Monday Update –October 2, 2017

Welcome to your weekly Title III update for October 2, 2017. Due to Hurricane María, I was unable to do the September 25 update. Fortunately, my family and I survived with no structural damage. We have water but no electricity or phone service and very limited internet service in the lobby of my condo.

As the last effects of María left the island, the First Circuit Court of Appeals made the Title III cases a lot more interesting. On August 10, 2017, Judge Swain issued an order denying the UCC’s motion to intervene in an Assured litigation. The UCC filed an interlocutory appeal and argued the case. On September 22, the First Circuit issued its ruling. At page 5-6, the Court stated:

“The UCC was appointed in June 2017. Such a creditors’ committee, the duties and powers of which are outlined by statute, see 11 U.S.C. § 1103(c), is intended to serve as “the primary negotiating bod[y] for the formulation of the plan of reorganization” representing the interests of the “class[] of creditors . . . from which [it was] selected.” H.R. Rep. No. 95-595, at 401 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6357. A creditors’ committee is ‘arguably the one party in interest that, for all practical purposes, typically represents stakeholders with the most interest in the outcome of virtually every proceeding.’”

Later, at page 12, the Court stated:

“We believe that the Second and Third Circuits have the better view and, accordingly, hold that the UCC was entitled to intervene under § 1109(b) and Rule 24(a)(1). The statutory language is, indeed, quite broad, providing that ‘a creditor’s committee . . . may raise and may appear and be heard on any issue in a case under this chapter.’”

Although the Circuit also opined that the District Court has discretion to limit the UCC’s participation, the decision definitely broadens its role in the Commonwealth’s bankruptcy. Moreover, the First Circuit mentioned (without a need to do so), that the UCC is a “primary negotiating bod[y] for the formulation of the plan of reorganization.” This means that the Board is not the only one who will be formulating the Plan of Adjustment pursuant to section 312 of PROMESA. The Board must be thrilled.

I must add that the Board stated that it would review the fiscal plan to determine whether there is a need to changes to the Fiscal Plan and the Title III cases. This brings us to an interesting crossroads in the case. Congress and the President have pledged to provide billions to Puerto Rico for its reconstruction, which begs the question of whether the Board will control this money. Section 204(d) of PROMESA states inter alia:

“IMPLEMENTATION OF FEDERAL PROGRAMS.—In taking actions under this Act, the Oversight Board shall not exercise applicable authorities to impede territorial actions taken to—

(1) comply with a court-issued consent decree or injunction, or an administrative order or settlement with a Federal agency, with respect to Federal programs;

(2) implement a federally authorized or federally delegated program;”

What this means is that the Board WILL NOT legally have control over any new money coming in from the Federal Government, but rather the Commonwealth government and Governor Rosselló will. Despite this, as we see recovery efforts ramp up, the Board, notwithstanding section 204(d), wants to be the administrator of the recovery funds and is even trying to lobby Congress to that effect. Further, section 203(e) of PROMESA states:

“TERMINATION OF BUDGET REDUCTIONS.—The Oversight Board shall cancel the reductions, hiring freezes, or prohibition on contracts and financial transactions under subsection (d) if the Oversight Board determines that the territorial government or covered territorial instrumentality, as applicable, has initiated appropriate measures to reduce expenditures or increase revenues to ensure that the territorial government or covered territorial instrumentality is in compliance with the applicable certified Budget or, in the case of the fiscal year in which the Oversight Board is established, the budget adopted by the Governor and the Legislature.”

Therefore, can the Governor argue to the Board that it has “increased revenues” with the addition of more federal funds and furloughs are not necessary? The Board seems to believe it can and announced Saturday, September 30, that there would be no discussion of furloughs until the summer of 2018.

Also, can Bondholders claim they should be paid more if the PR Government will receive greater amounts of federal funding? Questions, questions. What is clear is that the Board’s influence and power has been reduced since María came to PR.

Of lesser importance, although the Board requested that the October 4 hearing be postponed only until October 18, Judge Swain ordered that most of the motions will be decided without oral arguments and others postponed until the November 15 hearing. The Utier/Aurelius constitutional challenge briefing may also be moved. In addition, the Ad Hoc Group of PREPA Bondholders filed a notice of Interlocutory Appeal from Judge Swain’s denial of their request for lifting of the stay in order to request the appointment of a receiver. Let’s see what happens.

Finally, COFINA. COFINA money is currently being held by NY Mellon bank as per Judge Swain’s order. The Board, however, since June has been telling Judge Swain that the Government would likely need to borrow from COFINA come November/December. With the disaster left by hurricane María, not only will Judge Swain be inclined to allow such “borrowing”, she may also be further inclined to declare that COFINA is property of the Commonwealth as the UCC claims in its lawsuit. Trial in that case will be held from December 4-8 and could completely destroy COFINA claims in the amount of $17.6 billion. Would not be surprised to hear COFINA attempting to strike a deal to keep the entity in existence. Should the Government and the Board do a deal that keeps COFINA alive, surely it will set off numerous questions about the Commonwealth’s financial sustainability, whether this is just more of the same financial gimmicks and certainly more legal challenges. It would also likely result in the GO bondholders renewing their claims that COFINA is illegal and the funds are available resources for payment of their bonds.  Let’s not forget about the UCCs role here, too.

This summary is merely what I believe are the more salient motions and decisions in the cases. I receive an average of 20 filings each day so it would be impossible to summarize everything. If you have legal interest in these cases, I urge you to hire an attorney to represent you.

Monday Update – September 18, 2017

Welcome to your weekly Title III update for September 18, 2017. As Hurricane María bears down on Puerto Rico, we should recap several important things from the past week. Judge Swain denied the PREPA bondholders’ request to lift the stay to request the appointment of a receiver. Interestingly, the Court based its decision on only one of the Board’s arguments, making it clear that Judge Swain knows who the boss in these Title III cases is. At page 10 she stated:

“Section 305 of PROMESA provides that, “notwithstanding any power of the court, unless the Oversight Board consents or [the debtor’s Title III] plan [of adjustment] so provides, the court may not by any stay, order or decree, in the case or otherwise, interfere with – (1) any of the political or governmental powers of the debtor; (2) any of the property or revenues of the debtor; or (3) the use or enjoyment by the debtor of any income-producing property.” PROMESA § 305. The Debtor here, PREPA, is a government instrumentality of the Commonwealth, exercising governmental powers in providing electrical service to the inhabitants of the Commonwealth, using its property to generate that power and deriving income from the sale of the power so generated. The rates it charges for its services define the magnitude and impact of its principal revenues. The relief that Movants seek – permission to require the appointment of a receiver to manage PREPA’s operations and seek the approval of rates higher than those PREPA has thus far chosen to charge – is facially inconsistent with Section 305 of PROMESA. Section 305 bars the Court, “notwithstanding any power of the court,” from using “any . . . order or decree, in the case or otherwise,” to interfere with such basic functions and assets of PREPA absent the Oversight Board’s consent, which has not been given here.” (underlining added)

