The Cofina bonds include a repayment system wherein revenues from the Sales and Use Tax are used first to cover for what is owed to bondholders and whatever remains goes to the government. (horizontal-x3)
The Cofina bonds include a repayment system wherein revenues from the Sales and Use Tax are used first to cover for what is owed to bondholders and whatever remains goes to the government. (Shutterstock)

Managing Puerto Rico’s deb under a territorial bankruptcy process entails a path full of legal uncertainties that offer only two guaranties: bondholders will have no other option than to negotiate and the cuts in debt will go beyond what is owed to Wall Street.

On the one hand, the process for Tittle III of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), provides, in theory, that all claims for collecting against the government to be paralyzed until a restructuring of the government’s operations and debt is secured.

Therefore, the first to be affected in the process are the government’s creditors themselves, including those individuals and corporations who contracted with agencies and public corporations, because their payments for services already rendered could be delayed or even cut at the end of the process, expert bankruptcy processes’ attorney Rolando Emmanuelli explained.

At the same time, bankruptcy processes, such as the one established under Tittle III, allow for any non-essential expenses of the debtor to be questioned. That is why, a large portion of the debate over the Fiscal Plan and the PROMESA law revolves around what is an essential government service.

“Anything that is not an essential government services is going to be affected. The problem right now is that no one knows what that is because it’s not been defined,” said economist Antonio Fernós Sagebien.

In the certified Fiscal Plan, there is a general outline about what constitutes an essential service. However, the text only establishes some basic criteria.

If the government doesn’t define this it will end up being settled by the judge presiding over the case, Emmanuelli said.

Now, this decision, according to PROMESA, must respect the government’s priorities established in the Constitution and its laws. Among the priorities there is, on the one hand, the repayment of the constitutional debt and, on the other, the programs that allow the government comply with that established in the citizen’s Charter of Rights, a document which promises, among other things, security, health, education, and social wellbeing.

“Those are general concepts, but one could suspect that this could jeopardize donations by the government to entities who fail to comply directly with those criteria,” said Fernós Sagebien, wen estimating which services could be deemed non-essential.

Likewise, people or companies with business with the government could see their contracts cancelled in the middle of the operations’ and debt restructure process, if the court deems they are not of primordial importance.

In fact, these priorities will a large portion of the legal discussion which could be expected under a Tittle III. Emmanuelli was of the opinion that, for instance, among the first things to be ruled on by the court, will be the controversy over the priority for repayment between general obligations (GO’s) bondholders and bonds from the Puerto Rico Sales Tax Financing Corporation (Cofina).

The Cofina bonds include a repayment system wherein revenues from the Sales and Use Tax (IVU, by its Spanish acronym) are used first to cover for what is owed to bondholders and whatever remains goes to the government.

This system falls under a legal structure in which the IVU revenue is not considered government revenue until it reaches the General Fund. The GO bondholders, afforded with the main constitutional guaranty, question the legality of this scheme, because that repayment comes from the government’s legal capacity to levy taxes. It’s the same power that provides the revenue to pay the GO's.

The administration of governor Ricardo R ury to take money from the Cofina Trust if it needs to address any insufficiency of funds. This has been seen by bondholders as a breach of the agreements between the government and the court. That is why, yesterday, a group of Cofina bondholders sued the government and demanded from the court a ruling to declare this practice illegal. They argue, in part, that PROMESA establishes that in managing the debt repayment priorities will be respected and no assets may be transferred from one structure to another. “This is an important matter because whatever is decided will establish the priority in the Cofina repayment, which is one of the government’s largest debt," Emmanuelli said when estimating that this sort of controversy could reach the highest courts.

And that priority will be that which determines what each one’s share will be. In the case of the bankruptcy process in the city of Detroit, Michigan, the bonds with the most legal protections took a cut that was smaller than those that were devoid of protections or special guaranties, Emmanuelli explained.

The attorney, however, estimated that the cuts in Detroit, which in some cases exceeded 50% of the original bond value, were as severe because the municipal government didn’t have many assets to sell and raise the money necessary to repay bondholders.

This, however, is not the case of the government of Puerto Rico. Part of the government’s assets include multiple pieces of land, structures, beaches, easements, and public companies, among others. 


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