below, and the Commissioner disputes the Disputed CDS Losses and Disputed Carry-Forward NOLs claimed by
the Taxpayer;


 


Table 1


 


	Tax Year	 	Disputed CDS Losses ($)	 
	2007	 	 	756,713,558	 
	2008	 	 	3,413,450,726	 
	2009	 	 	2,881,788,012	 
	2010	 	 	417,637,425	 
	Total	 	 	7,469,589,721	 






 





 



1
The terms “CDS Contracts,” “Bank Settlement Notes” and “June 9, 2010 Event” are defined in
the Settlement Letter dated February 24, 2012 (the “Settlement Letter”). See Attachment 1.  


 




    	 



    	 



    

  


Table 2


 


	Tax Year	 	Disputed Carry-Forward NOLs ($)	 
	2007	 	 	0	 
	2008	 	 	1,286,490,389	 
	2009	 	 	2,844,867,442	 
	2010	 	 	328,629,729	 
	Total	 	 	4,459,987,560	 



  


WHEREAS, the Taxpayer reported the
following amounts attributable to the CDS Contracts for the 2010 Tax Year: Ordinary Premium Income of $89,007,679; Ordinary Loss
of $417,637,425; and Capital Gain of $379,900,391 (which the Taxpayer offset with capital loss unrelated to the CDS Contracts);


 


WHEREAS, during 2008, 2009, and
2010, AAC commuted all of the CDS Contracts from which the Disputed CDS Losses and the Disputed Carry-Forward NOLs arose, in return
for an aggregate payment by AAC of approximately $7,000,000,000.00, including approximately $5,700,000,000.00 in cash and approximately
$1,300,000,000.00 in Bank Settlement Notes, issued by AAC in 2010, with a par value of $2,000,000,000.00;


 


WHEREAS, as a result of the
Disputed CDS Losses the Taxpayer filed applications for tentative refunds and received tentative refunds as set forth in Table
3 below, the allowance of which is disputed by the Commissioner (the “Disputed Refunds”);


 


Table 3


 





	Tax Year	 	Disputed Refunds ($)	 
	2007	 	 	38,142,748	 
	2006	 	 	236,529,966	 
	2005	 	 	210,799,742	 
	2004	 	 	144,929,795	 
	2003	 	 	77,713,584	 
	TOTAL	 	 	708,115,835	 











 


WHEREAS, on November 8, 2010, the
Taxpayer commenced a voluntary case under Chapter 11 of Title 11 of the U.S. Code in the United States Bankruptcy Court for the
Southern District of New York, In re Ambac Financial Group, Inc. Chap. 11 Case No. 10-15973 (the “Bankruptcy Case”);


 


WHEREAS, on November 9, 2010,
the Taxpayer commenced an adversary proceeding against the United States in the United States Bankruptcy Court for the Southern
District of New York, Ambac Financial Group, Inc. v. United States, Adv. Proc. Case No. 10-4210 (the “Adversary Proceeding”);


 



    	 



    	 



    




  


WHEREAS, on May 4, 2011, the Commissioner
proposed adjustments disallowing certain of the Disputed CDS Losses claimed by the Taxpayer (“Disputed Proposed Adjustments”)
and on May 5, 2011 filed a Proof of Claim in the Bankruptcy Case for tax due in the amount of $760,749,586.00 and interest to petition
date due in the amount of $46,492,441.91, for a total of $807,242,027.91 (the “Proof of Claim”).


 


WHEREAS, the Settlement Letter
was presented by the Taxpayer and others to the United States on February 24, 2012, and supplemented by letter dated April 3, 2013
(the “Supplemental Letter”, see Attachment 2) (together the two letters constitute the “Offer”),
and the Offer was accepted by the United States on April 4, 2013 (see Attachment 3);


 


WHEREAS, the Commissioner does
not challenge that the Bank Settlement Notes issued by AAC in 2010 to commute certain CDS Contracts were characterized as debt
for federal income tax purposes, and that the issuance of the Bank Settlement Notes did not cause AAC to fail to be a member of
the “affiliated group” (as defined in section 1504(a) of the Internal Revenue Code (the “Code”)) of which
Taxpayer was the common parent, and did not result in an “ownership change” with respect to AAC for purposes of section
382 of the Code;


 


WHEREAS, the Commissioner has
determined that the June 9, 2010 Event did not cause AAC to fail to be a member of the “affiliated group” (as defined
in section 1504(a) of the Code) of which Taxpayer was the common parent, and did not result in an “ownership change”
with respect to AAC for purposes of section 382 of the Code;


 


WHEREAS, this Closing Agreement
resolves with finality all federal income tax liability of the Taxpayer for the 2003 through 2009 Tax Years, including the Disputed
Proposed Adjustments and the Disputed Refunds; and it resolves with finality the federal income tax liability of the Taxpayer for
the 2010 Tax Year solely with respect to items of income, gain, deduction or loss related to the CDS Contracts.


 


IT IS NOW HEREBY DETERMINED
AND AGREED FOR FEDERAL INCOME TAX PURPOSES THAT:


 


		(1)	The Taxpayer is entitled to claim the portion of the Disputed Carry-Forward NOLs for the Applicable Tax Years up to three billion,
four hundred million dollars ($3,400,000,000). The $3,400,000,000 of Disputed Carry-Forward NOLs shall be available as ordinary
loss carry-forwards.



