Puerto Rico's warring creditors duel over sales tax revenue

NEW YORK, April 10 (Reuters) - Puerto Rico bondholders in court on Tuesday denounced the island’s sales tax authority, COFINA, as a sham “end-run” around its constitution, in a creditor battle for control of the bankrupt, storm-ravaged island’s future tax revenues.

At a hearing in federal court in New York, a lawyer for a group of general obligation (GO) bondholders said Puerto Rican leaders created COFINA in 2006 so they could issue new bonds without technically violating the island’s constitutional limit on government debt sales.

The dispute is central to sorting out Puerto Rico’s $71.5 billion in debt, about half of which is owed to GO and COFINA bondholders.

Each side is owed about $18 billion and claims an ironclad right to the sales tax revenue. The outcome will determine which group recovers more of its investment, and which side will have a claim on decades of future sales tax.

“It would ascribe incompetence” to assume a legislature that wanted to limit the government’s debt capacity would then let a separate agency exceed that limit by billions of dollars, attorney Mark Stancil told Judge Laura Taylor Swain.

“COFINA was an end-run around the debt limit,” Stancil said.

Puerto Rico’s legislature created COFINA as the island slid toward a financial cliff and needed to raise cash. To ease nervous investors, lawmakers secured COFINA’s debt with sales tax revenue, and declared COFINA the owner of the revenue.

Antonio Yanez, a lawyer advocating for COFINA’s estate, said that structure was legal. “It is Puerto Rico law that COFINA owns the pledged sales tax,” Yanez said at Tuesday’s hearing. “The idea was that COFINA would be separate from the commonwealth.”

Puerto Rico last year filed the largest-ever U.S. government bankruptcy, and its woes were compounded in September, when Hurricane Maria decimated its outdated infrastructure and caused tens of billions of dollars in damage.

Stancil and other GO-side lawyers said GO debt is senior to all obligations, despite COFINA’s existence.

GO holders have the first claim on “available resources,” Stancil said, and “it can’t just be assumed away that ‘available resources’ means whatever the legislature says.”

“It’s up to the court to define,” he said.

Judge Swain had pointed questions, though.

“How,” she asked Stancil, “is the court in position to determine whether babies should eat or traffic lights get turned on ... before bondholders get paid?”

Swain also noted that Puerto Rico’s constitutional debt limit only applied to debt backed by Puerto Rico’s full faith and credit, such as GO debt.

“It could have been written” to encompass all debt, she said, but “it wasn’t written that way.”

Swain did not indicate when she would rule.

Reporting by Nick Brown Editing by Nick Zieminski