The judge in the Puerto Rico Electric Power Authority bankruptcy ruled bondholders had no lien on the authority’s revenues, which could result in bondholders recovering as little as 0.21% of their principal.

The Puerto Rico Oversight Board has introduced a plan of adjustment where that would be the payout if the judge ruled the bondholders had no lien or recourse rights.

Judge Laura Taylor Swain Wednesday rejected the bondholders’ claim they had a lien on the authority’s revenue stream, limiting their lien to money in just two funds at the authority holding tens of millions of dollars, compared to their claim for $8.47 billion.

Swain said she was not ready to rule whether the bondholders’ lien extended to two other funds that also held comparatively miniscule amounts of money.

Bondholders, she ruled, had a “unsecured net revenue claim” against PREPA but this would be valued less than the full bond claim, to be determined when more information becomes available. The value must be determined “consensually” or under a section of the bankruptcy code, she said.

Municipal Market Analytics Partner Matt Fabian said, “It seems like the judge’s reasoning derives from a close reading of the PREPA trust indenture — and not about revenue bond financing generally — the impact on other revenue bonds should be limited. It’s not the best case for the market overall but it’s not the worst.”

Puerto Rico Attorney John Mudd said he was not surprised by the ruling. “She has never decided anything of import in favor of bondholders.”

The PREPA bondholders “have a choice of taking the board offer or continuing with an appeal in a case they just lost,” Mudd said.

As for the impact of Swain’s decision on other U.S. municipal revenue bonds, Mudd said “it will depend on the language of each agreement on the law of each state since Swain’s opinion is the interpretation of the bond agreement and Puerto Rico law.” 

“As expected, Judge Laura Taylor Swain adopted almost entirely the arguments of the Oversight Board that the PREPA trust agreement only granted a lien on cash in accounts held directly by the trustee,” said Cate Long, Puerto Rico Clearinghouse Principal.

“Although the Uniform Commercial Code financing statement and trust agreement both pledged the revenues of the utility as collateral to repay the bonds, she decided that some ambiguous language … related to the sinking fund meant bondholders are only secured by that small amount of cash,” she said.

“Her opinion needs to be immediately appealed on several grounds and bondholders should ask the First Circuit [Court of Appeals] to stay further proceedings in the adversary case and confirmation hearings,” Long said.

Two bond attorneys wrote in a recent commentary that the board’s arguments, if successful, may pose a danger to the municipal revenue bond market.

The Ad Hoc Group of PREPA Bondholders would not comment on the decision.

The Puerto Rico Oversight Board released a statement saying it “welcomes the decision” and called it “a significant win for Puerto Rico and its path to reliable electricity and economic growth.”

The board added it is reviewing the ruling “to determine the implications of bondholders’ remaining claim but will continue to work on resolving the remaining issue of PREPA’s debt restructuring consensually.”

Puerto Rico’s Fiscal Agency and Financial Advisory Authority, which oversees financial matters for Puerto Rico’s local government, said, it “is pleased that the court recognized the important limitations on the bondholders’ liens and claims,” calling it “an important victory for our government and one more step towards the departure of the authority from Title III [bankruptcy].”

In her opinion, Swain acknowledged the opening statement of the trust agreement said PREPA “has pledged and does hereby pledge to the [bond] trustee the revenues of the system.” However, she said, the word “pledge” is an “unsecured” promise and did not create a lien, which would require use of the words “lien or charge.”

She said the words “as follows” at the end of the agreement’s opening statement are important because it limits what bondholders can claim a lien on to three to five internal funds.