 


		(2)	The Taxpayer is not entitled to claim any portion of the Disputed Carry-Forward NOLs for the Applicable Tax Years to the extent
it exceeds three billion, four hundred million dollars ($3,400,000,000); and the Taxpayer relinquishes all claim to the Disputed
Carry-Forward NOLs in excess of three billion, four hundred million dollars ($3,400,000,000), whether characterized as capital
or ordinary, which might otherwise be available or claimed by the Taxpayer (or any member of its affiliated group) to offset future
taxable income of the Taxpayer (or any member of its affiliated group). Disputed Carry-Forward NOLs relinquished by Taxpayer shall
be treated as having arisen in the 2008 tax year.



 


		(3)	The Taxpayer is liable for: (i) payment of one hundred one million, nine hundred thousand dollars ($101,900,000), which liability
shall be paid in accordance with the terms in paragraph 4 below in full and final satisfaction of the Taxpayer’s federal
income tax liability for the 2003 through 2009 Tax Years, and the Taxpayer’s federal income tax liability for the 2010 Tax
Year but only with regard to items of income, gain, deduction or loss related to the CDS Contracts; and, (ii) certain toll payments
defined in the Settlement Letter.



 


		(4)	Prior to the execution of this Closing Agreement, Taxpayer has satisfied all other conditions set forth in paragraphs 1 and
2 of the Settlement Letter, as amended by the Supplemental Letter, and AFGI has made a payment to the United States Department
of the Treasury of one million nine hundred thousand dollars ($1,900,000) and AAC and/or the Segregated Account (as defined in
the Settlement Letter) has made a payment to the United States Department of the Treasury of one hundred million dollars ($100,000,000).



 


		(5)	No portion of the payments described in paragraph 4 above and no portion of the toll payments
defined in the Settlement Letter will be attributable to additions to tax or other penalties under chapter 68 of the Code.



 






    	 



    	 



    




 


		(6)	This Closing Agreement finally and conclusively resolves the federal income tax liability (and
any liabilities in respect of interest under section 6601 of the Code and additions to tax and penalties that may be imposed under
the Code) of the Taxpayer for the 2003 through 2009 Tax Years. 



 


		(7)	This Closing Agreement also finally and conclusively resolves the federal income tax liability (and any liabilities in respect
of interest under section 6601 of the Code and additions to tax and penalties that may be imposed under the Code) of the Taxpayer
for the 2010 Tax Year but only with regard to items of income, gain, deduction or loss related to the CDS Contracts, including
the Disputed CDS Losses and Disputed Carry-Forward NOLs.



 


		(8)	Neither the issuance of the Bank Settlement Notes nor the June 9, 2010 Event caused AAC to fail to be a member of the “affiliated
group” (as defined in section 1504(a) of the Code) of which Taxpayer was the common parent or resulted in an “ownership
change” with respect to AAC for purposes of section 382 of the Code.



 


		(9)	No inference shall be made from the execution of this Closing Agreement by the Commissioner regarding the appropriate treatment
of credit default swaps for federal income tax purposes, and nothing contained in this Closing Agreement shall be considered an
acceptance by the United States of Taxpayer’s tax accounting methodology with respect to the CDS Contracts nor an admission
by the Taxpayer that there were faults in its tax accounting methodology with respect to the CDS Contracts.



 


		(10)	Nothing in this Closing Agreement shall be construed as a limitation on the Commissioner’s ability to adjust the tax
liabilities of Taxpayer except as expressly provided for in this Closing Agreement.



 


		(11)	The Taxpayer will include a copy of this Closing Agreement and all attachments with all of its federal income tax returns filed
for a period of 20 years from the date of execution.



 


		(12)	This agreement is final and conclusive except:



 


		a.	The matter it relates to may be reopened in the event of fraud, malfeasance, or misrepresentation of material fact;



 


		b.	It is subject to the I.R.C. provisions (including any stated exception for I.R.C. §7122) notwithstanding any other law
or rule of law; and



 


		c.	If it relates to a tax period ending after the date of this agreement, it is subject to any law enacted after the agreement
date that applies to the tax period.



 


By signing, the above parties
certify that they have read and agreed to the terms of this document.


 


		TAXPAYER:	       AMBAC FINANCIAL GROUP, INC.



ON BEHALF OF ITSELF AND THE AMBAC
FINANCIAL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED GROUP


 


	 	By:	 	 	 	 	 
	 	 	 	 	 	 	 
	 	Title:	 	 	Date Signed:	 	 
	 	 	 	 	 	 	 
	Commissioner of Internal Revenue	 	 	 	 
	 	 	 	 	 	 	 
	 	By:	 	 	 	 	 
	 	 	 	 	 	 	 
	 	Title:	 	 	Date Signed:	 	 


 






    	 



    	 



    

 


 


 


 





ATTACHMENT 1


 







 






    	 



    	 



    

 







 


		
        Dewey & LeBoeuf LLP

        1301 Avenue of the Americas

        New York, NY 10019-6092

         

        T+1 212 259 8330

        F +1 212 259 6333

        lhill@dl.com



 


SUBMITTED PURSUANT TO FRE 408 AND


WISCONSIN STATUTE SECTION 904.08


FOR SETTLEMENT PURPOSES


 


February 24, 2012


Preet Bharara, Esq.


