A bankruptcy judge’s ruling concerning the Puerto Rico Highways and Transportation Authority has ramifications for bonds far beyond those of the authority, analysts say.

Title III bankruptcy Judge Laura Taylor Swain issued her ruling Friday in the Title III case and in a related adversary proceedings filed by Peaje Investments LLC. She denied Peaje’s motion for a preliminary injunction and for relief from the Puerto Rico Oversight, Management and Economic Stability Act’s stay on debt litigation.

Swain’s ruling shows that bond investors should, among other things, pay close attention to the exact legal language protecting their investments, Municipal Market Analytics said in its weekly Outlook.

Lisa Washburn, MMA

“Without a doubt … this is a victory for the [Oversight] Board’s continuous effort to destroy all bondholder liens in Puerto Rico,” Puerto Rico attorney John Mudd wrote in his weekly email on the Title III case. Mudd has represented one of Puerto Rico’s municipalities in the proceeding.

At issue in the case are the toll revenues that the authority collects. Peaje, which owns $65 million of the bonds, claimed that it had “lien rights” under the authority’s Enabling Act and the 1968 Resolution that set terms for the issue.

The Highways and Transportation Authority has been in payment default since early July 2016, according to Moody’s Investors Service.

Swain said that Bankruptcy Code section 922(d) allows an exception to PROMESA’s stay on debt litigation if pledged special revenues subject to a lien were present. Though Swain acknowledged that there were pledged special revenues, she said there was no “statutory lien” in the act or the 1968 resolution.

Swain said that was the only type of lien she would rule on, because other types weren't presented in the motion. Mudd said it was standard procedure to address only the argument that the litigant made. If Peaje had claimed a different type of lien, an “agreement lien,” Mudd said the judge probably would have ruled against that, too.

Swain said the Enabling Act only said that the authority’s resolutions could include liens – not that the act itself was creating liens. She said the 1968 resolution was created by the authority itself. According to her, “statutory liens” can only be created through legislation.

Swain said bondholders wouldn’t experience “irreparable harm” from a continuation of the non-payment of their bonds. The toll revenues were being used to maintain the roads, she said, and those properly-maintained roads were ultimately necessary for toll revenues to exist. She questioned the adequacy of testimony provided by Peaje’s experts.

Peaje wanted the judge to issue a preliminary injunction telling the authority to resume depositing toll revenues with the bond trustee or, alternately, remove the stay on debt-related lawsuits against the authority. She denied both. The case can and will go forward. However, Mudd said the chance that Peaje would prevail with Swain is quite unlikely.

“Judge Swain’s decision is consistent with what I have mentioned time and again: she adheres to the letter of the law,” Mudd said. “Judge Swain will give government witnesses great weight. Hence, opponents must come loaded for bear against them.”

In MMA's Outlook publication, managing director Lisa Washburn and partner Matt Fabian said Swain’s ruling “highlights industry-wide problems of: 1) inconsistent construction of state statutes that ostensibly provide bondholder security like statutory liens; 2) widespread investor acceptance of perceived legal protections regardless of the quality of the specific language relied upon, particularly when credit spreads are tight and supply scarce."

“Puerto Rico investors are being continually presented with (at least temporarily enforced) limitations on security protections that they had believed were much stronger,” Washburn and Fabian wrote. “These limitations spring from poor drafting (in the case of HTA), suspended disbelief (COFINA), and a political/judicial pivot towards empathy for the debtor regardless of all else (GO).”

While the first two are “controllable risks” the third one has become unavoidable in the municipal market, they wrote. “The only investor solution in this case is avoiding obligors in even remote danger of seeking a court-based debt restructuring prior to bond maturity.”

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