LEGAL ANALYSIS: Judge Swain’s PRHTA statutory lien decision instructive for other Puerto Rico bondholders - Debtwire

LEGAL ANALYSIS: Judge Swain’s PRHTA statutory lien decision instructive for other Puerto Rico bondholders

21 November 2017 - 12:00 am

Judge Laura Taylor Swain recently denied Peaje Investments LLC’s request for a preliminary injunction directing the Puerto Rico Highways & Transportation Authority (PRHTA) to resume depositing with a fiscal agent toll revenues that had been pledged to pay holders of PRHTA bonds, including Peaje.[1]  After the governor of Puerto Rico had declared a state of emergency in April 2016, PRHTA had stopped making the deposits in order to use the funds to maintain the commonwealth’s transportation infrastructure. Key to Judge Swain’s decision was her conclusion that Peaje did not have a statutory lien on the toll proceeds.


The Peaje decision is notable for at least two reasons. First, it adds to the small body of case law that parses the definition of a statutory lien under the Bankruptcy Code in Chapter 9 cases. More immediately, the decision is important because of its potential applicability to the other Title III litigations overseen by Judge Swain. Below, the Debtwire legal analyst team reviews the Peaje decision, the treatment of statutory liens under the Bankruptcy Code and how Judge Swain’s decision could apply in the current litigation in COFINA’s Title III case among the Commonwealth’s Official Committee of Unsecured Creditors, COFINA and COFINA bondholders.


Peaje’s investment in PRHTA bonds is threatened by Puerto Rico’s insolvency


Peaje Investments LLC owns USD 65m in bonds issued by the Puerto Rico Highways & Transportation Authority (PRHTA). Payment on the bonds is made from dedicated tax and toll revenues pledged by PRHTA and deposited into a collateral account on a monthly basis. The account is held by a fiscal agent for the benefit of bondholders in an amount sufficient to make payment on the bonds prior to the use of toll revenues for any other purpose. The bonds are non-recourse and payable solely from the pledged revenues.


Legislation enacted by both the Commonwealth of Puerto Rico and the US Congress has threatened the presumed secured status of the Peaje bonds. In April 2016, Puerto Rico’s House of Representatives passed the Moratorium Act, which authorized the governor to issue executive orders declaring a state of emergency for commonwealth instrumentalities such as PRHTA and to stop turning over pledged revenues. In a series of orders in May and June 2016, former Governor Alejandro Garcia Padilla declared PRHTA to be in a state of emergency and directed it to stop channeling pledged revenues to the fiscal agent. The orders were to expire by their terms on 31 January 2017.


In June 2016, President Obama signed the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), which provided a process for the commonwealth and its instrumentalities to restructure its debt.[2] Title III of PROMESA incorporates many Bankruptcy Code provisions, including provisions staying collection efforts upon the filing of a bankruptcy petition and provisions relating to the reorganization of municipalities under Chapter 9 of the Bankruptcy Code.[3] PROMESA further created an Oversight Board with the authority to approve fiscal plans for the commonwealth and its instrumentalities and to commence restructuring proceedings.


On 27 January 2017, the commonwealth, under newly elected Governor Ricardo Rossello, enacted the Fiscal Responsibility Act (FRA), which repealed the sections of the Moratorium Act under which Governor Garcia Padilla had issued his executive orders suspending PRHTA’s payments to the fiscal agent. The FRA established an emergency period during which the governor could issue executive orders regarding the disbursement or disposition of funds by government instrumentalities. Notwithstanding Governor Rossello’s declaration of the emergency period under the FRA, he did not issue a new executive order further suspending the PRHTA payments. As a result, on 31 January 2017, the orders issued under the Moratorium Act expired by their terms. Despite the absence at that point of any prohibition on paying funds to the fiscal agent, PRHTA did not recommence payment. Furthermore, the commonwealth stated that the reserve funds that it had been using to pay bondholders would run out by July 2017.


On 28 April 2017, the Oversight Board adopted a fiscal economic growth plan (FEGP) to restructure PRHTA. Under the proposal, PRHTA bondholders would receive USD 1.233bn in new junior cash flow bonds to satisfy approximately USD 4.2bn in debt, which would be subordinated to new senior bonds to be offered to holders of COFINA and general obligation bond and also future debt issuances. On 29 April, the commonwealth enacted the Fiscal Plan Compliance Law to implement the PRHTA fiscal plan.