United States Attorney


Southern District of New York


U.S. Department of Justice


86 Chambers Street


New York, NY 10007


 


John A. DiCicco, Esq.


Principal Deputy Assistant Attorney General


Tax Division


United States Department of Justice


Washington, D.C. 20530


 


		Re:	Ambac Financial Group, Inc. v. United States,
Adv. Proc. No. 10-4210



(Bankr. S.D.N.Y.,
filed Nov. 9, 2010);


In the Matter
of the Rehabilitation of Segregated Account of Ambac Assurance 

Corp., No. 2010CV1576 (Wis. Cir. Ct. for Dane Cnty. Jan. 24, 2011), petition for review granted, No.
2011AP987 (Wis. Aug. 31, 2011);


In the Matter
of the Rehabilitation of Segregated Account of Ambac Assurance 


Corporation,
782 F. Supp. 2d 743 (W.D. Wis. 2011), appeal docketed,

No. 11-1158 (7th Cir. Jan. 19, 2011); and


United States v. Wisconsin
State Circuit Court for Dane County, et al.,

767 F. Supp. 2d 980 (W.D. Wis. 2011), appeal docketed, No. 11-1419

(7th Cir. Feb. 22, 2011).


 


Dewey
& LeBoeuf LLP is a New York limited liability partnership.


 


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Messrs. Bharara and DiCicco


February 24, 2012


Page 2


 


Dear Messrs Bharara and DiCicco:


 


This letter constitutes
an offer to settle the above-referenced proceedings on the terms described below. The settlement would be between the United States,
on the one hand, and Ambac Financial Group, Inc. (“Debtor” or “AFGI”), Ambac Assurance Corporation (“AAC”),
the Official Committee of Unsecured Creditors of AFGI (“Official Creditors Committee”), the Segregated Account of Ambac
Assurance Corporation (the “Segregated Account”)1, the court-appointed Rehabilitator of the Segregated Account
(the “Rehabilitator”) and the Wisconsin Office of the Commissioner of Insurance (“OCI”), on the other hand
(collectively, the United States, AFGI, AAC, Official Creditors Committee, Segregated Account, Rehabilitator and OCI are referred
herein as the “Parties”).2


 


 






1             On March 24, 2010, the Wisconsin Office of the
Commissioner of Insurance (“OCI”) approved the establishment of a segregated account of AAC, pursuant to Wis. Stat.
section 611.24(2), to segregate certain non-performing segments of AAC’s liabilities. All policy obligations of AAC not allocated
to the Segregated Account remain in the general account of AAC; and, in addition, the Segregated Account contains a secured note
issued by the general account (the “Secured Note”). Further, on March 24, 2010, OCI commenced rehabilitation proceedings
with respect to the Segregated Account in the District Court of Dane County, Wisconsin to facilitate an orderly run-off and/or
settlement of the liabilities in the Segregated Account.


 


2              In this letter, the term “IRS”
means the Internal Revenue Service; the term “Code” means the Internal Revenue Code of 1986, as amended; the term “Group”
means the “affiliated group” (as defined in Section 1504(a) of the Code) of which AFGI is the common parent, and AAC
(including the Segregated Account) is one of the members and the term “CDS Contracts” means all the CDS contracts identified
in Attachment A as the pay-as-you-go credit default swap contracts and other CDS contracts with respect to which items of income,
gain, deductions, or loss were reflected in any of the federal income tax returns filed by the Group for the tax years ending December
31, 2005, December 31, 2006, December 31, 2007, December 31, 2008, December 31, 2009 or December 31, 2010; the term “CDS
Contracts” does not include the CDS contracts identified in Attachment B as CDS contracts with respect to which items of
income, gain, deductions, or loss were not reflected in any of the federal income tax returns filed by the Group for the tax years
ending December 31, 2005, December 31, 2006, December 31, 2007, December 31, 2008, December 31, 2009 or December 31, 2010; the
term “Confirmation Order” means the plan of rehabilitation confirmation order; the term “Bank Settlement Notes”
means the surplus notes issued by AAC on June 7, 2010 pursuant to the Settlement Agreement, dated June 7, 2010, among AAC and certain
financial institutions as well as the issuance by the Segregated Account of $50 million in surplus notes on July 29, 2010 in connection
with a separate settlement, and the term “Plan of Reorganization” means AFGI’s reorganization plan submitted
to the United States Bankruptcy Court for the Southern District of New York as finally amended and confirmed.


 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 3


 


On November 8, 2010,
AFGI filed a voluntary case under Chapter 11 of Title 11 of the United States Code seeking bankruptcy protection (“Bankruptcy
Case”). On November 9, 2010, AFGI commenced an adversary proceeding in connection with the Bankruptcy Case against the United
States (“Adversary Proceeding”), seeking, in part, to obtain an injunction and a declaration that the Debtor applied
the proper accounting method with respect to losses on the CDS Contracts. The Adversary Proceeding is captioned Ambac Financial
Group, Inc. and The Official Committee of Unsecured Creditors v. United States of America, Adv. Pro. No. 10-4210 (SCC). On
May 5, 2011, the United States filed its proofs of claim in the Bankruptcy Case against AFGI, thereby asserting a priority claim
against the Debtor of $807,242,021.91 (“IRS Claims”). The IRS Claims seek the return of the tentative tax refunds received
by the Group resulting from the claimed recognition of losses in 2007 and 2008 with respect to the CDS Contracts. The Debtor filed
its objection to the IRS Claims on June 5, 2011.


