Puerto Rico's fiscal crisis is entering a dangerous new phase as Gov. Alejandro Garcia Padilla said the government is forced to choose between repaying creditors or paying for critical government services. (AP Photo/Ricardo Arduengo)

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A group of Puerto Rico bondholders proposed a payment plan Wednesday that would protect the value of their holdings while granting fiscal relief to the commonwealth.

The proposal would protect the holders of about $7.6 billion of senior bonds issued by Cofina, a Puerto Rican government entity created during an earlier fiscal squeeze and backed by a portion of the territory’s sales tax. At the same time, it would also limit interest payments over the next four fiscal years while extending payments further into the future.

“We said we can we try to shape relief for the commonwealth that’s consistent with the commonwealth’s demands that doesn’t involve bankruptcy or coercing people or doing violence to the Cofina structure,” said Susheel Kirpalani, head of the bankruptcy and restructuring group at the law firm Quinn Emanuel.

The proposal is the latest in a series of private sector negotiations going on while Congress tries to come up with a rescue plan for Puerto Rico, which is in the grips of an economic crisis and on the verge of a major default on its roughly $72 billion of debts. Those debts are owed by more than a dozen different government entities, and a myriad of investors have rival interests in the restructuring process.

The Obama administration and Democrats in Congress have called on Republicans to pass legislation that would enable the commonwealth to file for bankruptcy so that a bankruptcy court could help enforce a settlement on bondholders. The administration and congressional Republicans are also looking at setting up a financial control board for Puerto Rico similar to the one that helped restore fiscal order to the District of Columbia. House Speaker Paul Ryan (R-Wis.) has asked that a bill be brought to the floor by the end of March.

In an effort to prop up the island’s economy, the president’s budget proposal asks for $6.6 billion over 10 years for extending the Earned Income Tax Credit for Puerto Rico and for about $30 billion in Medicaid funds for the island.

At a hearing Wednesday, Senate Finance Committee Chairman Orrin Hatch (R-Utah) told Treasury Secretary Jack Lew that “I do not believe the administration has been straightforward about the nature of the debt restructuring authority it is seeking for the territory.”

Asked later whether the administration would be satisfied without a Chapter 9 option for Puerto Rico, Lew said “there are multiple ways of drafting it. It doesn’t have to be drafted as a bankruptcy code amendment. It could be drafted in terms of legislation that applies to the territories. The effect would have to be broad restructuring authority.” Otherwise, he said, litigation could drag on from five to 10 years.

Hatch said he was planning to have a bill before the end of March.

Kirpalani said the investors he represents want to reach a restructuring agreement with the commonwealth, but he said they also favor a financial control board.

“We think a fiscal control board is prudent,” he said. “Somebody’s got to be minding the revenues and payments for debt service. There’s a general consensus that a fiscal control board is a good thing.”

Under the plan Kirpalani outlined, the senior Cofina bondholders would get preferential treatment over the subordinated Cofina bondholders. And while that preferential treatment for senior bondholders was part of the terms of the original investment, there is likely to be some tension over that in the restructuring negotiations.

Sources familiar with the restructuring talks say that the owners of senior Cofina debt include Santander Bank, UBS, MetLife, Goldentree Asset Management, Whitebox Advisors and Puerto Rican pension funds. Owners of the $9.7 billion of less preferential, second-tier Cofina bonds include Goldman Sachs, Oppenheimer & Co., and Franklin Templeton.

Under the new Cofina restructuring proposal, the amount of sales tax devoted to paying interest to bondholders would rise gradually from zero in fiscal year 2017 to 2.5 percent in fiscal year 2021 and beyond. The current amount is 2.75 percent. That would reduce payments by Cofina to zero next year and no more than $600 million a year from 2021 through 2046.

The plan would also create a “backstopped” facility for low-income investors or pensioners who need income to meet basic needs.

That $600 million would be more than enough to fully compensate the holders of senior Cofina debt, but not the subordinated debt holders. The less preferential Cofina bonds could be extended as long as 2080, Kirpalani said.

The plan stands in contrast to a recent proposal to roll all of Puerto Rico’s debt together and issue a new basic bond and a growth bond. Some bondholders, such as those with Cofina debt, might get a more favorable treatment when trading their bonds for new ones.

Kirpalani said that the Cofina investors deserved different treatment. “When Cofina was created, the government had shut down for two weeks in 2006. There were 1,600 schools closed, and that left 500,000 schoolchildren without a place to go to school,” he said. “While every creditor group now seems to be running out of the burning building, when Cofina was created, we said, ‘Let’s run into the building and see what we can do.’”

Lew cosigned the idea that not all bondholders were entitled to the same deal.

“We have never said that all bondholders get treated equally so certainly there is the space to reflect the differences between different categories of bondholders,” Lew said at the Senate Finance Committee meeting Wednesday, “even the voluntary offer that the Commonwealth put forward reflect that principle.”

Lew added, “What doesn’t work, is to say that Puerto Rico should somehow solve the fiscal dilemma that it faces without some very broad restructuring authority because Puerto Rico’s debt is principally the thing that is drawing down its ability to stay solvent.”