The judge presiding over Puerto Rico's court-supervised restructuring has decided to withhold payment on $17 billion in sales-tax bonds until she decides how money should be divided among feuding creditors.
Ruling from a Manhattan courtroom linked via videoconference to viewers in San Juan, U.S. District Judge Laura Taylor Swain on Tuesday ordered "a freeze on all disbursements" to investors holding bonds known as Cofinas that are paid from local sales-tax revenues.
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Judge Swain's ruling, the first involving a substantive dispute between creditors since Puerto Rico entered bankruptcy earlier this month, means that a $16.3 million Cofina bond payment due on Thursday will instead be placed into escrow until she decides "who is rightfully entitled to it."
Subsequent monthly payments will also be escrowed, the judge said.
The decision marks a victory for Bank of New York Mellon Corp., the bond trustee caught between competing demands from hedge funds, mutual funds and bond insurers about which Cofina bonds, if any, should be paid out of roughly $400 million in available sales-tax money.
It is also a win for creditors holding general obligation bonds who are vying with Cofina bondholders for priority in the unprecedented bankruptcy.
The administration of Puerto Rico Gov. Ricardo Rossello had urged the judge to allow the payment, arguing that granting the trustee's request to freeze distributions would push Cofina into default and create new legal claims for creditors to assert.
While the payment scheduled for Thursday pales next to the amount of outstanding Cofina debt, the dispute is a microcosm of the tensions between competing creditor groups that hold different tranches of Puerto Rico's $73 billion pile of municipal bond debt.
"This is somewhat of a preliminary event," said Jonathan Polkes, an attorney representing MBIA Inc.'s National Public Finance Guarantee Corp. "The main event is coming."
Senior Cofina holders, including hedge fund Whitebox Advisors LLC and bond insurer Ambac Assurance Corp., contended that junior holders can't be paid because all Cofina bonds are now in default. Whitebox attorney Daniel Fliman told Judge Swain that seven defaults had already occurred and that all $16.3 million due this week should flow to senior holders as a result.
Junior Cofina holders asked to receive the $5 million in interest on their subordinated bonds and to preserve their claim on the sales-tax moneys. Lawyers also argued over whether the senior bonds had been accelerated and were immediately due and payable.
Meanwhile, creditors holding Puerto Rico's defaulted general obligation debt are making claims on the revenues backing the Cofina bonds, raising the question of which creditor group will be treated more favorably in an eventual restructuring.
Cofina bondholders, who have continued to be paid even as other Puerto Rico debt fell into default, are owed another small installment on July 1 and, more significantly, a $277 million payment on August 1.
Judge Swain cited the general obligation bondholders' claims against Cofina as a reason to hold back the payment, saying they demonstrated the conflicting theories surrounding the proper distribution of the funds.
The federal oversight board tasked with rehabilitating Puerto Rico's finances hasn't yet taken a position on the dispute. Martin Bienenstock, an attorney representing the board, told the judge he would soon propose a settlement protocol to try to move the warring camps toward a deal.
The U.S. territory accumulated its massive debt load through years of borrowing against a tax base sapped by poverty and out-migration to the U.S. mainland. Puerto Rico began issuing Cofinas a decade ago as a way to finance yawning budget gaps when the market lost confidence in the health of its general fund.
Write to Andrew Scurria at Andrew.Scurria@wsj.com
(END) Dow Jones Newswires
May 30, 2017 18:24 ET (22:24 GMT)