Puerto Rico Title III bankruptcy judge Laura Taylor Swain was wrong in ruling that the island’s special revenue bonds shouldn’t continue to pay in bankruptcy, said municipal bankruptcy expert James Spiotto.

On Monday Swain ruled that the island’s special revenue bonds didn’t need to pay during the bankruptcy, in a Title III adversary proceeding filed by three bond insurers. While the bonds may have liens on revenue, that's not the same thing as the right to receive payments during the Title III bankruptcy, she ruled.

James Spiotto is Managing Director of Chapman Strategic Advisors LLC and a board member of the Retirement Security Initiative organization.
Municipal bankruptcy expert James Spiotto said that a judge's Title III ruling on Puerto Rico special revenue bonds breaks with established law and precedent. Retirement Security Initiative

She was ruling on bonds issued by the Puerto Rico Highways and Transportation Authority, Convention Center District Authority, and Infrastructure Finance Authority.

One of the bond insurers, Assured Guaranty, has said it will appeal the decision to the U.S. Court of Appeals for the First District in Boston.

Swain didn’t appreciate the purpose of 1988 amendments to the United States Bankruptcy Code for municipal bankruptcy, said Spiotto, who testified at the congressional hearings that led to the adoption of the amendments.

The whole point of the 1988 amendments was that special revenue bonds would be paid even in Chapter 9 municipal bankruptcy, Spiotto said.

These parts of Chapter 9 are part of Title III of the Puerto Rico Oversight, Management, and Economic Stability Act. Congress passed the act in summer of 2016 to deal with the Puerto Rico debt crisis. Title III is the part of the act set up to manage a bankruptcy process.

The U.S. Senate report on the 1988 amendments said, “The automatic stay that becomes effective against creditors of a municipality is made inapplicable to the payment of principal and interest of municipal bonds paid from pledged revenues. In this context, ‘pledged revenues’ includes funds in the possession of the bond trustee as well as other pledged revenues.”

In Monday’s decision Swain also ruled that the special reserve fund held in trust shouldn’t be released to the bondholders.

Spiotto noted that courts in the Jefferson County, Ala., and Stockton, Calif., bankruptcies directed that special revenue bonds continue to be paid through the bankruptcy. In the Vallejo, Calif. bankruptcy the city continued to pay such bonds despite the bankruptcy.

Most judges have very little if any experience with Chapter 9 bankruptcy and are much more familiar with corporate bankruptcy, Spiotto said. This may explain Swain’s error, he said.

Swain’s decision will need to be reconsidered either by an appellate court or by her.

Frank Shafroth, director of George Mason University’s Center of State and Local Leadership, also testified at the 1988 hearing but had a different view of Swain’s decision.

“As the court wrote, ‘Nothing in the language of [U.S. Bankruptcy Code] 922(d) requires debtors, or third parties holding special revenues, to apply the revenues to outstanding obligations.’ That is … the court takes into consideration ‘other constraints.’

“For Judge Swain, after all, the balance … involves the well-being, including public health and safety, measured against bondholder interests…. As someone who was present when the U.S. Senate Subcommittee on the Constitution reported out Chapter 9, it was clear from the get-go that Congress did not intend to preempt governance issues and decisions potentially affecting human health and safety.”

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.