Puerto Rico Debt Case Starts With Squabble Among Bondholders

  • Commonwealth’s $123 billion bankruptcy hinges on sales taxes
  • ‘Failure is not an option,’ judge tells packed courtroom

How Did Puerto Rico Go Bankrupt?

Puerto Rico’s $123 billion bankruptcy can’t be resolved without first ending a long-standing dispute between different groups of bondholders, lawyers told the judge on the island’s first day in court.

The Wednesday hearing, which filled three courtrooms in San Juan with lawyers and reporters, was dominated by the fight between general obligation bondholders and creditors who’s debt is paid through sales taxes. The GO bondholders have challenged the legality of the bonds issued by the sales-tax agency, known as Cofina.

U.S. District Judge Laura Taylor Swain opened the hearing with a stark declaration that there isn’t enough money for the government to pay bondholders and still provide the same level of service it has in the past.

“The way forward will involve pain,” she said. 

She urged the bondholders, in particular, to try to move beyond their grievances in negotiations that will continue as the case progresses.

“Failure is not an option,” she said. “We cannot turn off all the lights and close the door on Puerto Rico.”

Local Investors

As lawyers for the various factions appeared before Swain, they took care to say their clients included bondholders who live on the island, or mutual funds serving Puerto Rican residents. Since Congress created an oversight board with broad power over the commonwealth’s government, the island has been rocked by regular protests, often involving University of Puerto Rico students.

One group has intentionally held back from protesting: retired workers seeking an official committee to represent them in the bankruptcy case.

“There is a temptation to want to take to the streets,” said their attorney, Robert Gordon of Clark Hill PLC. He has urged the group to avoid protesting or airing their complaints in the press until they have a chance to negotiate with the commonwealth and bondholders.

The U.S. Trustee, the Justice Department office responsible for appointing and monitoring official creditor committees, will file papers by May 19 on Gordon’s request for a retiree panel. The committees’ legal and other fees would be paid for by Puerto Rico.

The bondholder dispute at the heart of the restructuring case is so important that the federal oversight board may not even be able to propose a detailed plan to adjust the commonwealth’s debt until the fight ends, Martin Bienenstock, a lawyer for the board, told Swain. 

Instead, the board will try to get the groups to work out a deal. Failing that, the board will craft its own solution and present it to Swain, or simply let the parties duke it out in court, said Bienenstock, a partner at Proskauer Rose LLP.

‘No Surprise’

“It’s no surprise it’s about the money,” Bienenstock said.

Lawyers for the Cofina holders disagreed with Bienenstock’s assertion that the commonwealth had yet to take a stand on how the sales-tax proceeds should be spent, saying that a fiscal plan the oversight board crafted this year redirects sales tax revenue to other expenses, including government services and the general obligation bonds. That plan has not been formally implemented.

The case is so complicated that Cofina bondholders allied against the GO groups are also warring among themselves. Senior bondholders want Bank of New York Mellon Corp., the trustee for the bonds, to declare the debt in default and accelerate all payments. Junior bondholders disagree. A default would change which bondholders get paid. With a $16 million interest payment due on June 1, the trustee asked the judge to intervene.

Without ruling on the matter, Swain asked the lawyers to either resolve the issue or she would hold a hearing before June 1.

Puerto Rico filed separate cases two weeks ago under a specially crafted federal law that allows the commonwealth to use a bankruptcy-like process to reduce its staggering debts. One case is devoted to the Cofina obligations, while the other encompasses general obligation bonds and other debts. The cases will be jointly administered, meaning paperwork and other day-to-day matters will be consolidated, but will remain legally separate for now.

“The scope and scale of issues are frankly humbling,” Swain said.

The case is In re Commonwealth of Puerto Rico, 17-03283, U.S. District Court, District of Puerto Rico (San Juan).

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