On 3 May 2017, the Commonwealth filed a petition for relief under Title III. PRHTA followed with a petition filed on 21 May 2017. On 5 May, US Supreme Court Chief Justice John Roberts appointed Judge Swain to preside over Puerto Rico’s Title III restructurings. Bondholders, and bond insurers, cried foul, and commenced a series of litigations.


Peaje sues to protect its investment 


On such litigation is an adversary proceeding filed on 31 May in PRHTA’s Title III case. Peaje seeks an order directing PRHTA to deposit all pledged toll revenues with the fiscal agent for the benefit of bondholders and, in the alternative, granting relief from the automatic stay to permit Peaje to commence collection efforts on the bonds.


Peaje claimed that the 1965 Enabling Act that had established PRHTA as a public corporation and instrumentality of Puerto Rico (PRHTA Enabling Act), together with a 1968 Resolution pursuant to which PRHTA issued the bonds, gave Peaje a first-priority statutory lien in the toll revenues deposited with the fiscal agent. According to Peaje, because the lien was statutory, the lien continued to attach to PRHTA’s post-petition revenues, and PRHTA was required to continue depositing those funds with the fiscal agent.


The Enabling Act empowered PRHTA to finance its projects by issuing bonds payable solely from pledged funds. Specifically, the Act states that PRHTA “may from time to time issue and sell its own bonds” and that “[a]ny resolution or resolutions authorizing any bonds may contain provisions, which shall be part of the contract with the holders of the bonds . . . pledging . . . all or any part of [PRHTA’s revenues] to secure payment of the principal of and interest on the bonds . . . to the extent permitted by the provisions of subsection (l) of section 2004 of this title.”[4] The 1968 Resolution granted Peaje a first-priority lien in the toll revenues deposited with the fiscal agent to pay the bonds.


Peaje argued that its statutory lien exempted the pledged toll revenues from the operation of Bankruptcy Code section 552(a), which provides that a lien under a pre-petition security agreement does not extend to property received by the bankruptcy estate after the commencement of a bankruptcy case, 11 U.S.C. § 552(a), unless the security agreement creating the lien states that the lien extends to such proceeds or profits.[5] Under section 552(b)(1), even if the lien extends to such proceeds, the court can modify or cut off the lien based on “the equities of the case.”[6] Peaje argued that because its lien was statutory, and did not arise from a security agreement, section 552 simply didn’t apply.


Peaje also argued that it was exempted from the operation of Bankruptcy Code section 928(a), which provides that “special revenues” pledged pursuant to a security agreement are not affected by the automatic stay, except to the extent that the special revenues are needed for a project or system’s “necessary operating expenses.”[7] Since PRHTA did not dispute that the pledged toll receipts were “special revenues,” Judge Swain focused her analysis on whether Peaje’s lien was statutory.


Judge Swain holds that Peaje’s lien is not statutory


Judge Swain started her analysis with the Bankruptcy Code, which defines a statutory lien as one “arising solely by force of a statute on specified circumstances and conditions . . . .”[8] In contrast, the Code defines a security interest as a “lien created by an agreement,” and a “security agreement” as an agreement that “creates or provides for a security interest.”[9] The essence of a statutory lien is that no agreement is needed to create it; in other words, if the lien is dependent upon a contractual grant of a security interest, the lien is not statutory.[10] Other examples of statutory liens are tax liens, mechanics liens and wage liens.


Applying the Bankruptcy Code definition of statutory liens to the PRHTA Enabling Act, Judge Swain concluded that the statutory language providing that PRHTA “may” issue bonds and “may” pledge property did not create liens that arose “solely” by force of statute. Instead, the statute simply authorized PRHTA to enter into consensual liens with bondholders. Judge Swain analogized the PRHTA Enabling Act to Article 9 of the Uniform Commercial Code, which sets forth procedures for the creation and perfection of security interests. The fact that the validity of liens created under each statute can ultimately be traceable to a statute is insufficient to make them statutory.[11]


Judge Swain distinguished the cases relied upon by Peaje on the grounds that they involved statutes with self-executing provisions stating that liens “shall” arise upon the satisfaction of certain conditions, with no further action by the parties necessary. Thus, in either case, no contractual grant of a security interest was necessary for the lien to arise. In In re Braxton, the releveant statute granted a lien to the Pennsylvania Bureau of Unemployment Compensation Benefits on the real and personal property of any recipient who receives an overpayment of compensation benefits, in the amount of such overpayment.[12] The court noted that the “essence” of a statutory lien as defined in the Bankruptcy Code “is the need, or lack of it, for an agreement or judgment to create the lien. If the lien arises by force of statute, without any prior consent between the parties or judicial action, it will be deemed a statutory lien.” In In re Fonseca, the relevant statute provided that the government could deduct outstanding loan amounts from a departing employee’s lump sum sick leave payment.[13]


