Primary Government — The Commonwealth is a defendant in numerous legal proceedings pertaining to matters incidental to the performance of routine governmental operations. Under Act No. 104 of June 25, 1955, as amended, persons are authorized to sue the Commonwealth only for causes of actions set forth in said Act to a maximum amount of $75,000 or $150,000 if it involves actions for damages to more than one person or where a single injured party is entitled to several causes of action. Under certain circumstances, as provided in Act No. 9 of November 26, 1975, as amended, the Commonwealth may provide its officers and employees with legal representation, as well as assume the payment of any judgment that may be entered against them. There is no limitation on the payment of such judgments.
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With respect to pending and threatened litigation, excluding the litigation mentioned in the following paragraphs, the Commonwealth reported approximately $421 million as an amount to cover for awarded and anticipated unfavorable judgments at June 30, 2010. This amount was included as other long-term liabilities in the accompanying statement of net assets (deficit), and represents the amount estimated as probable liability or a liability with a fixed or expected due date that will require future available financial resources for this payment. The amounts claimed exceed $7 billion; however, the ultimate liability cannot be presently determined. It is the opinion of management that the claims are excessive and exaggerated. Management believes that the ultimate liability in excess of amounts provided, if any, would not be significant.
The Commonwealth is a defendant in two parallel lawsuits, one filed in the state court and the other at the federal court. The plaintiffs are various primary healthcare centers seeking to recover from the Commonwealth $800 million of Medicaid funds retained by the Department of Health of the Commonwealth since 1997. In February 2005, United States Court of Appeals for the First Circuit determined that the Commonwealth must return any funds withheld because of noncompliance with a federal law. As of June 30, 2010, the Commonwealth accrued $280 million for this legal contingency. The Commonwealth is a defendant in a class action presented by parents of special education students in the areas of education and healthcare. In October 2006, the State Court of Appeals decided in favor of the parents’ request to include damage claims pursuant to the same class action case although not as a remedy in the class action per se. The court now may award damages to the members of the class action and to do so it may look at the claims by dividing them into groups or consider each case individually. This will require that the parents prove the damages suffered. The Commonwealth plans to defend vigorously each individual case. As of June 30, 2010, the Commonwealth accrued $600 million for this legal contingency.
The Commonwealth receives financial assistance from the federal government in the form of grants and entitlements. Receipt of grants is generally conditioned upon compliance with terms and conditions of the grant agreements and applicable federal laws and regulations, including the expenditure of resources for eligible purposes. Substantially, all grants are subject to audit under Circular A-133 of the Office of Management and Budget of the United States of America (OMB Circular A-133), all of which are performed at the individual department or agency level. Disallowance as a result of these audits may become liabilities of the Commonwealth. At June 30, 2010, based on an evaluation of pending federal disallowances, the Commonwealth has recorded approximately $103 million as other long-term liabilities in the accompanying statement of net assets (deficit). Expenditures that are still subject to audit could be disallowed but management believes any such future disallowances would not be material to the basic financial statements.
Construction commitments at June 30, 2010, entered by PBA, amounted to approximately $72.7 million. In addition, the Commonwealth’s construction commitments for public housing facilities amounted to approximately $322 million at June 30, 2010.
On November 23, 1998, a global settlement agreement (the “Global Agreement”) was entered into by and between certain tobacco companies and certain states, territories, and other jurisdictions of the United States of America, including the Commonwealth. The agreement calls for annual payments through the year 2025, which will vary due to inflationary and volume adjustments. After 2025, the tobacco companies are to continue making contributions in perpetuity. Pursuant to Act No. 173 of July 30, 1999, which created the Children’s Trust (a blended component unit), the Commonwealth assigned and transferred to the Trust all payments that the Commonwealth is entitled to receive under the Global Agreement. Payments received under the agreement and recognized as revenue during the year ended June 30, 2010 amounted to approximately $76 million.