At page 13, she made the most important point of the opinion:

“Congress, similarly, denied the Title III court power to displace PREPA’s management, even for misconduct, by omitting Section 1104 of the Bankruptcy Code, which provides for the appointment of a trustee or an examiner in a Chapter 11 bankruptcy case, from the Bankruptcy Code provisions incorporated into PROMESA’s statutory scheme. Instead, Section 301(c)(7) of PROMESA specifically designates the Oversight Board as the sole “trustee” under PROMESA. See PROMESA § 301(c)(7).” (underlining added)

Anyone familiar with a Trustee in bankruptcy knows that when one is appointed for a debtor, she is the one who calls the shots. Hence, Judge Swain has made it clear that the Board, and not Puerto Rico’s elected officials, are in charge of the management of PREPA and the rest of the entities in Title III. Very telling. Board 2, Bondholders 0, but PREPA bondholders have vowed to appeal the decision. Peaje has already filed its notice of appeal.

Also this week, the COFINA agent answered the UCC’s complaint. As you remember from last week’s update, the UCC, as Commonwealth Agent filed a complaint against COFINA with 13 causes of action, including the unconstitutionality of the law. The COFINA agent came out swinging with a 71 page counterclaims, answer and defenses.

In addition to the oft repeated platitudes of legal opinions and legislative statements, COFINA’ First Cause of Action at page 29:

“[S]eeks a declaration that: (i) the statutes creating COFINA and directing transfer of the Pledged Sales Tax and the Dedicated Sales Tax Fund to COFINA are constitutional under the Constitution of Puerto Rico; (ii) the Pledged Sales Tax, including all Pledged Sales Tax revenue collected in the future, and the Dedicated Sales Tax Fund are the property of COFINA; and (iii) the Pledged Sales Tax and the Dedicated Sales Tax Fund are not “available resources” under the Constitution of Puerto Rico. In the alternative, Counterclaim Plaintiff seeks a declaration that: (i) COFINA has a perfected and unavoidable lien.”

Its Second Cause of Action states that Commonwealth actions violate the Takings Clause and Impairment of Contractual Obligations of both Constitutions. The Third Cause of Action that the Compliance law violates PROMESA, the Fourth Cause of Action that Act 84 violates PROMESA. The Fifth Cause of Action claims tortious interference with a contractual relation and the Sixth Cause of Action claims that if COFINA is unconstitutional, PR committed Fraud, which it likely did, since it should have known that the PR Constitution did not permit the surrendering of the power to tax and that GO’s had priority. The Seventh Cause of Action seeks an injunction but the Eighth Cause of Action claims that “GO Bonds, PBA Bonds and Other Debt Issued in Violation of the Debt Limit Set Forth in the Constitution of Puerto Rico Are Not Entitled to Priority Under the Constitution.”

The COFINA dispute promises to be an interesting slug-fest. The complaint was filed on September 8, but the UCC has already issued 22 subpoenas duces tecum including law firms, Banco Popular, Santander, Barclays and Moody’s, to name a few.

Also last week, Siemens Transportation Partnership, S.E., an HTA creditor, sought permission from the Court to conduct Rule 2004 discovery from the GDB, Carlos Vizcarrondo (GDB) and Hector Betancourt (AFAF). Ambac also sought leave to conduct discovery pursuant to Rule 2004 from the Board as representative of the Commonwealth of Puerto Rico, the Commonwealth; and AAFAF and other parties. More specifically, Siemens, at page 5 of its motions, states:

“Siemens files this Motion to obtain information about the account and the funds therein, including GDB’s funding of the account and any withdrawals or transfers, to determine whether and to what extent: (i) Siemens’ claim against HTA Authority may be paid from funds that are not property of HTA or GDB; and (ii) any third parties have received funds from the account, and if so, whether such transfers may give rise to a claim for fraudulent transfer, conversion or other action, such that Siemens may recover on account of its claim against HTA from parties or assets other than the HTA, which is a Debtor in the above-captioned proceeding, under Title III of PROMESA.”

On this same subject, the UCC reported to Judge Dein that the Board was not cooperating on the coordination of Rule 2004 discovery, which the Board confirmed saying:

“Based on the meet and confer and the Initial Work Plan, the Oversight Board proposes that the UCC’s motion be deferred, and that no decision be made on the UCC’s request to conduct an investigation at this time. The Oversight Board makes this proposal based on its belief that there is no need for the UCC to conduct a separate, potentially duplicative investigation at this time. It would be premature for the UCC to conduct its own investigation given the Independent Investigator’s commitment to maintain open lines of communication with the UCC, to solicit input from the UCC, and to seek documents, including but not limited to those already sought by the UCC. The Investigation should proceed as outlined above and, if there comes a time when the UCC is not satisfied with the speed or substance of the Investigation, it should make an application to the Court to pursue its own investigation on the specific matters on which it is not satisfied.”

Translation: The Board wants to be the only one conducting any investigation on Puerto Rico’s debt and wants no interference. The UCC, in my humble opinion, showed that the Board was conflicted and that it was dragging its feet, which lead Judge Dein to say coordinate because the discovery will be done. Let’s see what happens.

Also this week, PREPA filed a motion requesting an order establishing a procedure to reject power purchasing agreements, of which it states more than 60 exists. Pretty normal procedure in a bankruptcy, except that these contracts are for renewable energy. Why does the Board want to reject them? Is it, as I have been saying, to level the playing field to sell PREPA as free of encumbrances as possible? Is it preparing to sell only the generation part of PREPA? Questions, questions.

On September 11, 2017, Judge Swain listened to oral arguments in the Municipality of San Juan’s request for an injunction against the GDB RSA. Absent from the argument was any real proof of irreparable harm, which is essential to any injunction. In addition, Judge Swain seemed to believe that the monies deposited by the Municipality were a loan and hence could be altered via Title VI. Judge Swain took the arguments under advisement and will render her opinion soon. In the meantime, defendants filed a motion to dismiss the complaint and the one filed by the Municipality of Caguas. Given the Judge’s comments and the Federal Courts view of a municipality, they may be granted.

Finally, on Friday, Judge Dein heard arguments on the UCC’s renewed motion to intervene in the NY Mellon-COFINA bondholders dispute. The UCC has filed motion to intervene in most of the adversary proceedings filed in the Commonwealth and COFINA cases. Judge Dein seems baffled by the arguments and will have to further study them.

Before I leave I want to make one thing clear about these weekly updates. This summary is merely what I believe are the more salient motions and decisions in the cases. I receive an average of 20 filings each day so it would be impossible to summarize everything. If you have legal interest in these cases, I urge you to hire an attorney to represent you.