 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 4


 


The United States
has also sought to assert legal rights against AAC, under Treas. Reg §§ 1.1502-6(a) and 1.1502-78(b)(2), with respect
to any deficiency or underpayment of federal taxes against the Group. As authorized by statute, OCI approved the creation of the
Segregated Account, which OCI then placed into rehabilitation in the Wisconsin Circuit Court of Dane County (the “Rehabilitation
Court”) on March 24, 2010, with the Wisconsin Commissioner of Insurance appointed as Rehabilitator.  By order dated
November 7, 2010, the Rehabilitation Court approved the allocation of AAC’s federal tax liability for all prior tax years,
including any liability it may have with respect to the IRS Claims to the Segregated Account.3 On December 8, 2010,
the United States removed the Wisconsin rehabilitation proceeding involving the Segregated Account to the United States District
Court for the Western District of Wisconsin (the “District Court”). The Rehabilitator moved to remand the proceeding
to the Rehabilitation Court, and on January 14, 2011, that motion was granted by the District Court. The United States appealed
that decision to the United States Court of Appeals for the Seventh Circuit. On February 9, 2011, the United States
filed a complaint and a motion for a preliminary injunction in the District Court seeking, inter alia, to enjoin enforcement of
the injunction issued by the Rehabilitation Court and the Confirmation Order against the United States in a case captioned United
States of America v. Wisconsin State Circuit Court for Dane County, Case No. 11-cv-099. The District Court dismissed that suit
for lack of subject matter jurisdiction on February 18, 2011, and the United States filed a notice of appeal on February 22,
2011. The appeals at the Seventh Circuit are pending as Appeal Nos. 11-1158 and 11-1419.


 


On March 9, 2011,
the United States appealed the Order of Confirmation entered by the Rehabilitation Court on January 24, 2011. That appeal, No.
2011-AP-987, was dismissed by the Wisconsin Court of Appeals. The Wisconsin Supreme Court subsequently granted the United States’
Petition for Review. The matter has been briefed, argued before, and submitted for decision to the Wisconsin Supreme Court.


 





 



 3             It
is acknowledged that the United States disputes that this allocation was effective as to it.


 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 5


 


AFGI, AAC, the Official
Creditors Committee, the Segregated Account, the Rehabilitator, and OCI offer to resolve and settle the disputes described above
to avoid the burden, expense and uncertainty of litigation. The terms of this offer (the "Offer") are as follows:


 


1.      The proposed
settlement shall not be effective until this offer has been accepted by the United States, such acceptance including having received
a response of “no adverse criticism” from the Congressional Joint Committee on Taxation to effectuate the transactions
contemplated in this letter, and the conditions in 28 C.F.R. § 0.163 relating to the settlement of appeals authorized by the
Solicitor General shall also have been satisfied, and each of the other conditions below in this paragraph 1 have been satisfied.


 


		a.	The Rehabilitation Court shall have entered an order approving the transactions contemplated in
this letter.



 


		b.	The United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy
Court”) shall have entered an order approving the stipulated dismissal with prejudice of the Adversary Proceeding and approving
the other transactions contemplated in this letter, including the Plan of Reorganization.



 


		c.	AFGI (on behalf of itself, AAC, and the other members of the Group) and the IRS shall have entered
into a closing agreement under section 7121 of the Code that provides as follows:



 


		(1)	The closing agreement finally and conclusively resolves the federal income tax liability (and any
liabilities in respect of interest under section 6601 of the Code and additions to tax and penalties that may be imposed under
the Code with respect to this income tax liability) of the Group for the tax years ending December 31, 2003 through and including
December 31, 2009.



 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 6


 


		(2)	The closing agreement also finally and conclusively resolves the federal income tax liability (and
any liabilities in respect of interest under section 6601 of the Code and additions to tax and penalties that may be imposed under
the Code with respect to this income tax liability) of the Group for the tax year ending December 31, 2010, but only with regard
to any income, gain, deduction, or loss on the Group’s CDS Contracts.



 


		(3)	The Group (and each of its members) will relinquish all claim to all loss carry-forwards, whether
characterized as capital or ordinary, resulting from losses on the CDS Contracts arising on or before December 31, 2010, which
might otherwise be available to the Group (or any of its members) to offset future taxable income of the Group (or any of its members)
to the extent that these carry-forwards exceed $3,400,000,000. The $3,400,000,000 of losses shall be ordinary loss carry-forwards.
The Group has also claimed losses that have arisen separate and apart from its CDS Contracts (the “non-CDS NOLs”),
but the closing agreement will not address the non-CDS NOLs, to which the IRS reserves all of its rights.



 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 7


 


		(4)	Nothing contained in the closing agreement or settlement shall be considered an acceptance by the
United States of AFGI’s tax accounting methodology with respect to the CDS contracts nor an admission by AFGI that there
were faults in its tax accounting methodology with respect to the CDS contracts. No inference shall be made from the execution
of the closing agreement or settlement by the United States regarding the appropriate treatment of credit default swaps for federal
income tax purposes.



 


		(5)	The parties to the closing agreement acknowledge that such agreement is the product of arm’s
length negotiations and supersedes all prior communications, written or oral, with respect thereto. In connection with the negotiations
to enter into a closing agreement that satisfies the conditions described in this paragraph 1(c), the Parties agree that no payment
shall be required to be made by any members of the Group other than as described in paragraphs 2-4.



