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Puerto Rico: Commonwealth-COFINA Dispute Teed Up for Resolution by Year’s End


On May 3, 2017, the Financial Oversight and Management Board for Puerto Rico (“Oversight Board”), which was established under the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”), filed a voluntary petition for relief for the Commonwealth of Puerto Rico (the “Commonwealth”).  On May 5, Chief Justice Roberts appointed District Judge Laura Taylor Swain of the Southern District of New York to conduct the case.  Judge Swain was a bankruptcy judge in the Eastern District of New York before joining the district court in 2000. 

The Commonwealth’s bankruptcy case is not technically a bankruptcy case at all, because it was not filed under any Chapter of Title 11 of the United States Code, i.e., the Bankruptcy Code.  However, this is largely (though not entirely) a distinction without a difference:  Section 2161(a) of PROMESA provides that all or parts of 98 different Bankruptcy Code sections will apply to the Commonwealth’s case, including the automatic stay and provisions concerning the allowance of claims, the avoidance of prepetition transactions, the formation of a creditors’ committee, and plans of reorganization.


The Puerto Rico Sales Tax Financing Corporation (“COFINA”) is a government-owned corporation that issued bonds (the “COFINA Bonds”) to pay capital expenses and refinance the Commonwealth’s debt.  On May 5, 2017, two days after the commencement of the Commonwealth’s case, the Oversight Board filed a voluntary petition for COFINA, which case is being jointly administered with the Commonwealth’s case.

The COFINA Bonds are non-recourse bonds that are payable from and secured by a security interest in sales and use tax collected by the Commonwealth.  COFINA’s annual share of the sales and use tax is the greater of (i) a fixed amount (currently ~$750 million), which grows at 4% per year, or (ii) 2.75% of the sales and use tax collected that is shared between the Commonwealth and COFINA. 

One of the central disputes in these cases is whether the sales and use taxes pledged by COFINA to secure the COFINA Bonds belong to the Commonwealth or COFINA  (the “Commonwealth-COFINA Dispute”).  If they belong to the Commonwealth, then there may be no funds available to pay COFINA debt.  If they belong to COFINA, then the Commonwealth will not have access to these funds to pay its other liabilities and expenses.

The Dispute Resolution Stipulation and the Scheduling Order

On August 10, 2017, Judge Swain entered a stipulated order establishing procedures to govern resolution of the Commonwealth-COFINA dispute (the “Resolution Stipulation”).  In recognition of the fact that the Oversight Board acts for both the Commonwealth and COFINA, the Resolution Stipulation provides for appointment of agents to act independently for each of them:  (i) the Creditors’ Committee, to serve as the Commonwealth’s representative to litigate and/or settle the Commonwealth-COFINA Dispute on behalf of the Commonwealth (the “Commonwealth Agent”) and (ii) Bettina Whyte, an experienced restructuring professional who is currently Managing Director and Senior Advisor of Alvarez & Marsal, LLC,  to serve as the COFINA representative to litigate and/or settle the Commonwealth-COFINA Dispute on behalf of COFINA (the “COFINA Agent,” and, with the Commonwealth Agent, the “Agents”). 

The duties of the Agents are fiduciary in nature.  “Each Agent shall have a duty of good faith, care, and loyalty to the Debtor the Agent represents. In furtherance of such duties, each Agent shall, with the advice and assistance of counsel, endeavor to the best of the Agent’s ability under the circumstances to litigate and negotiate from the perspective of what result is best for the Debtor the Agent represents, as opposed to what result is best for any particular type of creditor of the Debtor the Agent represents.”    In addition, “each Agent may consider what result, through litigation, negotiation and mediation, will render its Debtor best able to achieve fiscal responsibility and access to the capital markets, in the judgment of each Agent.”  Finally, the Agents are expressly prohibited from litigating or negotiating intra-bondholder issues among the holders of the COFINA bonds (or between or among such bondholders and any insurer of those bonds). 

The Resolution Stipulation required the Agents to meet and confer regarding the time and form of litigation to resolve the Commonwealth-COFINA Dispute and to agree on a schedule that would enable the Court to rule, on a final basis, on the Commonwealth-COFINA Dispute, on or before December 15, 2017.  The parties complied with this requirement and submitted an agreed scheduling stipulation that Judge Swain approved on September 1 (“Scheduling Stipulation”). 

Pursuant to the Scheduling Stipulation, the Commonwealth Agent filed its Complaint on September 8, commencing Adversary Proceeding 17-257 (the “Commonwealth-COFINA Adversary”).  On September 12, the Commonwealth-COFINA Adversary was referred to Magistrate Judge Judith G. Dein of the U.S. District Court for the District of Massachusetts for pre-trial management.  On September 15, the COFINA Agent filed an answer to the Complaint and asserted eight counterclaims for declaratory judgment regarding the enforceability of the COFINA structure.   Discovery is scheduled to be completed no later than November 3, and briefing is scheduled to conclude no later than November 27.  The Court has reserved December 4-8 for a trial in the Commonwealth-COFINA Dispute.

We will continue to monitor the Commonwealth-COFINA Dispute and provide periodic updates as new developments arise.