The Oversight Board’s Chrysler Playbook

The second in a series on Puerto Rico’s pensions

On May 3, 2017, the Financial Oversight and Management Board filed the Commonwealth of Puerto Rico’s Title III petition. In the nearly four months since the filing, we have seen the Board develop a legal strategy that relies on elevating pensions over secured bondholders and invalidating contractual liens such as those held by pension obligation bondholders of ERS.   Each of these steps eerily echoes the legal strategy used by the Obama Administration during the Chrysler Bankruptcy.  But what does an automaker’s Chapter 11 bankruptcy have to do with Puerto Rico’s supposed insolvency you may ask?  More than you would imagine, and it’s not confined simply to the court room, either, as we explore.

First, let’s discuss what happened in the Chrysler Bankruptcy.

The Chrysler Bankruptcy

By December of 2008, Chrysler, after years of decline, was in dire straits. It was bloated, inefficient and burdened by labor contracts and pension costs.  The timing – during the midst of the Global Financial Crisis – could not have been worse.  This confluence led Chrysler, along with General Motors, to then start pleading for greater federal financial assistance (i.e. – a bailout; sound familiar?), arguing that liquidation would mean the loss of thousands of good (meaning union) jobs.

In December of 2008, the U.S. House of Representatives voted to bailout Chrysler, but the U.S. Senate voted it down. Then-President Bush proceeded to extend credit but when the credit ran out, then-President Obama intervened, forcing out Chrysler CEO Robert Nardelli and announcing that the federal government would provide additional funds to support Chrysler contingent on the completion of a merger with Fiat within 30 days.

After examining the restructuring plans, the Obama administration decided they were insufficient, thereby forcing Chrysler to file for bankruptcy in April of 2009. Within two months, Chrysler emerged as “The Chrysler Group,” owned by the United Auto Workers (55%), Fiat (20%), the US Government (8%) and Canada (2%). See, The Auto Bailout and the Rule of Law, by Todd Zywicki.

In the years leading to its bankruptcy, Chrysler had been unable to obtain financing and resorted to issuing secured debt to finance its operations. At the time of the filing, Chrysler owed around $6.9 billion in secured debt, but also $10 billion to an unsecured pension plan.

In a bankruptcy, secured debt has the first priority of payment and unsecured creditors get the rest in a pro rata basis. This general principal applies to all Bankruptcy Chapters and hence to Title III. Also, in a Chapter 11, the debtor prepares a Bankruptcy plan pursuant to 11 U.S.C. § 1123 in which it classifies the claims in order of priority and the debtors whose claims are impaired, have a right to vote on the plan. This is the same procedure of a Chapter 9 and hence, of Title III in PROMESA.

In Chrysler, it was done differently.  The U.S. Government created and funded a shell company that, through a § 363 sale, bought substantially all of Chrysler’s assets for $2 billion, giving the secured creditors a paltry return of 29 cents on the dollar. FIAT was brought in to manage the new firm and was given a slice of the new company’s stock. New Chrysler (formally: New CarCo Acquisition LLC) then assumed the old company’s debts to the retirees, most dealers, and trade creditors. The unsecured claims of the retirees’ benefits plan were replaced with a new $4.6 billion note as well as 55% of the new company’s stock.  Assessing the Chrysler Bankruptcy, by Mark J. Roe and David Skeel at page 5.

How the Board is using the Chrysler Playbook in Puerto Rico

In Puerto Rico, the Board has told the Court that COFINA, Peaje (HTA), and Altair (ERS) do not have a lien – essentially ripping up binding contracts. The Board has also told GO bondholders that they do not have a priority in payment structure, evidenced by the elevation of pensions over their constitutional-backed debt.

At the same time, the Board has allowed the Commonwealth to pay 100% of pensions, which will total $2.5 billion a year, as well as pay all suppliers and tax refunds. The Board will ensure a modest haircut of 10% on these pensions at some point in the future, although the details are vague and applies to only certain pensioners.  Even this move by the Board has met resistance from the Rosselló administration, who has rejected any claims that say they will not pay pensions in full.

As we can see, the Board is trying to deprive secured creditors of their security so their claims can be deeply cut while at the same time, favoring non-secured pensions to be paid. Exactly like Chrysler.

Not wanting to waste time while the Title III proceedings unfold, the Board and the Rosselló administration are getting a jump start through legislative actions.

Together, these seemingly ‘opposing entities’ have jointly pushed through legislation in the Puerto Rico House of Representatives and Senate that codifies pensions as a higher priority payment than constitutionally-prioritized debt, and worse, crystallizes entitlements from the date enactment, instead of upon retirement, which essentially attempts to lock in pensions at current rates and not subject them to a restructuring on a pro-rata basis in Title III without creating claims, a flexibility that the Commonwealth might otherwise have enjoyed. At the same time, they do a farcical face-off about a 10% cut in pensions to give the impression there will be some pain.

This action underscores that neither the Board nor the government are just waiting for the courts to act, as was the case in the Chrysler bankruptcy, but rather enacting policies that will lay the groundwork for the outcome they want in court – to give themselves and pensioner’s protection and outright injuring the secured bondholders they owe.

The Link between Puerto Rico and Chrysler

Judge Arthur González is a member of the Board and without a doubt its intellectual leader. He is on the most important committees, attends Judge Taylor Swain’s hearings (an old colleague of his as they used to be bankruptcy judges in the Southern District of New York together) and most importantly, was the presiding Judge in the Chrysler bankruptcy. Moreover, Judge Gonzalez was president Obama’s choice for the Board – a telling sign.

Additionally, the information I have received is that Judge González was adamant on hiring the Board’s law firm of Proskauer Rose, whose principal restructuring lawyer is Martin Bienestock. According to the University of Michigan Law School bio on Mr. Bienestock, he “developed for General Motors the section 363 sale free and clear strategy that the United States Auto Task Force deployed for both Chrysler and General Motors.” As the saying goes, there is no such thing as a coincidence. It is all too true in the case of Puerto Rico.

One closing thought, what bewilders me is how the Board and government believe they can pursue a legal strategy that will simply invalidate liens and contracts, and elevate pensions above and beyond adequate funding as directed by Congress in direct contradiction with PROMESA and the Puerto Rico Constitution.

In the next installment I will discuss the critics of the Chrysler Bankruptcy in detail, including some that will surprise you.

Monday Update – September 11, 2017

Welcome to Monday Title III update for September 11, 2017. Although Hurricane Irma rightfully drew attention away from the proceedings, several important things happened. Judge Swain issued the Peaje decision, holding that it had not shown during the August 8, 2017 injunction hearing a likelihood of success in its claim that its bonds had a statutory lien over the HTA toll revenues. Judge Swain opined on page 13 of the opinion that:

“Rather, the HTA Enabling Act provides that a ‘contract’ between HTA and a third party may contain a lien, which consensual lien would be enforceable assuming that it satisfied certain conditions. In this respect, the HTA Enabling Act is not meaningfully different from Article 9 of the Uniform Commercial Code, which is a model statutory provision that defines certain conditions under which a lien becomes enforceable. That a lien arising under Article 9 is enforceable does not, however, make that lien a statutory lien under Section 101(53) of the Bankruptcy Code; similarly, that HTA linens trace their validity to the HTA Enabling Act’s grant of authority to create liens does not make liens that HTA subsequently decided to create statutory in nature.”

