(Bloomberg) -- Puerto Rico's bankrupt power utility and its creditors squared off in court Monday on whether bondholders have a legal right to the electricity provider's future revenue.
The debate before the US Court of Appeals for the First Circuit centers around whether the island's main energy supplier, Electric Power Authority or Prepa, must repay its creditors more than just the roughly $19 million sitting in reserve accounts that a bankruptcy court last year ruled was the bondholders' only secured lien.
At stake is the $9 billion Prepa owes to investors and fuel-line lenders while island residents endure some of the highest electricity rates in the US amid frequent outages. The case is poised to affect revenue-backed municipal debt beyond Puerto Rico as water and sewer authorities, hospitals, toll roads, higher educational institutions and transit agencies all sell bonds with the pledge to repay investors from future revenue collections.
The bondholders say they have a claim to Prepa's current and future revenues based on Prepa's trust agreement and under the Uniform Commercial Code — a set of state laws that govern US commercial transactions. Puerto Rico's financial oversight board, which is managing Prepa's bankruptcy, disagrees, arguing the trust agreement only gave investors a secured lien on the reserve fund and nothing more.
"That was one of the weak links here," Martin Bienenstock, a lawyer for the oversight board, said during the court hearing about Prepa's trust agreement. Directing the money to the funds "is essentially an unsecured obligation," he said.
G. Eric Brunstad, a lawyer for a group of investors holding $2.8 billion of Prepa's bonds and includes Invesco Advisers, MacKay Shields, Goldman Sachs Asset Management and AllianceBernstein, argued the pledge is on the revenue stream.
"The lien itself begins when the security agreement is created, when the debtor signs it," Brunstad said in court.
A group of 14 attorneys general — all Republicans — filed a brief to the court last month backing bondholders, and warned that limiting their rights would hurt the $4 trillion municipal-bond market.
"The entire foundation of municipal finance rests on the answer," Brunstad told the court Monday in response to judges' questions on whether it's possible to grant a lien on future revenues and what a lien is actually on.
Glenn Kurtz, a lawyer for GoldenTree Asset Management, said the reserve accounts only held $19 million and claims that Prepa had the ability to direct $3 billion to $5 billion to the accounts from the start of its bankruptcy in 2017 through present day.
No such funds exist according to Peter Friedman, a lawyer for Puerto Rico's fiscal agency and financial advisory authority. Resolving Prepa's obligations, including a broke pension fund, has been a struggle for the island.
"This case would be dramatically different if Prepa had between $3 billion to $5 billion of cash in its accounts," Friedman said.
US District Court Judge Laura Taylor Swain ruled in March that Prepa's bondholders only had a secured lien on money already deposited into reserve accounts. In June, she limited their unsecured claim to the utility's net revenue at $2.38 billion. Various investors and bond insurance companies appealed Swain's rulings.
Prepa's proposed debt plan would reduce $10 billion of claims by 75% and has the support of BlackRock Financial Management and Nuveen Asset Management. A confirmation hearing on that restructuring proposal is set to begin on March 4.
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