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Tangled Web of Disputes on Legality of Cofina Structure

By on May 24, 2017

SAN JUAN — Although Puerto Rico Fiscal Agency & Financial Advisory Authority (Fafaa) officials have not taken sides in the dispute between Puerto Rico Sales Tax Financing Corp. (Cofina) bondholders and general-obligation (GO) bondholders over the legality of Cofina’s structure, a letter included in a lawsuit may show otherwise.

The letter written on behalf of Fafaa on May 16 by O’Melveny & Myers lawyer John J. Rapisardi to Eric Schaffer, a lawyer at ReedSmith, states that funds held at the Bank of New York Mellon (BNYM), the trustee of sales-tax revenue bonds issued by Cofina, are the property of Cofina. The assertion appears to support the corporation’s legality.

On May 17, during the first day of hearings in the bankruptcy petitions filed by the Financial Oversight & Management Board (FOMB) on behalf of Cofina and the Commonwealth of Puerto Rico, Martin Bienenstock, a lawyer representing the FOMB, said the government had not taken a stand on the dispute between Cofina and GO bondholders.

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On May 16, BNYM filed a complaint against the FOMB seeking an interpleader and declaratory relief because, on June 1, the board is slated to distribute $16.3 million to Cofina bondholders, but various groups of Cofina bondholders dispute who is entitled to the funds, subjecting the bank to different claims.

A group of senior beneficial bondholders and an insurer of certain senior Cofina bonds have sued BNYM in New York to compel the bank to declare events of default against the local government. They claim that because the Fiscal Plan Compliance Law will allow the commonwealth to take Cofina revenues to pay for various government services, a default should be declared.

By contrast, a group of subordinate beneficial holders of Cofina bonds argues that there is no default and they should be paid as usual. Cofina, on the other hand, contends that no default has occurred and that if any pledged sales-tax revenues were to be diverted, it would still have 30 days to “cure” any default.

In addition to the disputes among Cofina bondholders, GO bondholders are alleging the entire Cofina structure violates the Puerto Rico Constitution. Therefore, they say all sales-tax revenue, including such funds deposited at BNYM, should be available for general use by the commonwealth, including to pay GOs.

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In the letter to Schaffer, on behalf of Fafaa, Rapisardi said he was writing to present “our position regarding ownership of the accounts pledged as security for Cofina’s obligations under the bonds and held by the trustee,” referring to the BNYM.

He noted that under the law, all pledged property deposited in a so-called fondo de interés apremiante (FIA) account “shall be the property of Cofina.” Rapisardi was referring to the Dedicated Sales Tax Fund, known as FIA by its Spanish acronym. These funds are transferred from FIA and deposited in the accounts held by the trustee. The accounts are not the property of bondholders even though they have a lien, he said.

The letter also reiterates the authority granted by law to Cofina to direct use of the assets held in the accounts for general purposes.

Under the bond resolution, “Cofina can order the trustee, after certain obligations have been satisfied from the revenue account to ‘release to the corporation, free and clear from the lien of this resolution (the funds of the revenue account) to be applied for any lawful purpose of the corporation.’”

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While the wording in the letter appears to support Cofina’s legality, Rolando Emmanuelli, a bankruptcy lawyer, said he believes the government is not making an adjudication of the dispute between Cofina and GO bondholders, but merely restating that the monies held by the trustee belong to Cofina.

Judge Laura Taylor Swain, at the May 17 hearing on Puerto Rico’s Title III bankruptcy proceedings, did not go into BNYM’s petition and merely told the parties to seek a solution.

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