Judge Swain also decided that Peaje had failed to show that the 1968 Resolution was a law of the Commonwealth or that it would suffer irreparable damage. She determined that Peaje’s expert testimonies by Dr. Hildreth and Thomas Stanford were not credible. On the other hand, she gave credibility to HTA Executive Director González. Hence, even if Judge Swain’s legal conclusions regarding the Peaje lien were reversed on appeal, it is highly unlikely that her decision on the issue of irreparable harm would. A judge’s factual determinations based on testimony she heard are reviewed for clear error and that almost impossible to reverse.

Judge Swain’s decision is consistent with what I have mentioned time and again, she adheres to the letter of the law. If the HTA statute said that a bond created a lien, she would have decided in favor of Peaje, but since it did not, she decided in favor of the Board. This brings us to another important consideration: Judge Swain will give government witnesses great weight. Hence, opponents must come loaded for bear against them. It does not suffice to make them look silly.

Of course, this does not mean Peaje will not try to review her decision but may have to wait until the end of its case since this was only the denial of the injunction. Without a doubt, however, this is a victory for the Board’s continuous effort to destroy all bondholder liens in PR.

I would like mention an article that came out in Bond Buyer, a publication that I follow, and find very informative. There is a new litigation between the Commonwealth v. COFINA (not GO’s v. COFINA) which was filed on Friday, September 8 (more on that later). Judge Swain, however, has not put anything on hold, as evidenced by the Peaje decision. Moreover, although the Board has requested that Judge Swain decide the issues in the case by December 15th, this is unlikely to happen. She has set evidentiary hearings on the issues for December 4-8th. In the Peaje case, after one day of hearing, the post hearing motions extended until August 28th and she decided the issues 11 days later. The issues in COFINA are far more complex and I doubt the decision will come down before January-February.

Another interesting development is the Board’s Informative Motion to Set Briefing in the Aurelius and UTIER constitutional challenge. Plaintiffs’ claim that the Board members’ appointment violates the Appointment’s Clause of the US Constitution. This challenge signals the Board has taken this motion seriously and notified the Court it would hire Donald B. Verrilli, Jr., Obama’s former Solicitor General. Also, in this motion the Board seeks to extend the time to answer the complaints. It stated at page 4 of its motion:

“On the current schedule, the parties to each case will have completed their entire briefing before the Government is required to notify the Court of its plans to intervene or not. That leaves limited time for the parties to consult and exchange views with the Government before making their submissions. That consultation is a standard and important practice in a case like this one, as it involves a challenge to the constitutionality of a federal statute and implicates the significant interests of a broad range of government agencies.”

Although this is true, it seems to me the Board wishes to make sure the Trump administration does not pull the rug out from under it, which is certainly possible. Consider that if the Board was illegally appointed, President Trump would have the right to name all 7 Board members with only the consent of the Senate. That could be a huge difference in these cases.

In another interesting development, although the Unsecured Creditor’s Committee had requested and been denied intervention in the Mellon Bank interpleader COFINA litigation, it again requested leave to intervene and surprise, surprise, the Board, who claims it has no position on the COFINA issues, supported the request. It is quite clear that the Board wants to destroy the COFINA lien to use those proceeds to continue funding the PR Government as it has until now. Any claim to the contrary is pure hogwash. It goes without saying all COFINA creditors oppose the intervention.

The Unsecured Creditors’ Committee filed its complaint against COFINA in representation of the Commonwealth of Puerto Rico at 11:22pm Friday, September 8th. The 44 page complaint is a smorgasbord of lamentations against COFINA with 13 causes of action. The causes of action claim, inter alia, that the Commonwealth did not transfer to COFINA ownership of future SUT revenues; that Act 91 did not assign to COFINA any “right to receive” future SUT; that COFINA has no enforceable security interest in future SUT revenues; that any unperfected security interest COFINA may have in SUT receivables is voidable; that any security interest of COFINA revenues is subordinate to the rights of the Board as Trustee; that the commencement of the Title III case cut-off any security interest; that post-petition transfer of SUT revenues to non-Commonwealth entities violates the automatic stay, etc.

Obviously, the complaint takes the shotgun approach: If I don’t hit you with one barrel I’ll get you with the other, but there a few surprises. For example, the Fifth and Sixth Causes of Action states that if the Court determines that any interest of COFINA in SUT revenues is not a security interest or it was unperfected, it may be voidable pursuant to 11 U.S.C. § 544, § 547 or § 548. This would mean that depending on the section of the Bankruptcy Code that the UCC invokes, it could collect COFINA payments from bondholders as far back as two years or as early as 90 days before the filing of the petition. I imagine Mr. Kirpalani burst a vein when he read that.

In addition, the UCC claims in cause of action Twelve and Thirteenth that COFINA is unconstitutional pursuant to the Puerto Rico Constitution, which is a more likely case. Interestingly, the UCC states at page 33, paragraph 146:

“Puerto Rico’s constitution also prioritizes the payment of the Commonwealth’s public debt over all other debts and expenses in the event of a revenue shortfall (the “Constitutional Debt Priority”)”

At page 34, paragraph 147 it continues stating:

“There can be no dispute that, prior to the Commonwealth Petition Date, the SUT revenues dedicated to COFINA would, but for their dedication to COFINA, be “available revenues” of the Commonwealth (which would first be paid to the holders of lawfully issued Commonwealth public debt).52 Accordingly, the dedication of SUT revenues to COFINA reduced the revenues that would otherwise be available to the Commonwealth to pay its creditors.”

Does this mean that the Board, through its agent the UCC, recognizes that the money from COFINA belongs to the GO bondholders? Very much doubt it since the Board has said GO bondholders have no priority. Time will tell.

Weekly Update – September 6, 2017

Welcome to the weekly Title III update for September 6, 2017. Let’s recap a few important things from the last week.

First, the Board finally filed its complaint against Ricardo Rosselló for the implementation of the furlough of public employees, as per the March 13 certification of the fiscal plan. The Board seeks that the Court declare:

“[T]hat the Commonwealth Fiscal Plan certified by the FOMB includes the Amendments;”

 “[T]hat the Amendments are mandatory and binding parts of the Commonwealth Fiscal Plan;”

“[T]hat the Governor must enforce and comply with the entire Commonwealth Fiscal Plan, including its Amendments;”

And that it issue “an injunction prohibiting the Governor from refusing to enforce or comply with the Commonwealth Fiscal Plan (including the Amendments) and otherwise treating the Amendments as not part of the Commonwealth Fiscal Plan.”