 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 8


 


		d.	Additional conditions precedent to the effectiveness of the proposed settlement are (i) AFGI (on
behalf of itself, AAC, and the other members of the Group, whose written consent shall be obtained) and the IRS shall have entered
into a closing agreement under section 7121 of the Code providing that neither the issuance of the Bank Settlement Notes4
nor the June 9, 2010 Event5 (A) caused AAC to fail to be a member of the “affiliated group” (as defined
in section 1504(a) of the Code) of which AFGI was the common parent, or (B) resulted in an “ownership change” with
respect to AAC for purposes of section 382 of the Code, and (ii) the Internal Revenue Service shall have issued a favorable private
letter ruling (“PLR”) providing that upon emergence from bankruptcy AFGI would qualify for the Code section 382(l)(5)
exception, without regard to section 382(l)(5)(D); the PLR will be based solely on the information and representations included
in the private letter ruling request that shall be submitted by AFGI to the IRS within 60 days of the date of this Offer (the “Original
PLR Request”). The condition precedent described in this subparagraph 1(d)(ii) will be satisfied upon the IRS’s issuance
of such a PLR based upon the Original PLR Request. In connection with the negotiations relating to (i) and (ii) of this paragraph
1(d), the Parties agree that no payment shall be required to be made by any members of the Group other than as described in paragraphs
2 - 4.



 


		e.	Another condition precedent to the effectiveness of the proposed settlement is that the United
States and the Segregated Account shall enter into a separate and independent agreement to create and maintain an escrow account
holding a balance of not less than $100 million in cash or Qualifying Investments as defined in the Escrow Agreement -(the
“Escrow Account”). The terms and conditions of the Escrow Account are set forth in the form of Escrow Agreement attached
hereto as Appendix A.



 


 






4 The IRS reserves its right to request a written
opinion to be provided by KPMG relating to issues regarding the $50 million in surplus notes issued on July 29,2010, and to withhold
a final conclusion on the issues set out above prior to receiving such written opinion.


 


5 The “June 9, 2010 Event” refers to
AAC's nonpayment of dividends in full to the holders of the auction market preferred shares (AMPS) for six consecutive dividend
payment dates thereby entitling the holders of the AMPS, subject to OCI's approval, to elect two members of the board of directors
of AAC.


 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 9


 


		f.	Approval of the terms of the proposed settlement agreement as set forth herein by the AFGI and
AAC Boards of Directors (the "Boards"). Written notice will be provided to the United States within five (5) days of
the Boards' vote whether to accept or reject the terms of the Offer, and, after May 31, 2012, approval shall be deemed to have
occurred unless notice to the contrary is provided to the United States.



 


2.           Within ten (10)
business days following satisfaction of all conditions set forth in paragraph 1: (i) AFGI will pay the United States Department
of the Treasury one million nine hundred thousand dollars ($1,900,000); and (ii) AAC and/or the Segregated Account will pay the
United States Department of the Treasury one hundred million dollars ($100,000,000). The manner in which AAC and/or the Segregated
Account effectuates the payment to the IRS will not be construed as a concession of any legal issue by any of the Parties. The
payments that are described in the first sentence of this Paragraph 2 and the payments described in paragraphs 3 and 4 will be
in full and final satisfaction of the federal income tax liability (and any liabilities in respect of interest under section 6601
of the Code and additions to tax and penalties that may be imposed under the Code with respect to this income tax liability) of
the Group to the IRS for (i) the tax years ending December 31, 2003 through December 31, 2009; and (ii) the tax year ending December
31, 2010, but only with regard to items of income, gain, deduction, or loss on the Group’s CDS Contracts. Effective at the
time of the payment described in the first sentence of this paragraph 2, the Group (and all of its members, including AAC) shall
waive forever any right to claim any overpayment of any federal income tax, liability (and any overpayment of interest, additions
to tax, or penalties with respect to this income tax liability) of the Group for any tax period ended prior to January 1, 2010
and any right to claim any overpayment of any federal income tax liability (and any overpayment of interest, additions to tax,
or penalties with respect to this income tax liability), of the Group with regard to items of income, gain, deduction, or loss
on the CDS Contracts for the tax year ended December 31, 2010. No portion of the AFGI and AAC payments will be attributable to
additions to tax or other penalties under chapter 68 of the Code. No portion of the AFGI and AAC payments, and no portion of the
Tier C and Tier D IRS Payments described in paragraphs 3 and 4 below, shall be claimed as a deduction or other tax benefit on any
federal tax return for the year of this settlement or any future year.


 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 10


 


3.         Following the
effectiveness of the Tax Sharing Agreement between AFGI and AAC, which is attached as Exhibit A to the Plan of Reorganization (the
“TSA”), and the satisfaction of all conditions set forth in paragraph 1, AFGI will pay the IRS an amount equal to twelve
and a half percent (12.5%) of any payment made to AFGI by AAC associated with the net operating loss (“NOL”) Usage
Tier C as defined in the TSA (the “Tier C IRS Payment”). The Tier C IRS Payment, if any, shall be made within five
(5) business days following AFGI’s receipt of the Tier C payment, if any, made by AAC to AFGI.


