Puerto Rico government representatives told the judge for the Title III bankruptcy case that sales and use tax revenues used for paying Puerto Rico Sales Tax Corp. (COFINA) bonds belong to the territory's government.
The lawyers filed the claim Friday as part of an “adversary proceeding” in the case and in response to the judge’s request that they do so as part of the process of resolving the dispute between the commonwealth and COFINA holders.
Since at least Aug. 10 Title III Judge Laura Taylor Swain has made resolving the dispute on ownership of the pledged sales taxes a priority. Swain gave the lawyers representing the commonwealth position until the end of Friday to file their position.
Underneath the dispute over ownership is the commonwealth’s hope to restructure the $17.5 billion it currently owes in COFINA bonds. The Puerto Rico government argued that the commonwealth retained rights to the sales and use tax revenue backing the COFINA bonds and that the sale of the bonds violated debt limits in the commonwealth's constitution.
James Spiotto, who is managing director of Chapman Strategic Advisors and an attorney with municipal bankruptcy expertise, said the commonwealth’s arguments were weak.
There are precedents for Puerto Rico’s COFINA structure in New York City’s Sales Tax Asset Receivable Corp., set up in the mid-1970s, Spiotto said. In both cases lawyers thoroughly examined the structures for legality before they were set up.
“It is hard to say: what I represented to you isn’t true so therefore you take a loss,” Spiotto said, indicating that that was what Puerto Rico was effectively doing. “I’ve taken your money but you take a loss.”
Attorney Luc Despins and other attorneys with Paul Hastings LLP and Juan Casillas Ayala with Casillas, Santiago & Torres LLC represent the Official Committee of Unsecured Creditors. The committee acts for the interest of non-bond related creditors. In this matter the court has represented the committee as an “agent” of the interests of Puerto Rico’s government.
In the complaint the attorneys offer 13 causes of action for their claims. These largely take one of two approaches.
In one approach the attorneys state, “The COFINA enabling legislation did not transfer to COFINA present ownership of future sales and use tax revenues. Nor did it assign to COFINA the commonwealth’s ‘right to receive’ such revenues. At most, the purported transfer to COFINA of future SUT revenues amounted to an unsecured promise that yet-to-exist revenues would be transferred to COFINA in the future.”
The attorneys go on, “even if the transfer to COFINA was more than an unsecured promise and was not a secured transaction, it is still avoidable under applicable provisions of the Bankruptcy Code.”
In their other approach, the attorneys said the “the COFINA structure is unconstitutional because the substantial result of the COFINA enabling legislation was to evade or violate various provisions of the Puerto Rico constitution, including constitutional debt limits, the constitutional priority of payment (outside of Title III) granted to Puerto Rico’s public debtholders, and the constitution’s balanced budget clause.”
Against these attorneys, Spiotto said that COFINA has a statutory lien on the sales and use tax revenues and the Puerto Rico Oversight, Management and Economic Stability Act doesn’t give Swain the right to overturn a statutory lien.
Nevertheless, Spiotto said it would be in the interest of COFINA bondholders to negotiate some sort of restructuring of their bonds. “It’s always noted in distressed situations that the tree that bends in the wind doesn’t get uprooted.”
Swain has said she will issue a ruling on the commonwealth v. COFINA bondholders dispute by mid-December.