Puerto Rico bankruptcy Judge rejects key bondholder lines of attack

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Puerto Rico’s Title III bankruptcy judge, in dismissing a case filed by a bond insurer, threw cold water on bondholders' hopes of boosting their claims by challenging the island's fiscal plan.

The rejections came in a 46 page ruling Tuesday dismissing an Ambac Assurance adversary proceeding against the Puerto Rico Highways and Transportation Authority.

Ambac had filed seven claims for relief, some of them with multiple parts. Judge Laura Taylor Swain rejected most of them, and said the time wasn’t ripe to decide on the remaining ones. In essence, Ambac said it had the right to have the bonds it insured paid now in various ways and Swain rejected this right.

On May 3, 2017 -- the same day the Puerto Rico Oversight Board put Puerto Rico’s central government into Title III bankruptcy –– bond insurers Assured Guaranty and National Public Finance Guarantee filed an adversary proceeding in the case claiming the board’s fiscal plan was illegal because, among other things, it was inconsistent with the requirements of the Puerto Rico Oversight, Management, and Economic Stability Act.

While the insurers withdrew the suit in early October when it became clear that the board was going to revise the fiscal plan, they have been saying their legal strategy will continue to rely on similar arguments.

For example, in a Feb. 23 quarterly earnings call, Assured President Dominic Frederico said, “We expect that creditors will ultimately prevail in these avoidable courtroom disputes for a number of reasons, one of which is that … PROMESA requires that fiscal plans must respect constitutional priorities and contractual liens.”

Frederico was referring to PROMESA section 201(b).

In Tuesday’s Ambac decision Swain wrote, “The Oversight Board, pursuant to section 201(c)(3) of PROMESA, is specifically tasked with reviewing and approving proposed fiscal plans and is granted ‘sole discretion’ to determine in connection with such certification whether such fiscal plans satisfy the section 201(b) requirements….”

Swain said that PROMESA explicitly forbids her from reviewing board-certified fiscal plans. “To be meaningful, denial of jurisdiction to review the certification of the fiscal plan must be understood to preclude the review of claims that particular aspects of the fiscal plan are noncompliant with section 201(b) requirements.”

In Tuesday’s decision Swain also rejected another bondholder legal approach to restoring bond payment.

In its first claim for relief Ambac sought to have the court declare that Puerto Rico and the Highways and Transportation Authority had, through the diversion of funds away from the bonds, violated the Contracts Clause of Article 1 of the U.S. Constitution. Several other bondholder parties have made this claim in Puerto Rico Title III cases and adversary proceedings.

Over the course of eight pages Swain argued that this clause doesn’t compel an order for payment of the bonds now. The diversion of money away from paying the bonds started before PROMESA with Puerto Rico’s Moratorium Act and Moratorium Orders in April and May of 2016. Swain says the circumstances surrounding these acts make the abrogation of the bond contract legitimate and legal.

If Ambac had shown the act and the orders “unreasonable or unnecessary to effectuate an important governmental purpose,” then it would have a case, Swain said. But Swain said Puerto Rico faced a genuine fiscal emergency threatening the welfare of its people, and the actions were reasonable and legal in this context. Ambac failed to show that Puerto Rico had another viable approach.

James Spiotto, managing director of Chapman Strategic Advisors, said that Swain’s decision in late January on another adversary proceeding paved the road for the Ambac decision. Assured Guaranty and National were the plaintiffs that case, which also pertained to PRHTA bonds. She ruled that holders of these special revenue bonds didn’t have to be paid in bankruptcy after expenses were met and Puerto Rico’s general obligation holders were paid. Spiotto said that decision was carried over into Tuesday’s Ambac decision.

Swain also ruled that the PRHTA bondholders don’t have a lien on the money held by the bond trustee. Spiotto said that this deviated from the decision by the judge in the Jefferson County, Alabama bankruptcy.

In the January decision, “she took the wrong road,” and she is still on it in the Ambac decision, Spiotto said.

Assured and National have said they will be appealing the January decision.

Neither Ambac nor the PRHTA responded to a request for a comment.

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PROMESA Puerto Rico Highway & Transportation Authority Commonwealth of Puerto Rico University of Puerto Rico Puerto Rico Industrial Development Co Puerto Rico Employees Retirement System Puerto Rico Infrastructure Financial Authority Puerto Rico Aqueduct & Sewer Authority Puerto Rico Public Buildings Authority Puerto Rico Electric Power Authority Puerto Rico Public Finance Corporation Puerto Rico Sales Tax Financing Corp (COFINA) Government Development Bank for Puerto Rico Puerto Rico