Tuesday, September 17, 2019

PBA Creditors Refute Puerto Rico Fiscal Board Accusations of Sham Tactic Use

By on January 25, 2019

Editor’s note: The following originally appeared in the Jan. 24-30, 2019, issue of Caribbean Business.

The group PBA Funds, holders of Public Building Authority bonds, opposes Financial Oversight & Management Board (FOMB) attempts to annul $1 billion in lease payments and unpaid rent used to guarantee the bonds, arguing the PBA is a “sham.”

In another lawsuit, the Oversight Board is already trying to annul $6 billion in general-obligation (GO) debt because it violates constitutional debt limits; however, in that case, the board is also arguing that the PBA is a cover for certain financial transactions that were not included in debt calculations.

In a lawsuit filed Dec. 21, the Oversight Board said the PBA leases provide for the payment of about $401.6 million in annual “rent,” with an excess of $600 million in unpaid “rent” having accrued since the debtors’ respective petition dates. The board sought a court ruling that the leases are not “true leases,” but rather disguised financing transactions. “As a result, the PBA has no right under Promesa [the P.R. Oversight, Management & Economic Stability Act] or the Bankruptcy Code to receive post-petition rent payments from the debtors or administrative claims against the debtors,” the Oversight Board said, adding that some of the leases do not give rise to administrative claims against the government because the lessees are nondebtor entities.

PBA Funds said the board brought the litigation to mount pressure in anticipation of negotiations among various classes of creditors, with respect to a commonwealth adjustment plan. “They are not serious in seeking a judicial determination on the question of whether the PBA leases are true leases or a disguised financing,” PBA Funds said.

First, the group said, there is no allegation that any of the PBA Leases contain the crucial term that is the hallmark of financing: the ability of the tenant to convert monthly payments into equity or an ownership interest in the leased premises, as would be the case in a mortgage. “The case law on this issue is clear that without such an ownership interest, the ‘lease-disguised-as-financing’ argument fails,” PBA Funds said.

Those leases, PBA Funds added, continue to enjoy the presumption that they are true leases.

PBA Funds also noted that the Oversight Board is attacking the portion of the rent payments designed to service debt, but not the portion designed to cover operating expenses, such as the salaries and benefits of the PBA’s many hardworking employees.

“So, what is the rationale for filing a baseless action now? The complaint seemingly is nothing more than a transparent and futile attempt by the Official Unsecured Creditors Committee, which lacks standing to pursue the relief requested because it is not a tenant, landlord or third-party beneficiary under any of the leases at issue—to try and manufacture leverage in the mediation process for the benefit of certain creditors of the commonwealth at the expense of creditors of the PBA. A subsequent filing by the same plaintiffs removes any doubt that the complaint’s aims are purely tactical: The complaint was followed up by an equally inflammatory ‘omnibus objection’ to nearly half the commonwealth’s outstanding general-obligation debt, based in large part on the unsubstantiated premise that ‘the PBA structure is a sham,’” PBA Funds says.

Cofina deal may impact Constitution

On the other hand, U.S. District Court Judge Laura Taylor Swain took under advisement last week a ruling on the debt-adjustment plan for the Puerto Rico Sales Tax Financing Corp. (known as Cofina by its Spanish acronym) as well as on the settlement of the dispute between Cofina and general-obligation bondholders as she wanted to be careful about the repercussions of her ruling, worrying that it may have an impact on the island’s Constitution.

Approving the restructuring of Cofina’s $17 billion debt would legitimize the entity, whose constitutionality has been challenged in court and would validate the sales & use tax, which may not be changed over the next 40 years. The plan will virtually turn into federal law because it states all court disputes around it will be handled through the federal law Promesa in U.S. District Court. It will also change the definition of what constitutes “available resources” because Cofina will be used to pay for the restructuring.

During a hearing last week, Judge Swain went as far as asking whether the FOMB’s intent in seeking the confirmation of the Cofina debt deal was to rewrite the Constitution. Plan proponents wanted her to agree that the plan was federal law and 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, simply answered that she had the Constitution’s supremacy clause—which basically says federal laws have priority over state laws—to act. Kirpalani noted that Promesa already “overrides all territorial laws that are inconsistent with it.”

He suggested she could say in her order that the plan was federal law and 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 because there are certain limits to what she can do. Under Promesa, Swain cannot change the debt-adjustment plan because only the 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.

Judge Swain told Oversight Board lawyers to turn in several documents by this week, including supplemental material on the supremacy clause and on the validity provisions, to help her write a determination. A decision is slated to be made after that.

Cofina’s restructuring of its $17 billion debt has two parts. In the first part, commonwealth and Cofina bondholders settled their dispute over ownership of the sales & use tax (known as IVU by its Spanish acronym) by agreeing to divide the 5.5 percent portion of the total 11.5 percent sales & use tax. From the 5.5 percent portion, Cofina will keep 53.6 percent and the commonwealth will take the rest. According to court documents, the split will result in the commonwealth receiving about $400 million each year over the next 40 years from the sales & use tax.

Second, 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 percent of the value of their original bonds, while junior bondholders will recover 53 percent. Opponents of the deal asked the judge to wait until the Internal Revenue Service can decide whether the exchange of those bonds can be treated as taxable or as 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.

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