Judge Swain also rejected Peaje’s argument that it had a statutory lien for the additional reason that the 1968 Resolutions allegedly giving rise to the liens were issued by PRHTA, which is not a legislative body, but rather a corporation and instrumentality of the Commonwealth. Simply put, the 1968 Resolution is not a statute. Finally, Judge Swain rejected Peaje’s request for stay relief, finding that the interests were adequately protected by the Commonwealth’s efforts to maintain its toll roads, which would ensure that the roads would continue to generate revenues.


Peaje hasn’t conceded. It has appealed Judge Swain’s decision and it has also filed an amended complaint. In the amended complaint, Peaje argues that section 2004(l) of the PRHTA Enabling Act, which empowers PRHTA “to borrow money for any of its corporate purposes, and to issue bonds of the Authority in evidence of such indebtedness and to secure payment of bonds and interest thereon by pledge of, or other lien on, all or any of its properties, revenues or other income,” requires that bonds be secured. Peaje argues that the conjunction “and,” together with another provision stating that the bonds shall only be payable from funds “pledged for the payment of such bonds and interest thereon pursuant to [section 2004(l)],” creates a self-executing statutory lien. Peaje also asserts that the bond resolutions have the force of statute.


Parsing the language of Bankruptcy Code section 552 – In re Orange County


As previously noted, the Peaje decision is important because there is a comparative lack of judicial decisions elaborating upon the Bankruptcy Code’s definition of statutory liens in the context of municipal restructurings. Notably, Judge Swain did not rely upon what is perhaps the most notable of those authorities, a case that involved a lien dispute in Orange County’s Chapter 9 case in the mid-1990s.[14] The county’s Board of Supervisors had issued notes pursuant to a resolution and in accordance with certain provisions of the California Government Code authorizing state and local agencies to issue notes for short term financing and to pledge taxes, income or other revenues cash receipts to pay for such notes. When the Orange County declared bankruptcy in 1994, it stopped making payments on the notes, claiming that section 552(a) cut off bondholders’ liens. Holders of USD 60m in notes brought an action seeking a bankruptcy court order compelling Orange County to make the set aside the payments. The noteholders argued that since they possessed statutory liens on the pledged revenues, section 552(a) did not apply and their lien attached to the bankruptcy estate’s post-petition revenues. The bankruptcy court disagreed, and rejected the noteholders’ request for relief. The noteholders appealed, and the district court reversed the bankruptcy court, agreeing with the noteholders that they held statutory liens.


The district court first concluded that section 552(a), by its terms, only cuts off pre-petition liens that arise under security agreements, and not statutory liens. Like Judge Swain in Peaje, the court noted that the difference between statutory liens and security interests is whether a contractual provision granting a property interest is “a necessary precondition” for the existence of the lien. If so, the lien is not a statutory lien even if the statute defines the “scope and quality” of the lien.[15]


Turning next to text of the California statute, the court found that it gave rise to a statutory lien. The statute provided that “[t]he note or notes and the interest thereon shall be a first lien and charge against, and shall be payable from the first moneys received by the local agency from, such pledged moneys.”[16] The court relied upon the “shall” language in the statute to hold that the liens rose automatically by operation of statute – “[i]n mandatory ‘shall’ language, the statute imposes the lien.”[17] For the court, the fact that the statute permitted the County to decide “whether to pledge, and what to pledge,” was not dispositive – the important point was that once the County elected to pledge property, a lien arose, without the need for further action and without the need for any agreement.[18]


The COFINA dispute


Because Judge Swain oversees all of Puerto Rico’s Title III cases and the related adversary proceedings, her decisions in any one case can have important ramifications in other Puerto Rico Title III litigations. One such action is the adversary proceeding that was filed in COFINA’s Title III case by the Official Committee of Unsecured Creditors, as agent for the Commonwealth against the Puerto Rico Sales Tax Financing Corporation (COFINA).[19] The lawsuit, filed on the same day that Judge Swain issued her decision in Peaje, seeks to resolve the question of the ownership of certain Sales and Use Tax (SUT) proceeds that were pledged as payment for bonds issued by COFINA.


