Judge Swain worries about rewriting Puerto Rico’s Constitution
SAN JUAN – U.S. District Court Judge Laura Taylor Swain took under advisement Thursday ruling on the debt-adjustment plan of the Puerto Rico Sales Tax Financing Corp. (Cofina by its Spanish acronym), as well as on the settlement of the dispute between holders of Cofina and general obligation bonds, wanting to consider the repercussions of her ruling carefully.
Approving the restructuring of Cofina’s $17 billion debt would legitimize the entity, whose constitutionality has been challenged in court and would validate the island’s sales and use tax, which may not be changed over the next 40 years. The plan will virtually turn into a federal law because it states that all court disputes around it will be handled through the federal Puerto Rico Oversight, Management and Economic Stability Act (Promesa) in U.S. District Court.
During the hearing, Judge Swain went as far as asking whether the island’s Financial Oversight and Management Board intent, in seeking the confirmation of the Cofina debt deal, was to rewrite the Constitution. Plan proponents wanted her to agree that it was federal law and that its ancillary documents also had the force of law. “I don’t think I am ready to do that,” she said.
Susheel Kirpalani, a lawyer representing the Senior Bondholders’ Coalition, said the judge had Constitution’s Supremacy Clause, which establishes federal laws preclude state laws, to act. Kirpalani noted that Promesa already “overrides all territory law that is inconsistent with it.”
He suggested she could say in her order that the plan was federal law and that its ancillary documents merely protect property rights.
Lawyer John Mudd told Caribbean Business that Judge Swain appeared to have misgivings about the wording in some of the provisions of Cofina’s debt plan, as there are certain limits to what she can do. Under Promesa, the judge cannot change the debt-adjustment plan because only the fiscal oversight board has the authority to do so. “She can say I do not want that in there but she cannot change the plan,” he said.
Law of the land
Judge Swain told fiscal board lawyers to turn in several documents by Monday, including supplemental material on the Supremacy Clause and on the validity provisions to help her write a determination.
The restructuring of Cofina’s $17 billion debt has two parts. In the first part, commonwealth and Cofina bondholders settled their dispute over ownership of the sales and use tax by agreeing to divide the 5.5% portion of the 11.5% sales and use tax. From the 5.5% portion, Cofina will keep 53.6% and the commonwealth receives the rest. According to court documents, the split will result in the commonwealth receiving about $400 million a year from the sales and use tax over the next 40 years.
Secondly, under the debt plan, Cofina bondholders will exchange their current bonds for new bonds whose value is being cut. Cofina senior bondholders will recover 93% of the value of their original bonds and junior bondholders 53%.
Opponents of the deal asked Judge Swain to wait until the Internal Revenue Service can decide whether the exchange of those bonds can be treated as taxable or tax-free. If the judge abides by the request, the deal could be further delayed because the IRS is being affected by the federal government’s partial shutdown.
Thursday, the second day of the hearing, focused on arguments in favor and against the Cofina deal, including from members of the public.
Lawyer Rolando Emmanuelli Jiménez, who represents the solidarity program of the Puerto Rico Electric Power Authority’s Irrigation & Electrical Workers Union (ProSol-Utier), said the fiscal board had failed to present evidence showing the debt-adjustment plan was reasonable and complies with Promesa.
Lawrence Dvores, a junior Cofina bondholder, complained that junior bondholders were not given the opportunity to participate in the negotiations. He also complained that the plan would exempt certain officials involved in the negotiations from liability.
Gilberto Lugo, a lawyer who represents several credit unions, said the plan cannot be approved without ensuring that his clients are able to continue their lawsuit, which accuses the government of misrepresenting the financial state of the government. Many credit unions purchased government bonds and are now having financial difficulties.
Gary F. Eisenberg, who represents GMS Group, which holds $500 million in junior Cofina bonds, suggested that Cofina may have filed for bankruptcy fraudulently because, in the past, it never had liquidity problems and had the money to pay bondholders.
The money has been kept at Bank of New York Mellon Corp. since 2017, when a ruling put a stop to payments. Eisenberg said the deal constitutes an illegal taking.
Paul Hein, a junior bondholder, said the plan discriminates against stateside residents who have Cofina bonds because they are not allowed to change their bonds for cash, like local bondholders can. “Puerto Ricans can elect a 2-percent cash payment,” he said.
He also accused the commonwealth of trying to avoid its obligations as it wastes thousands of dollars in outside contractors, paid millions in Christmas bonuses and enacted a reform that granted $2 billion in tax relief.
Mark Elliot, managing director of Elliot Asset Management, said Cofina senior bondholders stand to gain more than stated or well-above par as opposed to junior bondholders, whom he said will get less than 40% recovery according to his calculations.
Judge Swain also heard several members of the public. Puerto Rico Rep. Manuel Natal said approval of the Cofina deal must wait until the resolution of a lawsuit he filed in local courts–which was removed to federal court–challenging the legality of the latest Cofina enabling law passed last year. Natal contends that his rights were violated as a lawmaker because he was not allowed to speak at the session that evaluated the Cofina law.
There were entities in favor of the deal who refuted what opponents said. Marcia Goldstein, a lawyer for National Public Finance, which has about $500 million in Puerto Rico debt, said the company is committed to Puerto Rico. While she said National supported the debt settlement, it did so to avoid costly litigation and help push other restructurings.
Dennis Dunne, counsel for Ambac Assurance, said that at the end of the day “all of us had the choice to continue litigating or go into settlement.” He said, in the end, stakeholders said the incremental costs and uncertainty were worse.
He added that the issue about bondholders having a lien over Cofina bonds was “besides the point” because what needed to be resolved was whether Cofina or the commonwealth owns the sales and use tax. The court has no choice but to confirm the plan, he said. “If you have every class of bondholder supporting it, that ends it. If approval percentages are high, one must consider why a judge should think otherwise.”
He denied negotiations for the Cofina deal were held behind closed doors, saying the Cofina-Commonwealth dispute was negotiated among agents that had no pecuniary interest in the outcome. The bond exchange was mediated by a group of judges.
Paul Rosen, a lawyer for the fiscal board, insisted the deal will allow the government to have more money at its disposal. He said anyone who asked to participate in the negotiations was allowed to do so.
Rosen also said the board did not wish to put a stop to all litigation under the plan and that adversary proceedings will be allowed to continue. Investment bankers and underwriters were not exempted from liability under the Cofina plan, he added.
However, Rosen did not know whether former government officials who worked on the debt would be exempted from liability. “I am not persuaded that they should be excluded,” Judge Swain said.