U.S. District Judge Laura Taylor Swain has approved a plan to restructure nearly $18 billion of Puerto Rico’s Sales Tax Financing Corp. (COFINA) debt. Judge Swain, who is based in New York but oversees Puerto Rico’s bankruptcy-like proceedings, said the Court believes that the COFINA plan is essential to the island’s financial recovery efforts.
The approval from Judge Swain required a two-step process. First, she had to determine whether the settlement agreement between COFINA bondholders and the Commonwealth was fair and reasonable. The agreement effectively provides a 53.65%/46.35% allocation of Puerto Rico’s Sales and Use Tax (“SUT”) revenue between COFINA and the Commonwealth, respectively. Judge Swain determined that the settlement “was a fair and reasonable settlement and compromise of the Commonwealth-COFINA Dispute given the substantial risks of litigation ….”
In total, Puerto Rico owes over $70 billion to bondholders and other creditors, as well as another $50 billion in unfunded pension obligations. The territory has been attempting to restructure this $120 billion of liabilities since it filed for bankruptcy-like protection in May of 2017.
Puerto Rico’s Financial Oversight Board, which has been spearheading the territory’s efforts to recover from its debt crisis, said that the COFINA/Commonwealth settlement will reduce debt services on COFINA bonds by $17.5 billion over the 40-year life of these new bonds and that this should save the island $456 million yearly. Futures SUT revenue that was supposed to go solely to COFINA will now be able to help support the Commonwealth. All of these issues clearly weighed on why Judge Swain decided to approve the settlement.
The deal also tackles a “gating issue” regarding sales tax liens and their validity, as well as how much those monies can be used to fulfill the island’s general debt obligations. According to Law360, resolving this issue has been integral to moving forward the debt restructuring proceedings that were put into place under the 2016 Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). It was under PROMESA that the U.S. territory was able to file for bankruptcy-like proceedings last year.
After determining that the settlement was fair and reasonable, Judge Swain turned to the COFINA Plan, which determined how the portion of the SUT allocated to COFINA bondholders would be split between the senior and junior/subordinate bondholders. Under the COFINA Plan, over a 40-year time period, Senior COFINA bondholders will receive a 93.01% recovery on their bonds while Junior/Subordinate bondholders will receive a 56.41% recovery.
While there were substantial objections from several groups of subordinate bondholders, Judge Swain ruled that “the Plan is hereby confirmed and the objections are overruled.” In finding that the COFINA Plan should be approved, she went through the “lengthy process leading to the Plan’s formulation” and found that the COFINA Plan was a fair plan considering “the totality of the circumstances.” She determined that the Plan was formulated “in good faith,” answering challenges from some subordinate bondholders who argued that the COFINA Plan was not fairly negotiated with their interests in mind.
COFINA bondholders holding about $14.5 billion of COFINA bonds have supported the COFINA Plan. The majority of senior bondholders, including hedge funds, are expected to make huge profits because of the COFINA Plan. Subordinated bondholders of COFINA, including many retirees, however, are not expected to be so lucky. Many subordinated bondholders are residents of Puerto Rico, including local businesses, retail investors, and others. Effectively, it appears as if institutional investors may end up profiting from the collapse of Puerto Rico, while individuals are left taking all the losses.
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