As I have said many times, I believe the Board is correct in its claim that the furloughs are part of the Fiscal Plan (see here at page 2). The Board’s motion, however, has an interesting tidbit that anticipates its position in all the litigation. On page 9 of its motion the Board states, “Regardless of the path by which the FOMB certifies a fiscal plan, Congress provided it sole and complete discretion regarding fiscal plan certification decisions. PROMESA § 201(c)(3). Congress also provided that such certifications are beyond challenge, depriving the federal courts of subject matter jurisdiction to hear any challenge to a certification decision by the FOMB. PROMESA § 106(e).” Since several challenges to the Board’s Fiscal Plan have been filed, here we see that the Board is unwavering in its position: The Fiscal Plan cannot be changed. Now, we will see if Judge Swain agrees.

Adding to the theatrical atmosphere of the case, the American Federation of State, County and Municipal Employees, who mere days before this complaint had asked the Court to determine that the Board could not order the furloughs, filed a motion to stay the Board’s complaint, to consolidate cases or to intervene. This will further delay the prosecution of the issue of furloughs.

Another interesting tidbit: The Board did not file a motion for an injunctive relief hearing. As I stated above, the Board is seeking an injunction from the Court but did not ask for a hearing on the issue. In the case of the Municipality of San Juan, for example, Judge Swain quickly sent a schedule following the August 25 request for a hearing, giving PR until September 1 to answer and setting a hearing on September 11. Since both President Carrión and Ms. Jaresko have said that if furloughs were not started on September 1, there would be a need to have them further extended and even increased from 10% to 20%, it can be argued that the Board, as the representative of the Commonwealth in the Title III filings, can take “any action necessary on behalf of the debtor to prosecute the case of the debtor” (Sec. 315(a) of PROMESA). Clearly, the Board feels no urgency to proceed with the case, meaning that it could take months for Judge Swain to decide the issue.

Is this controversy a Kabuki Theater? Time will tell.

Although the final order is yet to come, the parties in the Commonwealth v. COFINA controversy filed a schedule whereas the Unsecured Creditors Committee on behalf of the Commonwealth will file a complaint no later than September 8 and discovery will move quickly with a trial December 4-8. On October 27, there is a fact discovery deadline followed by the expert discovery deadline on November 3. All interventions will be discussed in the omnibus on November 15. Given the fact that in the Peaje hearing post evidentiary hearing documents were filed as late as 20 days after the hearing and given the complexity of these issues, I don’t expect a decision before January or February of 2018, with appeals still to come later in the year. Moreover, if Judge Swain finds in favor of the Commonwealth, then GO’s will be able to claim they are entitled to the SUT proceeds.

Finally, in a slew of media interviews, José Carrión gave during the week, he said that PREPA must be privatized quickly. On the other hand, Ramón Rosario, the Commonwealth’s Public Policy Secretary, said that the Government is looking for public-private partnerships and PREPA’s executive director said there would be no privatization of the agency.

Who is telling the truth, I wonder? Again, only time will tell.

Monday Update – August 28, 2017

Welcome to the Monday Title III-PROMESA Update! So much happens every day in Puerto Rico’s bankruptcy, including the Friday night news dump that I came up with the idea of updating every Monday what transpired during the previous week. Each day I receive dozens of notifications regarding the five Title III cases that comprise the bankruptcy and through this update I will highlight the previous week’s developments and shed a little light on their implications both to the case, to bondholders and the general public.

During the week of August 20-27, many motions were filed but perhaps most importantly, on August 22, Magistrate-Judge Dein held a “discovery hearing” in two key issues of the Title III litigation. The first was the COFINA Senior Parties objection to the Board and AFAF’s responses to certain areas of discovery. The objections read:

(i) the Oversight Board’s blanket refusal to designate any witness to testify in response to any of the topics in the subpoena; (ii) the Government Parties’ refusal to offer any testimony whatsoever concerning the Fiscal Plan’s treatment of the dedicated sales tax pledged to COFINA (the “DST”); and (iii) the Government Parties’ overly broad assertion of the deliberative process privilege.” (Page 2-3 of THE COFINA SENIOR PARTIES’ URGENT MOTION REGARDING DISCOVERY DISPUTES AND FOR A PRETRIAL HEARING PURSUANT TO FED. R. BANKR. P. 7016 of August 11, 2017)

The COFINA Senior Parties wanted to depose a member of the Board as to COFINA and its position pertaining to that bond issuance. The Board flatly refused to designate any Board members pursuant to Federal Rule of Civil Procedure 32(b), made applicable to Title III as per the Federal Bankruptcy Rules of Procedure. The Board opposed said designation adamantly but Judge Dein made it clear that she believed the COFINA Senior Parties were entitled to either a Board statement on COFINA or a designation for deposition. Based on this, Judge Dein issued the following order:

“The COFINA Senior Parties (“Senior Parties”) and the Financial Oversight and Management Board (“Oversight Board”) will attempt to reach a stipulation of facts in order to eliminate the need for the Senior Parties to take the deposition of the Oversight Board. These parties shall notify the court by August 29, 2017 as to whether a stipulation has been reached. If no stipulation has been reached, the court will rule on the pending request that the Oversight Board designate a witness to be deposed, as detailed in the Motion.” (Page 2 of Judge Dein’s order of August 23, 2017)

From the statements of Judge Dein during the hearing, it is clear the Board must come up with something that will satisfy the COFINA Senior Parties or one of its members will be deposed. The stipulation must be reached by August 29, 2017 or Judge Dein will decide.

Interestingly, once Judge Dein made her point, counsel for the COFINA Senior Parties seemed to lose interest in the rest of their claims and accepted that most of the discovery was subject to the deliberative process privilege and the procedures would be taken on a case-by-case basis.

The second key issue that came up was the Unsecured Creditors Committee request to do discovery on the GDB, Banco Popular, Inc., Banco Popular, Popular Securities, Banco Santander, Santander Asset Management and Santander Securities pursuant to Rule 2004 of the Federal Rules of Bankruptcy Procedure. But first, a little background is needed.

Last year, the Puerto Rican left and Democrats, broadly, were screaming for an audit of the debt so part of it could be declared illegal and hence not paid. Aside from the fact that illegal debt would still have to be paid (see here), Governor Rosselló said he would not do it and Mr. Carrión has said it’s a waste of time. Then, after the Board filed for Puerto Rico’s Title III and Unsecured Creditors Committee (UCC) was formed, it requested leave to do the aforementioned discovery, mentioning the possible conflict of interest of a member of the Board. All of a sudden, the Board discovered PROMESA allowed the Board to do so and said, no UCC cannot do it, only the Board can do it. Obviously, GDB, Banco Popular, Inc., Banco Popular, Popular Securities, Banco Santander, Santander Asset Management and Santander Securities all said they agreed for the Board to do it but objected that the UCC conduct said discovery. During the hearing, the Board’s attorney, Martin Bienestock, said that the UCC did not have to stand down since it simply had not gotten up, ridiculing the discovery request. Even the Retirees Committee waded in support of the Board, no wonder since it has been allowed full payment of pensions.

