Judge to ‘seriously’ evaluate legality of Puerto Rico Sales Tax Financing Corp.
SAN JUAN – Judge Laura Taylor Swain said she will “seriously” take under advisement whether to grant a summary judgment declaring the Puerto Rico Sales Tax Financing Corp. (Cofina by its Spanish acronym) illegal and that pledged sales and use taxes (IVU by its Spanish acronym) backing its bonds belong to the commonwealth.
Based on questions she raised Tuesday during a four-hour hearing at a federal court in New York, Judge Swain appeared to be inclined to rule in favor of Cofina’s legality.
“Why can’t there be a transfer of future revenues [from the commonwealth to Cofina]? In determining who owns the sales and use tax, do I need to resolve the consequences of the elimination or reduction of the sales and use tax?” were just some of the questions she asked.
However, she also said items related to the dispute centering on whether debt from general obligation (GO) bonds is more important than Cofina debt, will be left for the April 25 omnibus hearing.
Her remarks were made in relation to a lawsuit filed by the Committee of Unsecured Creditors against Bettina Whyte, Cofina’s representative in the dispute. The corporation was created in 2006 to collect the IVU and issue debt. The law says the money is not part of the commonwealth’s available resources but used to back Cofina bonds. Those who argue Cofina is illegal say Puerto Rico accepted $16 billion in investor money based on false assurances that the pledged sales tax was transferred to Cofina, and that the tax is actually commonwealth property,
Cofina supporters contend the structure is legal and an exercise of legislative authority; opponents, namely GO bondholders and the unsecured creditors among others, contend otherwise. They say Cofina was created to circumvent debt limits and that IVU revenue should revert to the general fund and be used to pay GOs, which are backed by the full faith and credit of the Constitution. They want a summary judgment declaring that Cofina violates debt limits and the balanced-budget clause.
Mark Stancil, who spoke on behalf of the GO bondholders, said the commonwealth did not transfer ownership of tens of billions of dollars in IVU revenue to Cofina for two reasons.
First, that the purported transfer was prohibited by the island’s Constitution. Article VI provides protections to holders of constitutional debt by declaring all “available resources” of the commonwealth pledged to payment of the constitutional debt, requires the legislature to appropriate for those payments, and grants an immediate and express remedy to compel the secretary of the Treasury to turn over those payments.
“At the same time, Article VI protects the commonwealth itself—and its citizens—by constraining the commonwealth’s capacity to issue constitutional debt. It prevents the commonwealth from issuing or guaranteeing new constitutional debt unless no more than 15% of the commonwealth’s recent annual revenues would be devoted to such scheduled debt service in any future year, and it limits the term of those obligations to 30 years,” Stancil said.
The purported transfer of IVU revenue to Cofina, he added, seeks to “circumvent that constitutional scheme with the stroke of a pen.” The essential premise of the Cofina transfer is that the legislature has the authority to declare that a broad swath of the commonwealth’s core tax revenue is not an available resource of the commonwealth. “That is, Cofina rests on the notion that Puerto Rico’s political actors are free to announce that the Constitution simply does not apply to revenues it chooses to send to Cofina,” he added.
While Cofina started out as an effort to refinance certain debt, it quickly morphed into “a blank check for politicians unwilling to make difficult choices,” Stancil said, adding Cofina now seeks to divert more than $50 billion from the island’s coffers over the next four decades, “just to service existing Cofina bonds.”
He disputed the fact that the commonwealth truly transferred ownership of the sales and use tax to Cofina and argued that the commonwealth retains all elements of ownership under Cofina’s enabling act.
“Most notably, the Commonwealth has the unfettered right under the express terms of the Cofina statute to eliminate the Pledged Sales Taxes entirely, leaving Cofina with nothing. That provision was included because the Puerto Rico Constitution expressly bars the Commonwealth from surrendering its power to impose and collect taxes,” he said, adding, “the Commonwealth retains the power to reduce or eliminate the tax revenue that Cofina purportedly owns. One can hardly own something when its very existence depends on someone else’s largesse.”
Cofina’s financial structure reinforces these doubts about the transfer’s legal validity. Although the pledged sales taxes are purported “property of Cofina,” the corporation has no taxing authority. The tax is collected by the Treasury Department and from there the revenues are transferred to an account in Banco Popular and from there to the Bank of New York Mellon, which is the trustee of Cofina bonds. The structure routes only some of the sales tax revenue to Cofina for only part of the fiscal year. The rest of the funds go to the commonwealth.
The committee’s lawyer, Luc Despins, raised similar claims. He said Cofina gives the impression it is run separate from the government but in reality is controlled by the Government Development Bank, which is run by the government.
At one point, Judge Swain asked the lawyers which version of the Constitution, whether English or Spanish, she should use to define the term “available resources,” because it appeared that in the English version the term meant all of the resources. The lawyers argued that the English version prevailed because the Constitution had to be ratified by Congress.
Cofina supporters pointed out that state law defines property rights and the enabling Cofina law gives the corporation those rights.
The Cofina agent, through lawyer Antonio Yanez, said that the legislature had the power to transfer the pledged sales tax to Cofina and that a declaration in the law that the sales tax is “property of Cofina” is more than a statement of intent. The Cofina Enabling Legislation is the law of Puerto Rico that Cofina bondholders relied upon to invest billions, and must be enforced, he added.
While the commonwealth parties argued that the money was not truly transferred to Cofina, its supporters said there was at least a transfer of the right to receive the tax.
The legislature has broad powers to levy taxes and to dispose of that money, he said, denying commonwealth claims that the legislature’s taxing power is limited by debt limits imposed by the Constitution and the balanced-budget clause.
Yanez said the debt limits do not apply to Cofina because they are not “direct” obligations backed by the commonwealth’s full faith and credit, and that Cofina’s enabling legislation is not an “impermissible evasion of the constitutional debt limits” because the clause only applies to “full faith and credit” debt.
“Rather, the Puerto Rico Constitution, by its plain terms, gives the Legislative Assembly a choice between issuing ‘full faith and credit’ debt necessarily subject to Constitutional Debt Limits and non-‘full faith and credit’ debt not subject to those limits. Indeed, the framers of the Puerto Rico Constitution expressly contemplated that public corporation debt would not be taken into account when computing the Commonwealth’s borrowing margin,” he said.
Act 56 provides that IVU and all future funds belong to Cofina.
And by using the phrase “’are hereby transferred,’ the Legislative Assembly made clear that Cofina became the owner of the Pledged Sales Tax,” he said.
Despins replied that if the Cofina parties have it their way, the constitutional debt limits, debt priority and balanced-budget clause will be stripped of all meaning.
‘The Puerto Rico Constitution merits more respect,” he said, citing cases in which courts have voided bond issuances that violate debt limits.