 


4.         Following the
effectiveness of the TSA and the satisfaction of all conditions set forth in paragraph 1, AFGI will pay the IRS an amount equal
to seventeen and a half percent (17.5%) of any payment made to AFGI by AAC associated with the NOL Usage Tier D as defined in the
TSA (the “Tier D IRS Payment”). The Tier D IRS Payment, if any, shall be made within five (5) business days following
AFGI’s receipt of the Tier D payment, if any, made by AAC to AFGI.


 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 11


 


5.         With respect
to the Tier C and Tier D payments made by AAC to AFGI, AFGI will disclose in its annual federal tax return the amount of such payments
received from AAC for the applicable year. The right of the IRS to receive the Tier C IRS and Tier D IRS Payments shall not be
treated for federal income tax purposes or any other purpose as an equity interest in AFGI or in AAC, and AFGI’s failure
to make Tier C IRS and Tier D IRS Payments will not give the IRS a claim against the Segregated Account, the general account of
AAC, or any subsidiary of AAC.


 


6.         Following the
satisfaction of all conditions set forth in paragraphs 1 and 2, OCI, the Segregated Account, the Rehabilitator, and AAC will, upon
the request of the United States, state in writing to the court that they support any motion brought by the United States seeking
to vacate (i) the Opinion and Order entered on January 14, 2011 by the United States District Court for the Western District of
Wisconsin in the proceeding captioned Theodore Nickel v. United States of America, Case No. 10-cv-778 and (ii) the Opinion
and Order entered on February 18, 2011 by the United States District Court for the Western District of Wisconsin in the proceeding
captioned United States of America v. Wisconsin State Circuit Court for Dane County, Case No. 11-cv-099.


 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 12


 


7.         Following the
satisfaction of all conditions set forth in paragraphs 1 and 2, upon stipulation, the United States, the Rehabilitator, OCI, AAC
and the Segregated Account, shall dismiss with prejudice the two cases that are currently pending before the U.S. Court of Appeals
for the Seventh Circuit and captioned as Theodore Nickel v. United States of America, Case No. 11-1158 and United States
of America v. Wisconsin State Circuit Court for Dane County, et. al., Case No. 11-1419.


 


8.         Following the
satisfaction of all conditions set forth in paragraphs 1 and 2, the IRS Claims filed in AFGI’s Chapter 11 Bankruptcy Case,
presently pending before the United States Bankruptcy Court for the Southern District of New York, shall be deemed allowed in the
amount of $120,000,000.00 which will be fully satisfied upon receipt by the United States Department of the Treasury of the payments
described in paragraph 2 and the payment, if any, described in paragraphs 3 and 4 above, and the IRS Claims will be deemed disallowed
in any greater amount. The $120,000,000.00 offer is for settlement purposes only and the Segregated Account and AAC shall have
no liability for any unpaid portion of this claim following satisfaction of the conditions in paragraphs 1 and 2, supra.
Furthermore, no cancellation of debt income shall arise with respect to the Group should no payments be made pursuant to paragraphs
3 and 4 above, or should such payments fail to bring the aggregate of payments, including those described in paragraph 2 above,
to an amount equal or exceeding $120,000,000.


 


9.         Following the
satisfaction of all conditions set forth in paragraphs 1 and 2, by stipulation, the United States and AFGI shall dismiss with prejudice
the Adversary Proceeding, presently pending before the United States Bankruptcy Court for the Southern District of New York (Case
No. 10-4210) and the motion to withdraw the reference, presently pending before the United States District Court for the Southern
District of New York.


 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 13


 


10.        This Offer shall
be conditioned upon the satisfaction of each of the following conditions:


 


		a.	The Seventh Circuit Court shall hold off rescheduling oral argument and not issue any dispositive
order, judgment or other ruling on the merits with respect to appeal No. 11-1158 or Appeal No. 11-1419.



 


		b.	Between the time the Offer is submitted to the United States and such time as the parties either
(1) satisfy all the conditions for the settlement to be effective set forth in paragraphs 1 and 2 above or (2) determine that said
conditions will not be satisfied, the United States will not submit any claim in the Rehabilitation Court or Bankruptcy Case or
take any other collection action (whether by assessment, levy, or by asserting the existence of a lien, or otherwise) with respect
to any federal income tax liability presently being asserted by the United States as to AFGI, AAC or any other member of the Group
for the 2010 tax year or any prior tax year, and will not seek to remove the rehabilitation proceeding from the Rehabilitation
Court or object to any motion of the Rehabilitator (except as to any motion that is inconsistent with the settlement terms set
forth herein). The United States, nevertheless, retains the right to submit a claim in the Rehabilitation Court or in the Bankruptcy
Case if such is necessary to satisfy a claims deadline established by the Rehabilitation Court or the Bankruptcy Court.



 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 14


 


11.         The Segregated
Account, OCI, AAC and the United States shall each be free to write the Wisconsin Supreme Court (and to respond to representations
made in contacts by other parties) with respect to the United States’ appeal to that court, No. 2011-AP-987, if the Supreme
Court has not before then issued its final decision with respect to that appeal. In those written submissions, no party shall request
a stay or dismissal of the proceedings before the Wisconsin Supreme Court.