The UCC, however, came out swinging, pointing out that Mr. Carrión had a conflict as part of the family that founded Banco Popular and an ongoing referral arrangement whereby he provides insurance for many clients of Banco Popular (isn’t this where the $1.8 billion is at?), and Mr. Carlos García was mentioned as the issuer of much of COFINA. The UCC also called the Banco Popular, Santander Securities and the GDB relationship a “revolving door” since many of its executives worked at different times in these places.

Judge Dein was not convinced by the Board’s approach. She asked when the entity that was to conduct the investigation on the debt and when it would commence. When Mr. Bienestock could not provide an answer, Judge Dein made clear that she was concerned about the cost of discovery, the extent but that the UCC and the Board had to coordinate its discovery and stated this in an order

  1. “The Rule 2004 Motion shall remain pending and the Court is not ruling on it herein;

  2. . . ;

  3. Once the FOMB retains its investigator for the investigation it intends to undertake (the “FOMB Investigator”), the FOMB and the FOMB Investigator shall meet and confer with the Creditors’ Committee’s attorneys to determine whether they can agree that certain areas of investigation can either be allocated between them or coordinated among them on terms they agree on;

  4. The FOMB, the FOMB Investigator, and the Creditors’ Committee shall take into account and undertake to avoid unreasonable interference with discovery in the pending adversary proceedings;

  5. On or before September 12, 2017, the FOMB and the Creditors’ Committee shall file with the Court a joint status report advising the Court (a) whether an agreement has been or will likely be reached resolving all or parts of the Rule 2004 Motion, and a proposed deadline for any agreement likely to be reached, (b) of the terms of any agreement already reached, (c) a joint schedule or separate schedules proposing, to the extent currently known, individual topics and targets of investigation and timelines for commencing and completing each investigation, and (d) the remaining unresolved issues in the Rule 2004 Motion for which rulings are requested and proposed hearing dates for such unresolved issues”

With this order, Judge Dein essentially authorized the Rule 2004 discovery but in a coordinated form. Hence, if the Board drags its feet, the UCC can come to the Judge and complain.  Moreover, in a very elegant way, Judge Dein put a deadline on the Board appointing its investigator in such a way that it can coordinate the discovery by the time the report must be made by September 12 or she will rule on the UCC’s motion.

Clearly, the Board lost on two important issues that it adamantly opposed, deposition of its members and debt discovery. It remains to be seen what will be the implications of these “defeats.”

From what we can see of the Board’s actions in the Title III proceedings, it wants to claim that all bond debt is illegal for one reason or another so they are unsecured claims with no constitutional priority (see Article VI, section 8 of the PR Constitution). This way it will substantially reduce debt payment and justify the ridiculously low debt service in the Fiscal Plan.

But with the UCC’s intrusion it has the problem that some of it members and their protected allies may be sued for millions of dollars. The UCC made it clear that it believes COFINA was illegal, and the 2014 GO issuance, as surpassing the debt limit of Article VI, section 2 of the Puerto Rico Constitution. It is very telling that one of the documents requests of the UCC to the banks is “Documents or Communications concerning any director and officer liability policies.” The Board members are immune from liability for their work as members of the Board but not for actions performed BEFORE they were members.

The decisions by Judge Dein seem to have convinced National and other bondholders to request discovery pursuant to Rule 2004, this time on the Fiscal Plan, the Budget and other documents issued by Puerto Rico and the Board. Movants claim they have asked Puerto Rico and the Board for certain documents since before the filing of the Title III petitions and that they are important for the understanding of the future Plan of Adjustment which must be based on the Fiscal Plan. Expect the Board and AAFAF to claim they have been produced or that now is not the time. Judge Dein will have another opportunity to rule on discovery sometime in the next month.

On Friday, August 25, 2017, the Municipality of San Juan filed a Preliminary Injunction in a case it has previously filed against the Board, Puerto Rico and the GDB. The Injunction seeks to stop the GDB from soliciting votes and tabulating them on its RSA, which it said it would start once the Governor signed the statute that permits it. Since it was signed Friday, the Municipality sought the injunction. The Municipality claims the RSA violates section 601 of PROMESA, and it very likely does. The problem as I see it is the proof of irreparable harm required in these procedures, especially since section 601 requires Court approval of any RSA in a hearing in which any party may challenge whether the requirements of the section have been met. Judge Swain would likely postpone any ruling until the aforementioned hearing. In any event, I believe the Municipality’s claim, as well as those of the Municipality of Caguas in a separate lawsuit are very valid and require careful scrutiny.

I hope you found this new update helpful… till next Monday…!

The Coming Puerto Rico Public Pension Fight

The first in a series on Puerto Rico’s Pensions

Last week, the Supervisory Board held its 9th Public Meeting in Farajado, Puerto Rico. A key item on the agenda, “Discussion of Pension Reform,” was over-shadowed by the pending fight over furloughs, but is perhaps one of the most important items discussed.

As many know, one of the critical issues before the Supervisory Board is how to address the future of Puerto Rico’s public pension system and a $49 billion actuarial deficit.  In fact, this is one of the reasons Speaker Ryan and the Congressional Republicans insisted on having an expert like Andrew Biggs on the Board.  His knowledge of pensions ostensibly would help reform Puerto Rico’s public pension system to become a model for cities and states across the country.

What PROMESA Says the Board Must Do

Section 211(a) of PROMESA requires the Board, if it determines pensions are underfunded, to conduct an analysis prepared by an independent actuary […] to assist the Oversight Board in evaluating the fiscal and economic impact of the pension cash flows.” The Board hired Pension Trustee Advisors, Inc., a Colorado corporation, for this endeavor in February.  To date, we have yet to see any documents or plans generated by this company or produced by the Board.

Instead, the government with the support of the Board moved first. Since February, Puerto Rico passed a law to convert the government and its component units into a single employer and although the Board instructed that pensions had to be cut by 10% by fiscal year 2020 in the Fiscal Plan, the Board green-lighted the government to move over $2 billion from the General Fund to the public pension system.  At the same time, neither Governor Rosselló nor the Board provided any monies for debt service in FY18.  This had the effect of elevating payment of public pensions above secured creditors.

Then, on May 21, 2017, the Board filed a Title III bankruptcy petition for the Government Retirement and the Judiciary Retirement Fund.  Further, the government passed a measure to transfer $390,480,000 from the Central Government, Judiciary and Teacher’s retirement funds to the General Fund for the payment of pensions, known as RC 188.