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Discretely Presented Component Units — in the normal course of their operations, various component units are subject to guarantees, actions brought by third parties seeking damages or entering into commitments. Such actions are disclosed in the separately issued reports of the component units, some of which are summarized below:
(a) GDB
On August 18, 2002, the Legislature approved Law No. 198, which creates the Cooperative Development Investment Fund. The purpose of this fund is to promote the development of cooperative entities. This fund will be capitalized through contributions to be provided by GDB up to $25 million to be matched by cooperative entities. As of June 30, 2010, GDB has contributed $16.2 million to the Cooperative Development Investment Fund, $624,000 of which were contributed during the year ended June 30, 2010.
The Development Fund has entered into an agreement with the Economic Development Bank for Puerto Rico (EDB) whereby the Development Fund would guarantee a portion of loans granted by EDB under a government program named “The Key for Your Business” (the “Program”). Under the agreement, the Development Fund would assign $10 million of its capital for the Program. The Development Fund guarantees one-third of the outstanding principal balance of each loan plus accrued interest and certain other charges. On August 28, 2008, the Development Fund and EDB amended the agreement to increase from $10 million to $15 million the Development Fund’s capital designated for the Program. The Development Fund charges one percent of the loan amount as guarantee fee and no loan can exceed $50,000. At June 30, 2010, outstanding guarantees amounted to approximately $8 million, and the allowance for losses on guarantees amounted to approximately $2.5 million.
The Housing Finance Authority acts as a servicer for a number of mortgage loans owned by other investors. The servicing is generally subcontracted to a third party. As of June 30, 2010, the principal balance of the mortgage loans serviced for others is approximately as follows (expressed in thousands):
R-G Mortgage, Inc. $ 1,496
Popular Mortgage, Inc. 85
Office for the Administration of the Assets of the Urban Renovation and Housing Corporation or its successor without guaranteed mortgage
loan payments 44
Total $ 1,625
GDB and certain of its component units are defendants in several lawsuits arising out of the normal course of business. Management, based on advice of legal counsel, is of the opinion that the ultimate liability, if any, resulting from these pending proceedings will not have a material adverse effect on the financial position and results of operations of GDB or its component units.
(b) PRHTA
On December 24, 2003, Siemens Transportation Partnership Puerto Rico S.E. (“STT”) and others filed legal claims against PRHTA in the amounts of approximately $50 million for damages, amounts withheld, acceleration of work and other causes of action in connection with the construction of the Urban Train Project. On November 24, 2004, PRHTA filed a counter claim against STT for liquidating damages as stipulated in the contract in the amount of $100 million. PRHTA amended its counter claim on November 17, 2008 to include other credits against STT.
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Therefore, the total claimed damages were increased to $233 million. Under the contractual obligation between STT and PRHTA, STT was responsible to defend, indemnify, and hold harmless PRHTA from claims asserted by third parties against the PRHTA for the acts and omissions by STT, or any of its subcontractors, in the project. Presently, some Alignment Sections Contractor (ASC’s) has asserted claims against PRHTA for damages suffered in part by STT actions or omissions amounting to $150 million, approximately. On September 22, 2005, PRHTA filed a third party complaint for breach of contract, liquidated damages and others against various ASC’s in the amount of $25 million. On April 20, 2007, the Administrative Judge designated this case as a complex litigation and remitted it to the Chief Justice of the Supreme Court who has to assign a presiding judge for the case. On August 28, 2008, STT amended its complaint to adjust the amount claimed to $114 million. On April 21, 2009, in accordance to the calendar approved by the Court through its order dated May 6, 2009, the PRHTA filed and amended third party complaint in which, aside from amending its allegation to the already appearing parties, the guarantors and sureties, and assurance companies were brought to the case. In June 2009, a committee was assigned to evaluate the STT claims, which entailed a period of negotiations between STT and PRHTA. As a result of said negotiations, on May 28, 2010, PRHTA settled all claims with Siemens. During July 2010, PRHTA settled these legal cases with STT and Necso and issued a new line of credit of $63 million to pay the total amount for these settlements and other legal claims for approximately $62 million. On December 22, 2009, Chartis Insurance Company (Chartis) filed a complaint against STT and PRHTA, requesting a Declaratory Judgment in its favor to support its position to deny cover to Siemens request for coverage for all costs associated to its defend and subsequent settlement reached in case KAC2003-8807 (804). The PRHTA’s was included in case merely as party with interest, but no monetary claim was asserted against it.
