Red Alert: GO Bondholders Sue to Clawback Cofina Funds

On Thursday, October 6, 2016, I hosted a conference call for media and the general public on the status of the cases in federal court related to PROMESA and bond litigation in general. During the call, I mentioned that although no case had yet been filed, it was to be expected that some GO bondholders would claim that COFINA funds should be used to pay the island’s default on General Obligation bonds. On Friday October 7, Lex Claims requested from Judge Besosa leave to amend its complaint to include claims against COFINA. This is the proposed amended complaint.

Lex Claims’ First Cause of Action is amended by explaining that the Fiscal Oversight Board will not be in operations anytime soon, and Judge Besosa received testimony that it could take 6 months to be up and running. Hence, plaintiffs aver that only private enforcement of sections 204(c)(3) and 207 can provide relief of Puerto Rico’s illegal actions. Plaintiffs Second Cause of Action claims that Executive Order 2016-30 is preempted by section 303(3) of PROMESA because “it unlawfully subordinates the rights of holders of the Constitutional Debt to the rights of COFINA bondholders.” The Third Cause of Action alleges the Moratorium Law is preempted by Section 303(1). The Twelfth Cause of Action is a claim for violation of civil rights (42 U.S.C. § 1983) due to the violation of sections 204(c)(3), 207 and 303 of PROMESA.

Plaintiffs request in relation to COFINA, the following remedies:

“Declaring that, if given effect, the Commonwealth’s purported diversion of a portion of the SUT to COFINA would constitute an unlawful surrender or suspension of its power to collect taxes in violation of Article VI, Section 2 of the Puerto Rico Constitution . . .

Enjoining enforcement or implementation of the unlawful Executive Order and
the Moratorium Act, with such injunction requiring the Secretary of the Treasury to apply all “available resources,” including revenues previously derived from the collection of the Commonwealth’s SUT, to the repayment of the Constitutional Debt.”

In other words, plaintiffs want the Court to declare that they have a right to the COFINA stream of income to pay GO bonds first or what is more commonly known as clawback. As I said during my conference call, this was bound to happen and is happening now. Expect COFINA bondholders to seek intervention if Judge Besosa allows the amendment, which he probably will.

Plaintiffs are asking Judge Besosa to decide whether pursuant to Article VI, sec. 8 of the PR Constitution, COFINA funds are “available resources” to pay public debt. Judge Besosa could decide the issue or certify the question to the PR Supreme Court. By the certification mechanism, Judge Besosa would ask the PR Supreme Court to decide this important issue of Commonwealth Constitutional law. He may not do so, however, given the need for the issues to be decided quickly. Many federal judges here refuse to certify questions given the time the PR Supreme Court could take to decide such issues.

For those who may not know what COFINA is, it is a public corporation created for the sole purpose of issuing sales tax-backed revenue bonds. Some commentators have described COFINA as extra-constitutional debt, or illegal debt, and others have described it as a pay-day loan scam.

Some commentators such as the former head of the FDIC have said Cofina is extra-constitutional debt, or illegal debt, and others have described it as a pay-day loan scam. Many argue COFINA was created as a workaround to allow the government to continue borrowing without running up against the 15% constitutional debt limit of Article VI, section 2 of the PR Constitution.

COFINA is simply a collector of sales-tax revenue that issues bonds. While it may be, in a technical sense, a public corporation, the central government is the collector of sales tax revenue. It simply transfers that money out of the general fund and into an entity it created called COFINA – those revenues should be treated like part of the general fund just like any other government tax revenue.

What of causes of action Four to Eleven? Plaintiffs want to have these claims in the complaint but agree that they would be stayed. In other words, they are willing to wait for the stay to expire on its own to act on them. Essentially, plaintiffs want the Court to stop the Government’s actions they deem contrary to PROMESA until the stay expires or the Board is up and running. Let’s see what happens.