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The Commonwealth and the GOs, part 2

posted by Stephen Lubben

In my last post, I noted that the joint committee-Board objection to the 2012 and 2014 Puerto Rico GOs was at least plausible, and thus is likely headed for more extensive litigation. As Mark and Mitu have also noted, it also matters a good deal that the objectors also have arguments for why the claim on the bonds is not replaced by a similar claim for unjust enrichment or the like (although we might wonder if such a claim would enjoy the special constitutional priority the GOs do, if we think that priority really matters in a sovereign/muni bankruptcy process).

This past weekend, the FT's John Dizard quoted a hedge fund type as saying that the objectors' argument about the Building Authority's leases (see my prior post) was "nonsense." Not a lot of deep analysis there, but it does confirm there is a fight ahead. And we can assume that the Commonwealth's words will be used against it – after all, at the time of issuance, Puerto Rico and its agents undoubtedly said lots about how assuredly valid these bonds were.

The obvious conclusion is that the objectors have made this move as an opening shot in a broader play to negotiate a haircut with the GOs. After all, they look like they are almost done dealing with the COFINA debt, the other big chunk outstanding.

Sure. But what I find really interesting is the more subtle point that with this move, the objectors have also opened up some space between the GOs as a class. That is, presumably the non-challenged GOs will not have to take as severe of a haircut if $6 billion has already been knocked off the GO total. If I'm a holder of 2011 GOs (which I'm not, btw), I might then start to think that I don't really mind if the objectors win. And thus intra-GO warfare might break out.

Some asset managers are also going to face challenges if they have 2011 GOs in one fund, and 2014 GOs in another. And then there is Assured Guaranty Municipal Corp., which insured both the 2011 and 2012 (but not the 2014) ... 


The pre and post 2012 GO and PBA debt has traded 10 points wide for some time under the assumption that because of the general default the guarantee on the PBA debt would be triggered and recoveries on post 2012 debt would be lower (but not zero).

The Title 3 court issued an order for the development of the procedures to litigate the GO/PBA invalidation on Jan 31.

By my calculation this part of the process alone will take over 4 months before any schedule is agreed upon for litigation.

Meanwhile the term of the current Oversight Board members expires at the end of August. Likely creditors will push out litigation until these board members (who have not followed Promesa on multiple levels) will be replaced by Congress and President Trump.

Procedures order here: https://drive.google.com/file/d/1pnFHCbmPfIiLg2zBHjyI1eRxoAYdCEZO/view?usp=sharing

"When Invalidity Is an Unwillingness to Pay, Despite Past Representations

The High Court and many federal courts consistently supported bondholder rights in cases, like the current Puerto Rico dalliance with unwillingness to pay, when municipalities and state supreme courts attempted to invalidate/repudiate debt issued to good faith bond purchasers for good value provided to the government and the bond purchaser relied on the representation of the government issuer that all requirements for the valid issuance of the debt had been fully complied with prior to issuance.

The U.S. Supreme Court in a series of decisions, especially in its October 1875 term, reaffirmed a rule that previously had been followed in earlier U.S. Supreme Court decisions and even earlier common law rulings of England’s Court of the Exchequer. Namely, the claims of a bona fide holder of bonds against a state or local government issuer, in reliance upon recitals and representations at the time of issuance that the bonds were issued in full compliance with all requirements of the laws and constitutional provisions as determined by the issuer and its agents prior to issuance, must prevail.

The recitals and representations are conclusive.

This is more emphatically true when the conclusive determination is one peculiarly within the knowledge of the persons to whom the power to issue bonds has been granted, namely, the state or local government. See Town of Coloma v. Eaves, 92 U.S. 484 (1875); County of Moultrie v. Rockingham Ten-Cent Savings Bank, 92 U.S. 631 (1875); Marcy v. Township of Oswego, 92 U.S. 637 (1875). These cases focus on the party best able to detect any defect, which as a general rule, is the issuer.

In the Township of Oswego case, the Court was faced with the post-issuance questioning of the debt limitation being violated. The Supreme Court noted the prerequisite to issuance of debt is to answer the question of there being “sufficient taxable property to warrant the amount” of the bonds and that decision has been referred to the inquiry and determination of the issuer before bonds can be issued to bona fide bond purchasers. Accordingly, the bona fide bond purchaser is not required, when purchasing the bonds, to look beyond the acts of the government and its recitals/representations as to compliance with the constitution and laws of the state as contained in bonds and related documents. The Court rejected any belated post-issuance effort by the government to claim that the bonds were invalid due to a violation of the debt limit.

Invalidity Without Past Representation of Compliance

Some may note the U.S. Supreme Court has approved invalidating bonds that have violated the constitution and debt limits but in very different circumstances. See Buchanan v. City of Litchfield, 102 U.S. 278 (1880). However, the Litchfield ruling clearly pointed out that the failure to have any recitals or representations as to full compliance with constitutional provisions relating to debt limits and the failure to have any assessment valuation for the relevant year permitted the question of invalidity. The Court further noted that such questioning that would not be viable if there had been the recitals and representations made as was done in Knox County, Township of Oswego, Town of Coloma and the other cases previously decided by the U.S. Supreme Court. Clearly, the basis for Puerto Rico’s claim of invalidity of its general obligation bonds was rejected by both Litchfield and Township of Oswego decisions.

Even the Certificates of Participation (“COPs”) of the Detroit case, cited by the Puerto Rico movants, where the Emergency Manager claimed the COPs were the product of a “criminal mayor” and purportedly unsupported by any state statute or other precedent, resulted in a settlement, not a zero recovery for the investors."

Via James Spiotto (generally considered the leading muni bk commentator)


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