The Puerto Rico Oversight Board sued over 230 government suppliers Tuesday, in a step to claw back some of $4.2 billion in payments made by the commonwealth in the run-up to its bankruptcy.
The suits filed Tuesday against non-bond creditors are seen as a step in the board's plan to claw back payments and fees from bondholders, underwriters and advisors before a Thursday deadline.
Clawing back money from suppliers is going to make it harder for Puerto Rico’s government to achieve fiscal responsibility and to ultimately gain access to the capital markets, said municipal bankruptcy expert James Spiotto. The suppliers may be less willing to work with the government in the future.
“If you’re going to live by the sword, you may die by the sword,” Spiotto said. If the board wants to try to claw back already-paid sums because of legal technicalities, the companies can also try to use the technicalities to their advantage. For example, they can refuse to supply goods and services unless they are paid on the first of the month if their contracts have this requirement.
Spiotto said that usually in municipal bankruptcy a government’s financial arrangements with suppliers are worked out in discussions and negotiations rather than through adversary complaints, bankruptcy’s version of law suits.
The process of pursuing the complaints could become messy and time consuming, Spiotto said. “The real question is not whether you can do it but does it make sense to do it?” Generally a debtor feels it needs to continue relationships with suppliers.
University of North Carolina School of Law Professor Melissa Jacoby said in an email, “Suing a high volume of suppliers for pre-bankruptcy transfers (especially ‘preferential transfers’ under 547 of the Bankruptcy Code) is typical in large corporate bankruptcies. To my knowledge it has not, however, been a common feature of other recent government (municipal) bankruptcies. This action is consistent with my belief that there is growing convergence between corporate and municipal restructurings.”
According to a board press statement, the board’s complaints are against individuals and entities to which the government had paid at least $2.5 million each from May 2013 to May 2017 “without a valid contract or for whom payments didn’t match the respective contract” during the four period.
The board went on, “The legal actions do not necessarily imply that the individuals and entities committed any wrongdoing. If a vendor demonstrates a proper basis for the payments, the Oversight Board will dismiss the claim.”
These sorts of government claims against suppliers are generally based on preferences, invalid contracts, or fraudulent conveyances, Spiotto said. Preferences focus on payments made within 90 days prior to a bankruptcy filing, which in this case was in May 2017. If the firm was paid in the 90 days period for work done prior to that period, under the law the money might be able to be clawed back.
Various factors will determine if the firms have valid contracts, said Spiotto, Chapman Strategic Advisors managing director.
In fraudulent conveyances, a government examines whether a supplier was paid more for its services in a period than the services were worth. Normally it looks at the two years prior to the bankruptcy but in this case it is looking at four years, Spiotto said.
Spiotto said the board might not be trying to get its money back from these firms but rather may seek to use the complaints to void the firms’ claims against the government.
An examination of one of the board’s complaints, that against TEC Contractors, LLC, reveals the board specified six claims for relief, drawing upon both federal bankruptcy law and local Puerto Rico law.
The first count stated that Puerto Rico law requires a written contract with a vendor and there appeared to be no such contract. The second count says that under federal law since Puerto Rico was insolvent during the two year’s prior to the bankruptcy, its payments made to TEC in the period were “fraudulent” and it can avoid them. The third count makes a similar argument but appeals to a different part of federal law and to a section of Puerto Rico law.
The fourth count said that TEC received more than it should have in the 90 day period prior to bankruptcy if the sum is compared it to the general settlement expected in the bankruptcy and that under federal law this money can be clawed back. The fifth count cites another federal law to claw back funds. The sixth count says that any of TEC’s claims against the board must be disallowed until the defendant returns money that Puerto Rico paid it.
TEC Contractors could not reached for comment, as the filing provided no contact information other than a mailing address.