In 2007, the Puerto Rico Legislative Assembly established COFINA as an independent public corporation attached to the Government Development Bank (COFINA Enabling Act). COFINA’s purpose is to finance certain debt obligations of the commonwealth payable to the bank. COFINA was authorized to issue bonds secured by the first proceeds of a SUT that had been enacted the previous year, which were transferred to and deposited in a Dedicated Sales Tax Fund. The COFINA Enabling Act provides that the currently deposited proceeds and all future proceeds required to be deposited in the Dedicated Sales Tax Fund were “transferred to, and shall be the property of COFINA.”[20] The deposited funds are to be used by COFINA exclusively to pay, finance or refinance the commonwealth’s extraconstitutional and other enumerated debts. The pledged funds do not “constitute resources available to the Commonwealth of Puerto Rico” – in other words, they cannot be used as a source of payment for the general obligation debts backed by the Commonwealth’s full faith and credit, including GO bonds.[21] The statute provides that COFINA’s pledge of deposited SUT revenues to bondholders “shall be valid and binding as of the time it is made without the need for a public or notarized document,” and that the pledged funds shall be subject to a perfected lien “immediately.”[22]


On 13 July 2007 COFINA adopted a Sales Tax Revenue Bond Resolution, which states that COFINA bonds are obligations of COFINA, are payable from the fund, and are not commonwealth debts backed by the commonwealth’s full faith and credit.[23] Over the next few years COFINA issued over USD 16bn in COFINA bonds backed by pledged SUT revenues.




On 29 April 2017, the commonwealth enacted the Fiscal Plan Compliance Law, which proposed to use the pledged taxes in the Dedicated Sales Tax Fund for purposes other than the payment of the COFINA bonds, notwithstanding the statutory language providing that the funds are property of COFINA and not available resources of the commonwealth. On May 2, senior COFINA bondholders brought an action in the federal district court for Puerto Rico alleging that the commonwealth’s fiscal plan wrongly impairs their rights, takes their property in violation of the U.S. and Puerto Rico constitutions and seeks an injunction preventing the Commonwealth from redirecting the pledged proceeds. Ambac Assurance Company also filed an action seeking a declaratory judgment that the fiscal plan was unconstitutional and enjoining the filing of any Title III petitions based on the plan. [24] On 5 May, COFINA commenced its own Title III proceeding, thereby staying the litigations.


On 8 September, the Official Committee of Unsecured Creditors, on behalf of the commonwealth, commenced an adversary proceeding against COFINA seeking a determination that the SUT revenues pledged by COFINA to secure its bonds are the property of the commonwealth and that the COFINA structure is unconstitutional because it permits Puerto Rico to evade its constitutional debt limits. In the alternative, the UCC seeks a declaration that any purported transfer of future revenues to COFINA gave rise only to an unsecured claim or, that if COFINA in fact does have a security interest in those revenues, section 552(a) of the Bankruptcy Code cut off their security interest when COFINA filed its Title III case. COFINA filed counterclaims seeking a declaration that COFINA owns the pledged funds outright. In the alternative, COFINA seeks a declaration that it has a fully perfected statutory lien on the funds. On 6 November, ad hoc groups of COFINA and GO bondholders and insurers of COFINA bonds National Public Finance Guarantee Corporation and AMBAC Assurance separately intervened as defendants. Among the defenses asserted by the COFINA bondholders is that their lien is statutory and section 552(a) did not operate to cut off their liens upon COFINA’s title III filing. Furthermore, the bondholders argue that section 552 does not cut off its lien on post-petition assets because the pledged funds are special revenues, and thus are exempted from the operation of Bankruptcy Code section 928(b), which provides that special revenues remain subject to any lien from arising from a pre-petition security agreement, are still “subject to the necessary operating expenses of . . . a project or system.” 




Potential application of Orange County and Peaje to the COFINA dispute


If Judge Swain were to apply the reasoning of In re Orange County to the question of whether COFINA bondholders have a statutory lien on the pledged SUT assets, the answer should be yes. Like the California statute at issue in Orange County, the operative language in the COFINA Enabling Act provides that the mere act of pledging gives rise to a fully perfected, enforceable lien in favor of pledged funds. The COFINA statute states that the pledge “shall be valid and binding” when made, that the revenues encumbered “shall be subject to said lien immediately” and that “said lien shall be valid and binding and shall prevail against any third party.”[25] Other than the act of pledging, COFINA is not required to take any action, nor is any agreement necessary, for a fully perfected lien to arise.


