Puerto Rico Claims It Has No Fiduciary Duty to Protect Creditors

(Bloomberg) -- Puerto Rico, the biggest government in the U.S. to ever go bankrupt, will argue this week that it shouldn’t be treated like a broke business during the proceedings: Its residents, not creditors, should come first.

Government lawyers will argue with bondholders Wednesday in federal court in San Juan over what ground rules should apply in the forthcoming legal battle at the heart of the $74 billion restructuring.

Creditors want U.S. District Court Judge Laura Taylor Swain to declare that government agencies that issued or guaranteed debt bear the same legal responsibilities imposed on corporations in bankruptcy. That could mean putting creditors ahead of residents in the competition for limited public finances.

“It’s a big deal,” retired U.S. Bankruptcy Judge Richard Schmidt said in an interview. “The government may be trying to give itself the flexibility to make decisions that may not be in the best interest” of some of its creditors.

Before Puerto Rico submits the details of its debt-cutting plan to court, the government and most creditor groups want a judge to decide who has first call on sales-taxes, one of the island’s most important sources of cash. Deciding that so-called gating issue is likely to require an expensive, months-long court fight pitting general-obligation bondholders against creditors of the sales-tax agency, known as Cofina.

Puerto Rico Claims It Has No Fiduciary Duty to Protect Creditors

On Wednesday, Swain will consider appointing separate agents who would potentially take opposing views on that dispute. One to represent the interest of the commonwealth, and indirectly general obligation bondholders, and one to represent Cofina and its creditors.

That fight must be resolved by November, or the island may need to fund government operations using the disputed sales taxes, according to the federal oversight board that put Puerto Rico and some of its government agencies into bankruptcy.

One creditor group has asked Swain to send the question to the Supreme Court of Puerto Rico because the dispute involves how to interpret the island’s constitution. Swain will hear that request on Wednesday.

Also on Wednesday, the lead mediator appointed by Swain will make a presentation laying out how mediation will work. Earlier this month, Swain appointed a panel of sitting judges to help mediate the most pressing disputes in the case, including the sales-tax conflict.

The case is In re Commonwealth of Puerto Rico, 17-03283, U.S. District Court, District of Puerto Rico (San Juan).