Editor’s note: The following originally appeared in the Feb. 21 -27, 2019, issue of Caribbean Business.
Bondholders of the Puerto Rico Sales Tax Financing Corp. (known as Cofina by its Spanish acronym) are moving forward with court challenges against the debt-adjustment plan although restructured bonds have begun to trade in the market.
Several labor unions and independent Rep. Manuel Natal provided notice they had filed an appeal in the U.S. First Circuit Court of Appeals against the deal. On the other hand, Elliot Asset Management, a Boston-based investment firm, said it was also going to challenge Cofina’s debt-adjustment plan, arguing it is unconstitutional.
James Sparks, principal at Elliot Asset Management, said Cofina’s debt-adjustment plan, approved Feb. 5 by the U.S. District Court, left junior Cofina bondholders with disproportionate losses of their investments while others are reaping benefits. He said the deal violates the constitutional contract clause that prohibits laws that retroactively go against contracts as well as the takings clause, which requires the government to pay just compensation for the taking of private property.
“No court can override the Constitution,” Sparks said, when asked about clauses in the deal that prevent collateral challenges to it.
The restructuring of Cofina’s $17 billion debt, which went into effect Feb. 12, has two parts. In the first, commonwealth and Cofina bondholders settled their dispute over ownership of the sales & use tax (IVU by its Spanish acronym) by agreeing to divide the 5.5 percent portion of the 11.5 percent IVU. From the 5.5 percent portion, Cofina will keep 53.6 percent and the commonwealth receives the rest. Secondly, under the debt plan, Cofina bondholders were to exchange their current bonds for new bonds whose value was cut. While Cofina senior bondholders are slated to recover 93 percent of the value of their original bonds, junior bondholders are slated to recover only 53 percent.
No adjustment without representation
The central argument of the proposed lawsuit is that junior Cofina bondholders were inadequately represented in the negotiations that led to the debt-adjustment plan and, as a result, obtained an unjust compensation for what they had invested.
According to a tabulation summary submitted Jan. 15 by Prime Clerk, the case manager, the Cofina bondholders were divided into 10 classes to determine which were entitled to vote. Holders in Class 4 (Senior Cofina Bond Claims [Taxable Election]) and Class 7 (Junior Cofina Bond Claims [Taxable Election]) were deemed to accept the plan. Class 10 or Section 510(b) Subordinated Claims were deemed to reject the plan and were not eligible to make an election of distribution under the plan.
The tabulation summary of the remaining classes, from 1 to 9, concluded that a majority supported the plan. In Class 1—consisting of Senior Cofina Bond claims with about 1,849 ballots—about 85.5 percent accepted the plan in its entirety, while 14.4 percent rejected it. In Class 2, consisting of Senior Cofina Bond claims held by Ambac, there was only one vote accepting the plan. Class 3, consisting of Senior Cofina Bonds held by National, only listed one vote for the plan. In Class 5, consisting of Junior Cofina bonds, about 67.5 percent of the 9,359 votes supported the plan while 32.4 percent rejected it. Class 6, comprising junior Cofina bonds held by Assured, only showed one vote, which was in favor of the plan. Class 8, composed of GS Derivative claims, showed that no ballots were received and was deemed to have accepted the plan. In Class 9, comprised of general unsecured claims, only two ballots were received, which were in favor of the plan.
During court proceedings to approve the plan, several junior Cofina bondholders complained they had not been involved in the negotiations over the Commonwealth-Cofina dispute involving ownership of the sales & use tax revenue. Some bondholders said that although Cofina bonds are secured by a statutory lien, money from the IVU was given to the commonwealth without evidence to demonstrate Cofina’s legality—which was challenged by commonwealth general-obligation bondholders—and would not have been upheld by a court of law.
Institutional investors, holding both senior and subordinate bonds that they had bought at very cheap prices, along with the commonwealth and the Financial Oversight & Management Board, were the ones that negotiated the plan of adjustment. A recent Wall Street Journal report quoted an anonymous Oppenheimer Fund source as stating that junior bondholders got the wrong deal in the bargain.
Sparks said losses incurred by junior bondholders as part of the deal were unjustified because Cofina was a solvent entity before it filed for bankruptcy and there is currently enough money to pay bondholders the amounts that they are due. Under the design of the debt-adjustment plan, however, “seniors are getting more than a dollar and juniors less than 50 cents,” he said.
This week, Cofina investors participating in the bond exchange, which went into effect Feb. 12, noticed that their accounts did not add up. Cate Long, who leads a research service for Puerto Rico bondholders, published on Twitter that a subordinate current interest bond, which should have had a recovery of 56 percent or $2,800 (56% of $5,000). “Instead, the bondholder was given $1,086 between cash and one splinter bond. Useless,” she wrote.
Junior Cofina bondholders got an unfair deal because they were represented in negotiations by groups that also held senior Cofina bonds in a conflict of interest. Franklin Templeton sold the lion’s share of its Puerto Rico debt, including Cofina junior bonds. Five of the funds in the Cofina Senior Bondholders Coalition—Aristeia Capital, GoldenTree, Old Bellows, Tilden Park and Taconic Capital—made huge purchases of more than $1 billion in subordinated bonds just after Hurricane Maria, when prices fell.
Groups such as the Senior Bondholders Coalition could not represent junior bondholders while also representing senior bondholders at the same time. The president of Elliot Asset Management said the Senior Coalition’s only claim to junior representation is the fact that many senior bondholders also own junior bonds, which were purchased at rock-bottom prices.
“All those people bought the bonds at cheap prices, bought votes and made a lot of money,” said Elliot, whose firm represents many individual retail Cofina bondholders.
Bonistas de Patio, a local nonprofit group representing bondholders that claimed to represent bondholders in general, were inaccessible. “Nobody could reach them. They did not return calls,” Sparks said, adding that a request made by Bonistas for $7 million in legal fees for their role in the debt-adjustment plan “is ridiculous.”
Elliot said the process that led to the confirmation of the Cofina deal was also done in a way that made it difficult for investors to make an informed choice or to even cast votes against the deal—in part because the “800 pages of legalese” was mailed during the holiday season when many investors were traveling.
He also criticized Judge Laura Taylor Swain for sidetracking many retail investors. After initially saying she was going to take letters sent to her for her consideration in the process, she then said she would only take into account legal documents submitted in court. “She said in court she was considering all letters…. Many of us wrote in [to her],” Elliot said.
In court documents prior to the confirmation of Cofina’s debt-adjustment plan, Elliot had suggested alternatives to the deal’s current distribution. “Putting aside the fact that there exists enough revenue to cover all existing Cofina bonds, and since most outstanding Cofina bonds are callable, the commonwealth could immediately call the existing bonds and then issue new bonds with lower interest rates. The commonwealth would save money on interest going forward and satisfy 100 percent of its outstanding, and constitutional, obligations to Cofina bondholders,” he said.