 


If, prior to the consummation
of this proposed settlement, the Wisconsin Supreme Court issues a ruling that is favorable to the United States and that results
in a remand to either the Wisconsin Court of Appeals or the Rehabilitation Court, the United States will promptly move to stay
proceedings in the court to which proceedings have been remanded and will later dismiss with prejudice its case then pending before
the Wisconsin Court of Appeals or the Rehabilitation Court, and any objection to the Rehabilitation Court’s orders, upon
satisfaction of the conditions set forth in paragraphs 1 and 2.


 


12.         The Offer is
valid unless and until withdrawn in writing by the Debtor, AAC, OCI, the Segregated Account or the Official Creditors Committee.


 


13.         Except as to
the terms contained herein in paragraph 1.e, no term contained within this Offer will have any force or effect if settlement is
not consummated.


 


	 	Respectfully submitted,
	 	 
	 	Dewey & LeBoeuf LLP
	 	 
	 	By:	 
	 	Lawrence M. Hill
	 	Counsel for Debtor and AAC


 




    	 



    	 



    

 


Messrs. Bharara and DiCicco


February 24, 2012


Page 15


 


	 	Foley & Lardner LLP
	 	 
	 	By:	 
	 	Kevin G. Fitzgerald
	 	Counsel for the Segregated Account, the Rehabilitator, and OCI
	 	 
	 	Morrison & Foerster LLP
	 	 
	 	By:	 
	 	Anthony Princi
	 	Counsel for the Official Creditors Committee


 


		cc:	Jeannette A. Vargas



Daniel P. Filor


Ellen London


Carina H. Schoenberger


Anthony T. Sheehan


Roger A. Peterson


Michael B. Van Sicklen


Edward Froelich


Robert Kovacev


Sashka Koleva


   




    	 



    	 



    

 













 


 


 





ATTACHMENT 2


 







 


 






    	 



    	 



    

 


SUBMITTED PURSUANT TO FRE 408 AND

WISCONSIN STATUTE SECTION 904.8

FOR SETTLEMENT PURPOSES


 


April 3, 2013


 


Preet Bharara, Esq.


United States Attorney

Southern District of New York


U.S. Department of Justice


86 Chambers Street

New York, NY 10007


 


John A. DiCicco, Esq.

Principal Deputy Assistant Attorney General

Tax Division

United States Department of Justice

Washington, DC 10530


 


Ambac Financial Group, Inc. v. United States,
Adv. Proc.No. 10-4210 (Bankr. S.D.N.Y., filed Nov. 9, 2010);


In the Matter of the Rehabilitation of Segregated
Account of Ambac Assurance Corp., 

No. 2010CV1576 (Wis. Cir. Ct. for Dane Cnty. Jan. 24, 2011) petition for review granted, No. 2011AP987 (Wis. Aug. 31, 2011);


In the Matter of the Rehabilitation of Segregated
Account of Ambac Assurance Corporation, 782 F. Supp. 2d 743 (W.D. Wis. 2011), appeal docketed, 

No. 11-1158 (7th Cir. Jan. 19, 2011); and

United States v. Wisconsin State Circuit Court for Dane County, et al.,


767 F. Supp. 2d 980 (W.D. Wis. 2011), appeal docketed,
No. 11-1419


(7th Cir. Feb. 22, 2011)


 


Dear Messrs. Bharara and DiCicco:


 


On February 24, 2012, Ambac Financial Group,
Inc. (“Debtor” or AFGI”), Ambac Assurance Corporation (“AAC”), the Official Committee of Unsecured
Credits of AFGI (“Official Creditors Committee”), the Segregated Account of Ambac Assurance Corporation (the “Segregated
Account”), the court-appointed Rehabilitator of the Segregated Account (the “Rehabilitator”) and the Wisconsin
Office of the Commissioner of Insurance (“OCI”), presented a settlement offer (“Settlement Letter”) to
settle the above-referenced proceedings. This letter modifies and supplements the terms of the Settlement Letter, as follows:


 




    	 



    	 



    

 


	Preet Bharara, Esq.
	Page 2


 


		(i)	Paragraph 1(b) of the Settlement Letter is modified by deleting reference to the dismissal of the Adversary Proceeding. As
modified, paragraph 1(b) shall read: “The United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy
Court”) shall have entered an order approving the proposed settlement of the transactions contemplated in this letter, including
the Plan of Reorganization.



 


		(ii)	Paragraph 1(c)(6) shall be added to the Settlement Letter to state: “The closing agreement shall be executed only upon
the satisfaction of all other conditions set forth in paragraphs 1 and 2 of the Settlement Letter and the entry of an order of
the United States Bankruptcy Court for the Southern District of New York, in the Chapter 11 bankruptcy proceeding of In re Ambac
Financial Group, Inc. Chap 11 Case No. 10-15973, approving the terms of this settlement between AFGI, on behalf of itself and
as agent for the members of AFGI and Subsidiaries consolidated group, and the United States.”



 


		(iii)	Paragraph 2 of the Settlement Letter is modified by deleting the first sentence “Within ten (10) business days following
satisfaction of all conditions set forth in paragraph 1: (i) AFGI will pay the United States Department of the Treasury one million
nine hundred thousand dollars ($1,900,000); and (ii) AAC and/or the Segregated Account will pay the United States Department of
the Treasury one hundred million dollars ($100,000,000).” The first sentence in paragraph 2 shall read: “Following
satisfaction of all conditions set forth in paragraph 1, except the reference to a closing agreement within paragraphs 1(c) and
(d), AFGI and the United States shall meet at which time the United States will deliver to AFGI an executed closing agreement in
accordance with the Settlement Letter upon confirmation that: (i) AFGI has paid the United States Department of the Treasury one
million nine hundred thousand dollars ($1,900,000); and (ii) AAC and/or the Segregated Account has paid the United States Department
of the Treasury one hundred million dollars ($100,000,000).”