The only pending claims are those between the PRHTA, ICA (Bayamón Alignment Section) and KKZ (Rio Piedras Alignment Section). Notwithstanding, the Court stayed said proceedings in light of ongoing negotiations between PRHTA, ICA and KKZ. According to current negotiation status, the PRHTA expects to have executed agreements with ICA and KKZ by the end of April 2011, which foresee an offset between retained funds to said contractors and the execution of pending corrective works at their respective Alignment Sections. Due to current negotiations with ICA and KKZ and the staying on the judicial proceedings, the PRHTA exposure in terms of potential loss or gain for these claims is none.
Redondo Construction (RC) filed legal claims against the PRHTA in the amount of approximately $38.1 million for damages, additional compensation, unpaid claims, prejudgment interests and other causes of action related to various construction contracts. On August 31, 2009, the Bankruptcy Court entered judgment in favor of RC for approximately $22.2 million plus prejudgment interest at 6% to 6.5%. The PRHTA filed several post judgment motions to amend judgment and to oppose prejudgment interest. During December 2009, the PRHTA was served with another claim from RC for economic damages of approximately $40 million.
PRHTA is a defendant or co-defendant in various lawsuits for alleged damages in cases principally related to construction projects. These are generally either fully or partially covered by insurance. The contactors are required, under the terms of the construction agreements to carry adequate public liability insurance and to hold harmless the PRHTA from lawsuits brought on account of damages relating to the construction of the projects.
As of June 30, 2010, PRHTA, based on legal advice, has recorded a provision of approximately $121.9 million, of which $25 million has been classified as current, to cover probable losses on those claims not fully covered by insurance. In the opinion of legal counsel, any liability in excess of
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the insurance coverage and/or the recorded provisions that may arise for such claims will not be significant to the PRHTA’s financial position or results of operations.
(c) PRASA
PRASA is a defendant on various lawsuits presented by customers alleging that PRASA has over billed them due to the methodology used to estimate consumption. The plaintiffs requested a certification of the suit as a class action and seek recovery damages in the amount of approximately $793 million and an injunction enjoining PRASA from continuing to bill using the current methodology. PRASA’s potential exposure from these lawsuits cannot be presently determined and, as such, no liability is being reported on the accompanying basic financial statements.
PRASA is the defendant or codefendant in various other lawsuits. The ultimate outcome of the lawsuits cannot presently be determined. However, management, based on the advice of legal counsels, is of the opinion that these lawsuits will not have a material impact on the basic financial statements.
(d) PREPA
PREPA is a defendant or codefendant in several lawsuits incidental to its business, some involving substantial amounts. In those instances that management and legal counsel believe that the outcome of the litigation will be unfavorable to PREPA, a provision has been made to cover the estimated liability. PREPA’s management, based on discussions with legal counsel believes that the additional liability, if any, resulting from the ultimate resolution of these matters will not have a material effect on PREPA’s financial position or results of operations.
On May 18, 2000, Abengoa, Puerto Rico, S.E. (Abengoa), PREPA’s contractor for the repowering of San Juan steam plant units 5 and 6, unilaterally declared a termination of the contract with PREPA and filed a complaint for breach of contract. PREPA has moved for time to answer the complaint and has filed a counterclaim for the cost of the project and for all damages caused to PREPA by the alleged illegal contract termination. PREPA believes that the actions by the contractor will not materially affect the ability of PREPA to provide service nor there will be a material difference in the quality of service provided by PREPA. In June 2004, the Office of the Comptroller of the Commonwealth of Puerto Rico (the “Comptroller”) issued a report stating that PREPA overcharged its clients by approximately $49.8 million, and should reimburse this amount to such clients. After this report was made public, two lawsuits were filed by clients of PREPA against PREPA demanding the reimbursement of such alleged overcharges. PREPA’s position is that the Comptroller incorrectly based his conclusion on data that is not relevant to the calculation of PREPA’s rates, and that PREPA’s rates were properly established in the year 2000 in accordance with applicable laws and regulations. In particular, PREPA notes that its rates properly take into consideration the cost of the fuel used by PREPA’s generating facilities and the cost of the electricity purchased from the two co-generating facilities that sell power to PREPA.
