Four investment funds holding Puerto Rico Sales Tax Financing Corp. senior bonds sued the trustee, Bank of New York Mellon, alleging that the issuer is in default and that BNY Mellon has breached its duty to bondholders.

Whitebox Advisors LLC controls the four funds: Whitebox Multi-Strategy Partners, L.P.; Whitebox Asymmetric Partners, L.P.; Whitebox Institutional Partners, L.P.; and Pandora Select Partners, L.P. They filed their suit over the bonds, known by the Spanish acronym COFINA, in New York Supreme Court for New York City on Wednesday.

“BNY Mellon has performed its obligations as trustee under the governing documents and will defend vigorously against this meritless suit,” BNY Mellon said in an email to The Bond Buyer.


The bondholders said that Puerto Rico Financial Agency and Fiscal Advisory Authority executive director Gerardo Portela Franco, left, made a statement undermining COFINA's sacrosanctity.
The bondholders said that Puerto Rico Financial Agency and Fiscal Advisory Authority executive director Gerardo Portela Franco, left, made a statement undermining COFINA's sacrosanctity.

While most other Puerto Rico debt is either in payment default or relying on debt security reserves to make payment, COFINA bonds continue to make payments without drawing on debt service reserves.
However, the plaintiffs say that Puerto Rico and COFINA have defaulted at least five times between them in the last two years.

They focus on what they see as breaches to two sections of the 2007 resolution that founded COFINA. Section 705 requires COFINA to “at all times defend, preserve, and protect the pledge of the pledged property [sales tax revenues] … against all claims and demands of all persons whomsoever.” Section 706 states that Puerto Rico’s government shall not “limit or restrict the rights … of [COFINA] to meet its obligations to its bondholders.”

In July 2016 some holders of Puerto Rico general obligation bonds sued Puerto Rico to protect their bonds against what was then a potential payment default. In their suit the plaintiffs said that the sales tax revenues were available resources for the payment of the GO bonds. “COFINA failed to take any steps to defend against such challenges, in clear violation of COFINA’s covenant to defend,” according to the suit.

As trustee Bank of New York Mellon was legally responsible for demanding COFINA take action against this suit and BNY Mellon didn’t do this, the litigants claim.

The plaintiffs made a similar complaint concerning the March 13 Puerto Rico Oversight Board fiscal plan. The plan assumes that sales taxes that have been promised to pay COFINA bonds will be diverted, according to the plaintiffs. This was a breach of the commonwealth’s promise not to limit or restrict COFINA to protect the bondholders.

The bondholders said that Puerto Rico Financial Agency and Fiscal Advisory Authority executive director Gerardo Portela Franco made a statement on Feb. 2 undermining the sacrosanctity of COFINA.

The litigants said that BNY Mellon should have declared Puerto Rico’s government in default after the fiscal plan's approval and taken steps to defend the COFINA senior bondholders.

The litigants hold COFINA senior capital appreciation bonds. Since these wouldn’t normally be paid out for many years and because in the meantime the litigants are worried about whether there will be enough money to pay them, the litigants say that the trustee should have exercised its right to accelerate all COFINA bonds. This would have led any money that was available to go to COFINA senior bonds, including capital appreciation bonds, in preference to the subordinate bonds.

In preparation for such acceleration the trustees should have not made distribution of debt service to COFINA holders on Feb. 1, the Whitebox group had told the trustee in January 2017.

However, the trustee made the payment, the Whitebox group complains.

The Whitebox group also tells the court that BNY Mellon has a conflict of interest because it represents both senior and subordinate COFINA holders. By failing to act on this conflict of interest by handling over the subordinate bonds to a “co-trustee,” the bank is failing to fulfill is fiduciary duties, the group says.

The plaintiffs ask the court to award compensatory and/or equitable relief for the plaintiffs against the bank “for breaches of its contractual and fiduciary duties, its gross negligence and ordinary negligence.” They ask for nominal damages for the breach of contract and an order that BNY Mellon appoint a separate trustee to handle certain classes of the bonds.

The law firm Kasowitz Benson Torres LLP is representing the litigants in the case.

On Thursday Fitch Ratings affirmed its C rating and negative rating watch on COFINA bonds, saying some sort of restructuring seemed inevitable.

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