Yesterday, the Oversight Board filed a lawsuit against Puerto Rico Public Buildings Authority (PBA) since they understand that rental payments made by a dozen agencies to that public corporation are not true leases but “disguised financing transaction” that contributed to the issuance of PBA bonds for $4 billion.
In order to file their lawsuit against PBA, and also for the first time, the Board –that on behalf of the Puerto Rican government assumes the role of debtor in PROMESA Title III cases- joined forces with the Unsecured Creditors Committee (UCC). The intention is to cancel some 1,900 existing contracts that may represent about $401 million in rental payments -made by agencies such as the Department of Education and the Treasury annually- and to eliminate any claim on payment priority that the public corporation, its bondholders or third parties may file against the government.
This claim came up yesterday, just two days after Martin Bienenstock –the main legal advisor for the Board- revealed at the Title III general hearing that the process to reach a consensual negotiation with different creditors may fail. And that due to a controversy over the rent that the government pays to PBA and other issues related to the Kobre & Kim Debt Investigation Report.
According to the litigation filed by Bienenstock and his colleague Hermann D. Bauer –from O´Neill & Borges- as well as the main legal advisor for the UCC, Luc A. Despins and Juan J. Casillas from Casillas, Santiago & Torres, the relief sought is important for the debtor to emerge from Title III.
“Rental payments” for 20 years
According to the lawsuit, the “disguised” financing structure started in the mid-1990s when they created a mechanism for PBA to issue bonds to finance purchases, improvements and maintenance to buildings that were going to be used by some government agencies. In 2011, PBA issued revenue bonds, these are obligations of and payable from “the net revenues of the public corporation” that issued them.
According to the document, through PBA bonds, such debt would count on some tax on the funds –resulting from the alleged “rent” paid by agencies- in some PBA accounts.
However, and according to the document that is now before the consideration of Judge Laura Taylor Swain, the analysis conducted by the Board and the UCC suggests that these leases between PBA and government agencies are not related to the activities of a public corporation dedicated to the rental of buildings.
Actually, and as stated in the lawsuit, the wording and validity of such contracts states that PBA bonds are payable from and secure by a pledge of the rental payments owed by the “governmental entity that leased the building.”
The validity of the contracts is the same of that of the PBA bonds and, in some cases, contracts provide that the entity leasing the building would cover the expenses of the debt restructuring process of that public corporation.
The lawsuit also states that, in addition, each lease contains an 'absolute and unconditional' provision that requires the tenant to pay full 'rent', at all times, and under all circumstances for the rental period even if the property has been sold or destroyed, even if that were a PBA responsibility.
For the Board and the UCC, another mechanism that proves that PBA leasing contracts were a disguised financing transaction was created when some of the buildings that PBA rents to sister agencies belong to the central government.
As part of the agreement, read the lawsuit, the central government -as owner - rented the building to PBA for a royalty of $10. The same day that contract was signed, PBA rented that building to another agency for amount that would cover the principal and the bonds issued by the public corporation.
There were two contracts following this procedure, signed between August and September 2011 by the Department of Education, according to the lawsuit.
Since the government invoked PROMESA Title III, PBA did not receive income for rent what led to a debt of more than $600 million, said the Board and the UCC.
Early in 2018, some bondholders requested in court to resume rental payments for the public corporation. Then, Swain decided that PBA would have priority over "rent" that agencies have not paid, unless it was determined that such agreements do not meet the requirements of a lease under Section 365 (d) (3) of the Bankruptcy Code.
In this scenario, the lawsuit filed by the Board seems to open a Pandora's box regarding the PBA debt. But, in turn, the arguments of the Board and the UCC on the use of a financial structure to issue debt in PBA are similar to the findings of the Board´s independent investigator in other entities exclusively created to issue debt as the Public Finance Corporation and the Sales Tax Financing Corporation (Cofina), whose repayments were not included in the constitutional Debt Limit Calculation.
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