As noted above, Judge Swain neither discussed nor relied upon the long-standing Orange County decision in declining to grant relief in Peaje. Perhaps that is because the PRHTA enabling statute does not contain the prescriptive word “shall,” but only provides that that PRTHA “may” issue bonds that “may” contain provisions pledges of PRHTA’s revenues to secure payment. Thus, in Peaje Judge Swain did not have to address the question of whether a statute containing prescriptive “shall” language, like the language in the COFINA enabling statute, gives rise to a statutory lien.


Notably, in the Peaje case PRHTA has asserted that Orange County was “wrongly decided with regard to the existence of a statutory lien.”[26] So if the section 552(a) question is ultimately litigated in the COFINA action, we can expect the Committee to argue that the COFINA Enabling Act does not create a statutory lien, notwithstanding the fact that the statute contains prescriptive “shall” language. The Committee may argue that the COFINA liens are not statutory liens under Code section 101(53) because the act that constitutes the “specified circumstance or condition” giving rise to the statutory lien, i.e. COFINA’s pledge of property to pay the bonds, is an act related to the creation of a consensual lien arising from an agreement. Notably, the “circumstance or condition” giving rise to the statutory liens in each of the Fonseca and Brixton cases was completely unrelated to an agreement to create a security interest, and thus would be difficult to conflate with acts taken to create a consensual lien.


The Committee may also argue that that the lien is not statutory because the lien couldn’t arise until COFINA issued the bond resolution. Here again, the bondholders’ argument would be that the COFINA Resolution and the bonds are more in the nature of a consensual security agreement, notwithstanding the fact that COFINA’s authority to create the lien derives from and is automatically perfected by statute. Indeed, the COFINA Resolution states that it is a contract between COFINA and bondholders, and that the Resolution “creates” a continuing pledge and lien on the pledged property. Also, if Judge Swain ultimately concludes that the lien springs from the COFINA Resolution, and not the COFINA Enabling Act, then the bondholders’ liens will clearly not be held to be statutory liens, since they will be deemed to have arisen from the act of a public corporation, not a legislature.


It is important to remember that the principal dispute in the COFINA litigation is the ownership of the pledged SUT funds. Both the Commonwealth and COFINA claim the pledged funds as their own property. However, to the extent that the Judge Swain may find that the commonwealth owns the funds, the question of the nature of COFINA bondholders’ interest will be incredibly important. At stake is the question of how almost USD 10bn in COFINA pledged sales tax revenue over the next 10 years will be applied to satisfy the commonwealth’s obligations. If the COFINA bondholders’ lien is statutory, they can claim that their lien on pledged sales tax revenues continues to attach to bankruptcy estate revenues generated after the commencement of the case, giving COFINA a priority over all other creditors with respect to those revenues, with commensurate improvement in their recoveries. Conversely, if it is held that there is no statutory lien on those revenues, then the commonwealth can continue to divert them from being deposited in the Dedicated Sales Tax Fund and use them for other purposes, e.g. to pay GO bondholders or other commonwealth debts. How Judge Swain ultimately decides this issue will have enormous consequences for the COFINA bondholders, the commonwealth and its citizens, many of whom are owners of COFINA bonds themselves.


CLICK HERE to view all filings in PRHTA‘s Title III case.
CLICK HERE to view all filings in the Commonwealth of Puerto Rico‘s Title III case.
CLICK HERE for all Debtwire reporting on Puerto Rico.


by Paul C. Gunther


Paul Gunther is a former practicing restructuring and litigation attorney. Prior to joining Debtwire as a Legal Analyst, Paul practiced in the New York offices of Dentons US LLP, Salans LLP and Mayer Brown LLP. He has represented various constituencies in high-profile restructurings.


Any opinion, analysis or information provided in this article is not intended, nor should be construed, as legal advice, including, but not limited to, investment advice as defined by the Investment Company Act of 1940. Debtwire does not provide any legal advice and subscribers should consult with their own legal counsel for matters requiring legal advice.




[1] Opinion and Order Denying Motion for Preliminary Injunction and Motion for Relief from the Automatic StayPeaje Inv. LLC v. Puerto Rico Highways & Trans. Auth., Adv. Pro. No. 17-151, 152 (D.P.R. Sep. 8, 2017) (“Peaje Opinion”). 

[2] 48 U.S.C. § 2101 et seq.

[3] 11 U.S.C. § 362(a)(3) (as incorporated into PROMESA, the statute provides that the filing of a bankruptcy petition