Government Bankruptcies: Needs of Citizens Take Priority Over Creditor Claims (Assured Guaranty v. Puerto Rico)

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Citizen needs take priority

By: Donald L Swanson

Puerto Rico’s long-standing financial straits, rendered more dire by Hurricane Maria, create an issue of bankruptcy priority: should available funds be used to, (i) address hurricane devastation and daily citizen needs, or (ii) pay creditor claims when due?

–The answer to this priority is simple and easy in Puerto Rico: citizen needs take priority.

But creditors of governments in dire straits are, often, oblivious to this priority, insisting on the same protections creditors receive in private-person bankruptcies.

–For example, creditors with liens on a government’s assets or revenues often think their liens should be respected and enforced, to the detriment of the needs of citizens in dire straits, like they would be in a private person’s bankruptcy. But they are wrong.

And it’s easy to see why they are wrong. Here’s what local governments commonly provide:

–Water, gas, electricity, cable, internet and other utilities

–Clean, maintained and safe streets, walkways, parks, pools and other accommodations

–Public transportation

–Police, fire, ambulance and other safety services

–Trash pickup, recycling, yard waste removal and similar services

–Schools with quality education and food services, along with athletics, music, drama, art and other extra-curriculars

–Courts, judges, prosecutors, public defenders, jury administrators, and other judicial services

–Tax assessment, collection and related processes

–Voting process administration

–Well-maintained facilities to house governmental operations

–Etc.

Businesses and individuals have no corresponding responsibilities. So . . . bankruptcy laws account and adjust for this reality.

A New Opinion

The Puerto Rico bankruptcy provides an example of the priority of essential government responsibilities over claims of secured creditors. The case is Assured Guaranty Corp. v. Commonwealth of Puerto Rico [Fn. 1]. The new opinion is dated January 30, 2018.

–Background

Plaintiffs in this lawsuit are “financial guarantee insurers” of public bond obligations in Puerto Rico.

One bond obligor is the Puerto Rico Highway and Transportation Authority (the “HTA”). Laws establishing this entity allow for, (i) liens of creditors on revenues from toll facilities, fuel taxes and motor vehicle license fees, and (ii) a sinking fund to receive and distribute such revenues to lien creditors.

–Chronology

In 2016, U.S. Congress adopts the Puerto Rico Oversight, Management, and Economic Stability Act (the “Act”) to help Puerto Rico and its public corporation restructure their debts in a bankruptcy-type proceeding.

–The Act establishes a Financial Oversight and Management Board to help “achieve fiscal responsibility and access to capital markets.” Thus far, the Board has certified two fiscal plans.

On July 1, 2016, HTA defaults on bond payments totaling $4.5 million, and Plaintiffs pay the insured amount of such defaults.

On January 1, 2017, HTA again defaults on bond payments totaling, this time, $1 million, and Plaintiffs, again, pay the insured amount.

On May 3 & 21, 2017, the Oversight Board files bankruptcy-type proceedings under the Act for Puerto Rico and for HTA.

–Complaint

On June 3, 2017, Plaintiffs files this lawsuit in the bankruptcy, (i) claiming HTA’s failure to make bond payments when due violates provisions of the Act, and (ii) requesting a declaration that sinking fund money be used to make bond payments when due.

–Plaintiffs claim that Puerto Rico’s fiscal plans unlawfully “redirect and misappropriate” the pledged toll, tax and fee revenues away from lien creditors.

–Ruling and Rationale

On January 30, 2018, the Bankruptcy Court dismisses Plaintiffs’ Complaint for failure to state a claim upon which relief can be granted. Here is its reasoning:

1. Plaintiffs rely on 11 U.S.C. § 928(a), which provides that “special revenues acquired by the debtor after the commencement of the case shall remain subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case.” The Court rejects this argument because § 928(a):

–contains “no language” requiring “payment of special revenues to the bondholders”;

–merely allows pre-petition liens to remain in place after bankruptcy filing; and

–does not, (i) address “lien enforcement” or “payment of the secured obligation,” (ii) provide an exception to the automatic bankruptcy stay against lien enforcement, or (iii) mandate any payment action by the debtor.

2. Plaintiffs also rely on 11 U.S.C. § 922(d), which provides that a bankruptcy petition “does not operate as a stay of application of pledged special revenues” to “payment of indebtedness secured by such revenues.” The Court rejects this argument because § 922(d):

–merely allows a debtor to voluntarily use pledged revenues to pay creditors—it does not enforce or mandate any such payments; and

–does not, (i) allow a creditor to enforce a lien on special revenues, (ii) allow a creditor to interfere with governmental revenues, or (iii) require that revenues be used to pay pre-petition obligations.

3. Plaintiffs claim, further, that lien creditors either own outright, or have a beneficial trust interest in, the sinking fund revenues. The Court rejects this argument because:

–it is inconsistent with language of the enabling legislation;

–a beneficial trust claim to the revenue is inconsistent with a claim to outright ownership; and

–a creditor is prohibited, by § 305 of the Act, from interfering with debtor’s “property or revenues” or its “use or enjoyment” of “any income producing property.”

Accordingly, the Court refuses to interfere with the Debtors’ use of the sinking fund money.

Conclusion

A government in financial stress is not the same as an individual or business in similar straits. A government’s ongoing responsibilities to its people, in a dire straits bankruptcy, must trump the demands and rights of creditors. Such a result is, of course, a far cry from what happens for individuals and businesses in bankruptcy.

The new Puerto Rico bankruptcy opinion described above is yet another illustration of this reality.

Footnote 1: This case appears, and is documented, on the docket of the Puerto Rico Bankruptcy Court at Adv. Proc. No. 17-155 & 17-156, but the heading on each filing on the Bankruptcy docket is this: “United States District Court for the District of Puerto Rico.”

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