In 2008, Power Technologies Corp. filed a suit against PREPA, alleging that PREPA had withdrawn from a contracting process for a new energy facility, in which Power Technologies was involved, without explanation or justification. Power Technologies seeks damages of $51.4 million. The case is currently in discovery stage.
- 178 - (e) PRMeSA
PRMeSA has accounts receivable aggregating $24 million at June 30, 2010, from the Hospital of the Municipality of San Juan, related to medical services rendered. PRMeSA alleges that these amounts are related to services rendered during the period from June 30, 2005 to June 30, 2008.
PRMeSA filed at the Department of Justice of the Commonwealth and with the Commission for the Resolution of Controversies over Payments and Debts between Governmental Agencies, a claim demanding the resolution of this matter. On June 29, 2009, the Commission designated the OMB to serve as a mediator in this claim. As of June 30, 2010, no resolution or recommendation has been made by the OMB in connection with this controversy.
PRMeSA is a party in certain legal actions and claims related to medical malpractice arising in the ordinary conduct of its business. Although PRMeSA appears as a defendant in the claims, many of them involve medical personnel of the member institutions, and in effect, these claims are against said institutions. As a result of the deficiency as of June 30, 2010, of funds available in the Self- Insured Fund, any unfavorable outcome may have a significant effect on the financial condition of PRMeSA.
Based on a review of current facts and circumstances, management has provided for what is believed to be a reasonable estimate of the exposure to loss associated to litigation. PRMeSA has established an accrual reserve for claim losses in the amount of $7 million at June 30, 2010.
(f) PRIFA
At June 30, 2010, PRIFA is a defendant in various legal proceeding arising from its normal operations. Management, based on the advice of its legal counsel, is of the opinion that the ultimate liability, if any, resulting from these pending proceedings and legal actions in the aggregate will not have a material effect on the PRIFA’s financial statements. However, management is of the opinion that they will reach settlements in certain cases. A liability to cover claims and other contingencies amounting to $7.9 million has been reflected as part of accounts payable and accrued expenses in the accompanying statement of net assets (deficit).
(g) PRHIA
PRHIA is codefendant in a case involving a claim for $14 million by a provider of information technology services. PRHIA’s legal counsel believes that at this stage an estimate can be made as to the financial effect of $1,500,000 to the litigation and cannot offer any evaluation of the likelihood of a favorable or unfavorable outcome.
(h) SPECIAL COMMUNITIES PERPETUAL TRUST
The Special Communities Perpetual Trust (the “Trust”) has financial assistance agreements with several municipalities of the Commonwealth to provide funding for the construction, improvement and rehabilitation of certain projects of the Special Communities. At June 30, 2010, the Trust’s commitments with the municipalities amounted to approximately $116.7 million, from which a total of approximately $88.8 million had been disbursed.
The Trust is a defendant in numerous legal proceedings pertaining to matters incidental to the performance its normal operations. The Trust recorded approximately $10,060,000 to cover for awarded and anticipated unfavorable judgments at June 30, 2010. This amount represents the amount estimated as probable liability that will require future available financial resources for its
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payment. The amounts claimed approximate $70 million; however, the ultimate liability cannot be presently determined. It is the opinion of management that the claims are excessive and exaggerated. Management, based on the advice of its legal counsel, believes that the ultimate liability in excess of amounts provided would likely not exceed $12.7 million.
Environmental Commitments and Contingencies Primary Government
During 2009, the Commonwealth adopted GASB Statement No. 49, “Accounting and Financial Reporting for Pollution Remediation Obligations”. This Statement addresses accounting and financial reporting standards for pollution (including contamination) remediation obligations, which are obligations to address the current or potential detrimental effects of existing pollution by participating in pollution remediation activities such as site assessments and cleanups. The scope excludes pollution prevention or control obligations with respect to current operations, and future pollution remediation