 




    	 



    	 



    

 


	Preet Bharara, Esq.
	Page 3


 


The remainder of paragraph (2)
in the Settlement Letter will remain unchanged. The amount to be paid by AAC and/or the Segregated Account pursuant to paragraph
2 of the Settlement Letter may be funded in accordance with paragraph 3 of the Escrow Agreement, dated as of March 8, 2012 (the
“Escrow Agreement”), between the Segregated Account, the United States of America and The Bank of New York Mellon,
as escrow agent, in which case the Segregated Account and the United States of America shall take such actions as are required
by the Escrow Agreement to effect such funding. Alternatively, the amount to be paid by AAC and/or the Segregated Account pursuant
to paragraph 2 of the Settlement Letter may be funded in cash, in which case the Segregated Account and the United States of America
shall take such actions as may be necessary to terminate the arrangements effected by the Escrow Agreement and return all Escrow
Property (as defined in the Escrow Agreement) to the Segregated Account.


 


It is further agreed that paragraph
9 shall be modified by removing from that paragraph reference to the satisfaction of all conditions set forth in paragraphs 1 and
2. As modified, paragraph 9 shall read: “Following receipt by the Taxpayer of the executed closing agreement in accordance
with the terms of the Settlement Letter, as modified by this letter, by stipulation, the United States and AFGI shall dismiss with
prejudice the Adversary Proceeding, presently pending before the United States Bankruptcy Court for the Southern District of New
York (Case No. 10-4210) and the motion to withdraw the reference, presently pending before the United States District Court for
the Southern District of New York.”


 




    	 



    	 



    

 


	Preet Bharara, Esq.
	Page 4


 


It is further agreed that the
private letter ruling dated October 25, 2012 issued by the Internal Revenue Service (PLR-117798-12) to Ambac Financial Group. Inc.
satisfies the requirements set forth in paragraph 1(d)(ii) of the Settlement Letter.


 


All terms and conditions of the
Settlement Letter will remain unchanged except as expressly provided for in this letter.


 


	 	Respectfully submitted,
	 	 
	 	Shearman & Sterling LLP
	 	 
	 	By:	 
	 	Lawrence M. Hill
	 	Counsel for debtor and AAC
	 	 
	 	Foley & Lardner LLP
	 	 	 
	 	By:	 
	 	Kevin G. Fitzgerald
	 	Counsel for the Segregated

Account, the Rehabilitator,

and OCI
	 	 	 
	 	Morrison & Foerster LLP
	 	 	 
	 	By:	 
	 	Anthony Princi
	 	Counsel for the Official 

Creditors Committee


 




    	 



    	 



    

 


	Preet Bharara, Esq.
	Page 5


 


	 	Acknowledged and Agreed:	 
	 	 	 
	 	UNITED STATES OF AMERICA	 
	 	 	 	 
	 	By:	 	 
	 	 	 	 
	Cc:	 	Daniel P. Filor	 
	 	 	Ellen London	 
	 	 	Carina H. Schoenberger	 
	 	 	Anthony T. Sheehan	 
	 	 	Roger A. Peterson	 
	 	 	Michael B. Van Sicklen	 
	 	 	Edward Froelich	 
	 	 	Robert Kovacev	 
	 	 	Sashka Koleva	 
	 	 	Jeanette A. Vargas	 


 




    	 



    	 



    

 









 





	
         ATTACHMENT
3



 




    	 



    	 



    






 





		U.S. Department of Justice
	 
	Tax Division
	 	 
	Please reply to:	Office of Review
	 	Post Office Box 310
	 	Ben Franklin Station
	 	 	Washington. D.C. 20044




 





KK:AR:ETPerelmuter


CMN 2011100390


 


April 4, 2013


 


	By Telecopier and Regular Mail 
	Lawrence M. Hill, Esquire 
	SHEARMAN & STERLING, LLP 
	599 Lexington Avenue 
	New York, NY 10022-6069




 





	Re:	Ambac Financial Group, Inc. v. United States,
    Adv. Proc. No. 10-4210 (Bankr. S.D.N.Y.); In the Matter of the
    Rehabilitation of Segregated Account of Ambac Assurance Corp., No. 10 CV 1576 (Wis. Circuit
    Court for Dane County); Theodore K. Nickel v. United States (7th Cir. - No. 1158);
    United States v. Wisconsin State Circuit Court for Dane County, et
    al. (7th Cir. - No. 11-1419)



    	
         

        Dear Mr. Hill:

         

        This
        refers to your offer dated February 24, 2012, as supplemented and modified by letter dated April 3, 2013, submitted on behalf of
        Ambac Financial Group, Inc. and Ambac Assurance Corporation. This offer has been accepted on behalf
        of the Attorney General on the terms set forth therein. The Internal Revenue Service is being informed of this action.

         


	 



    	 



    

 


	 	 	Sincerely yours,
	 	 	 
	 	 	Kathryn Keneally
	 	 	Assistant Attorney General
	 	 	 
	 	By:	
	 	 	Ann Reid
	 	 	Acting Chief, Office of Review


 




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