All of this was done with the Board’s approval, but not without opposition from other stakeholders.  On July 27, 2017, Altair Global Credit Opportunities Fund (A), LLC and others filed an adversary proceeding to challenge this action by the Puerto Rican Government. Altair & company claim they have a lien over Government contributions to the retirement fund and that RC188 is null and void; that they hold a secured claim to the full extent of their allowed claim against the ERS; that they hold a secured claim to the full extent of their allowed claim against the Commonwealth and that their lien continues in any Pledged Property transferred to the Commonwealth from the ERS. They also claim that the transfer of the Pledged Property from the ERS to the Commonwealth pursuant to Joint Resolution 188, on its face, constitutes an unconstitutional taking of private property without just compensation within the meaning of the U.S. and P.R. Takings Clauses; and that RC 188 substantially interferes with their contract rights with the ERS in violation of the U.S. and P.R. Contracts Clauses. Finally, they also ask for damages and that PROMESA does not preclude such claim. Since it was filed only recently, we have no idea how Judge Swain will handle it, except that it will be done swiftly.

Echoes of the Chrysler-UAW Pension Bailout

This strategy by the Board – elevating pensioners over secured bondholders – evokes memories of the Chrysler bankruptcy, which saw the Obama Administration support unsecured UAW pensioners become secured creditors – literally jumping the line ahead of actual secured creditors. The judge in that case was none other than Judge Arthur Gonzalez, the key architect behind the Board’s legal strategy.

Neither the Constitution nor PROMESA explicitly do not allow for the payment of public pensions to be put ahead of bondholders, which was the ultimate outcome in the Chrysler case.  Now, the PR Supreme Court granted pensioners rights in Bayron Toro v. Serra, 119 D.P.R. 605, 608 (1987), stating that, “Once an employee is retired, when he has complied with all the conditions for his retirement, his pension is not subject to changes or impairments.” However, this precedent is subject to Article VI, Section 8 of the PR Constitution that states:

“In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made in accordance with the order of priorities established by law.”

While Section 201(b)(1)(C) of PROMESA states that the Fiscal Plan must provide adequate funding for public pension systems, Section 201(b)(1)(N) requires the Fiscal Plan to respect the relative lawful priorities or lawful liens, as may be applicable, in the constitution, other laws.”

Moreover, the Committee on Natural Resources Report on PROMESA states the following:

“The Committee acknowledges the concern as to the ambiguity of the language regarding the funding of public pension systems. To clarify, Section 201(b)(1)(C) tasks the Oversight Board with ensuring fiscal plans ‘provide adequate funding for public pension systems.’ This language should not be interpreted to reprioritize pension liabilities ahead of the lawful priorities or liens of bondholders as established under the territory’s constitution, laws, or other agreements. While this language seeks to provide an adequate level of funding for pension systems, it does not allow for pensions to be unduly favored over other indebtedness in a restructuring.

Realizing that creditors and Congress are onto them, the Board has attempted to mask their strategy.

In their latest document, Explanatory Memorandum on Pension Reform,” the Board claims, “expenditures are being reduced throughout the Commonwealth’s budget and holders of government bonds are not likely to be repaid in full. Retirement plan participants, like other unsecured creditors, will have a reduction in the amounts paid to them by the Commonwealth.”  Board member Ana Matosantos went further, rejecting Christian Sobrino’s claim that Governor Rosselló will fund 100% of the public pensioner’s benefits, stating “honoring 100% of the obligations is not workable.”

The Board has shown its hand, and they will face a stiff test before Judge Swain. Congress was clear that funding pensions was important, but not equal to or above existing constitutional and lawful priorities.  To date, the Board and Puerto Rico have decided unsecured pensioners have higher priority.

Why is the Board and the government putting payment of pensions before payment of public debt in direct contradiction of both PROMESA and the Puerto Rican Constitution? Why is the Board pursuing this legal strategy?

I will explore and hope to explain the reasons for this in my series on public pensions in Puerto Rico.

 

Bondholder Negotiations and the Road to Nowhere

The Negotiation Farce

We are now in April and, come May 1, the PROMESA stay on litigation expires. Where are we on bondholder negotiations? What happens if there is no Title VI restructuring?

It looks like the answers to those questions might be “nowhere” and “we’re about to find out,” respectively.

Last year, the Oversight Board announced with great fanfare the start of bondholder’s negotiations set for December 19, 2016, but aside from a meet and greet session, nothing happened. And that has remained the case even after the board certified Governor Rossello’s second fiscal plan last month.

After certifying the plan, the board requested that the two senior-most bondholder groups, General Obligations and COFINAs, enter into private mediation to settle their ongoing dispute.

This request kicked off a flurry of letters from creditors, including joint letters authored by holders of some $13 billion of both GO and COFINA debt, which outlined numerous criticisms of the fiscal plan. The letters also asked the government to commence negotiations with bondholders immediately, arguing that the stay expires too soon to waste time negotiating a creditor dispute rather than negotiating with all bondholders.

Despite these overtures, however, the Puerto Rican Government and the Board have not moved onto negotiation, and have instead pushed forward with the mediation process, assigning Judge Allan Gropper to serve as mediator in talks reportedly starting today and lasting through the end of the week.

Why? To Sow Confusion

It appears that the Oversight Board and the Government are intentionally conflating mediation between two creditors in active litigation and actual negotiation with creditors.

It is impossible that a real solution to the GO/COFINA dispute will be brokered over a mere 48-72 hours, especially given the numerous, unaddressed problems that parties on each side have with the fiscal plan. Moreover, even if a settlement was reached, there will be only two weeks for real negotiation to occur after the mediation ends.

But the Board does not appear genuinely interested in a resolution to the dispute or conducting serious negotiation talks. Rather, I think the board is intentionally confusing the issue with the hope of stalling for Title III.

Once the stay runs out, the Board will most likely say that the mediation proceedings themselves actually qualify as a good faith effort toward reaching a consensual agreement under Title VI of PROMESA, and will use that to justify throwing the entire process into a Title III restructuring.

Will Mediation Count as a Good Faith Effort at Negotiation?

Mediation is a type of alternate dispute resolution where a supposedly neutral person helps the parties involved to resolve their disputes. It is not the same thing as a negotiation, especially when some of the parties say they don’t want to participate in the process.

Section 206 of PROMESA requires the entity (PR) to make “good-faith efforts to reach a consensual restructuring with creditors” before the Board issues a certification for Title III. Good faith negotiations is part of Chapter 9 of the Bankruptcy Code, but the section that deals with it, 109(c), was not adopted by PROMESA. Nevertheless, it is a requirement and likely bankruptcy law precedents will be used by the Courts to determine if there have been any.

To be sure, bondholders will raise this point in court. While we often hear from Oversight Board members and Commonwealth leaders that this process is not subject to judicial review – and while that also seems to be the intellectual opinion of Judge Gonzalez and Marty Beinenstock – I don’t think any judge appointed to oversee the Title III process will just let such a crucial issue like this go unquestioned.

Thus it seems very unlikely that a judge will agree with the Board that its attempts to force bondholders into mediation will satisfy PROMESA’s requirement of a good faith effort at a consensual negotiations.

Has the Board or the Puerto Rican Government Provided Sufficient Information for Good Faith Negotiations to Commence?

In the Detroit litigation, the Court determined that the city had not negotiated in good faith for failing to provide sufficient information to make counterproposals and that there was not sufficient time to do so. In this case, negotiations started on June 14 and bankruptcy was filed on July 18. See In Re Detroit, 504 B.R. 97, 175 (E.D. Mich. 2013). As I said earlier, after the conclusion of mediation proceedings on April 14, there will be only 16 days until the end of the stay. Even in the unlikely event that mediation is allowed to constitute part of a negotiation process, there will still only be 18 days between April 13 and the end of the stay.

The issue of sufficient information is important with respect to Puerto Rico’s financial statements, since sec. 206(a)(2) requires PR to adopt   “procedures necessary to deliver timely audited financial statements; and . . . made public draft financial statements and other information sufficient for any interested person to make an informed decision with respect to a possible restructuring.”

Since the Board’s report by Ernst & Young, at pages 5, 9-10 and 16 states that the financial information it used (provided by the PR Government) is poor, it can hardly mean that it is “sufficient for any interested person to make an informed decision with respect to a possible restructuring.”

Hence, the way in which these negotiations are conducted and the information provided is of paramount importance for the Title III petition not to be dismissed by section 304 of PROMESA. As of yet, it does not appear that the government has submitted sufficient information for real negotiations to occur.

Does the Fiscal Plan Satisfy Requirements in PROMESA?

It is my belief the Court may review the fiscal plan to determine whether it complies with PROMESA in the intersection of sections 201(b)(1)(N) and section 314(b)(7). Section 201(b)(1)(N) requires that the Fiscal Plan “respect the relative lawful priorities or lawful liens, as may be applicable, in the constitution, other laws, or agreements of a covered territory or covered territorial instrumentality in effect prior to the date of enactment of” PROMESA.

The Fiscal Plan as approved, however, does not do this in any of it sections. In fact it states, at page 6 that it does not determine, inter alia, “the scope, timing or specific use of revenues to be frozen or redirected as ‘claw back’ revenue, the value, validity and/or perfection of pledges or whether any particular bond or debt issuance may have been improvidently issued” Since the Bankruptcy plan, pursuant to section 314(b)(7), must be “consistent with the applicable Fiscal Plan certified by the Oversight Board under title II” one can argue that any Bankruptcy Plan based on a deficient Fiscal Plan is invalid and hence the Court would have to make said review of the Fiscal Plan. Moreover, the Fiscal Plan cannot violate the US Constitution and bondholders seem poised to make that challenge.

What if the Court were to find that the Bankruptcy Plan is not consistent with what should be the Fiscal Plan? Pursuant to 11 U.S.C. § 930 (adopted in PROMESA by section 301), if the Court could determines that the Bankruptcy Plan could not be certified, it can dismiss the proceeding and PR would not have the protection of the automatic stay.

Or is the Strategy to File for Title III, then Negotiate?

Given all of these obvious shortcomings of an impending Title III petition, it’s worth asking why the Board would file for Title III and risk having it dismissed. The answer likely lies in Section 304(b) of POMESA, which does not allow the dismissal of a Title III petition during its first 120 days.

Therefore, the Board could use this window to negotiate AFTER filing Title III (including Court mandated mediation as in Detroit) and then claim that it negotiated in good faith. It could then aver that it would be a shame to dismiss the claim after all this time. Essentially, the board could file for Title III with full knowledge that its petition will most likely be rejected, if only to buy itself four more months.

Let’s see.

LEX CLAIMS ORAL ARGUMENT APRIL 4, 2017

On April 4, 2017, Judges Howard, Lynch and Barron heard oral arguments in the Lex Claims case, where Judge Besosa had decided the PROMESA stay did not apply to some of the claims, including the validity of COFINA and its alleged lien.

As usual, right from the start of the Supervisory Board’s argument, the Judges started asking pointed questions. Judge Barron started asking technical questions that boiled down to whether the stay applied to a declaration that Governor Garcia Padilla’s executive order were invalid or preempted. Judge Howard asked if some or all of the causes of action arose after PROMESA was approved. The Board’s lawyers denied this but clearly the Judges are not convinced. Judge Lynch seemed concerned about other cases arising but was assured there are none.

Judge Howard asked about mediation and was assured it would start next week. When Senior COFINA lawyers started their argument, Judge Barron asked why the declaration of the Executive order was preempted. COFINA had to admit that such declaration is not an issue of control.

Ambac came next for appellants and likened the Lex complaint to a bank in state court attempting to determine where income should go for a bankruptcy debtor but this did not bar Judge Barron from asking the same question as to declaratory judgment. We can see a pattern there.

Once Lex Claims came to argue, it invoked section 303(3) of PROMESA claiming this was not precluded by the stay. Judge Lynch, who seems intent on preserving the stay, asked if there was explicit language that pointed that way. Lex conceded there was none but that the overall interpretation of PROMESA showed that. Lynch did not seem convinced. Lex continued arguing that they did not seek control, but Judge Barron challenged this view. Judge Lynch went to the offensive and asked if you filed your complaint, why should we relieve you of it in clear reference to the second amended complaint. Lex answered that it could amend the complaint.

From this we may surmise that as the Circuit Court’s stay order stated, the Judges will decide the stay will apply to all of the Lex Claims’ complaint, although Judge Barron could file a partly dissenting opinion or convince them it does not apply to the declaratory judgment sought by appellee. Since I assume the panel will be as swift as it was in the Peaje case, a decision could come down by next week or earlier. If it comes down by next Tuesday, April 11, there would only be 19 days left of the stay.

This brings us to another issue. Since it is clear negotiations will start later than April 10, the PROMESA stay which was enacted to afford PR an opportunity to attempt to restructure its debt consensually has been instead used by the Government and the Board to pick and choose winners among bondholders. This may have serious repercussions in the coming Title III as I will discuss in an upcoming posting.

TITLE VI OF PROMESA: CREDITOR COLLECTIVE ACTION

PROMESA provides two mechanisms to restructure PR’s debt, Title III, a bankruptcy like procedure and Title VI, a mechanism to formalize agreements negotiated between PR and its creditors. Moreover, the way PROMESA is written, Title VI negotiations are indispensable for eligibility to Title III.

Section 206(a)(1) of PROMESA requires that before the Board issues a restructuring certification (permission for Title III) it determine that “the entity has made good-faith efforts to reach a consensual restructuring with creditors” Hence, Title VI negotiations are imperative. What is the procedure for these negotiations? Who negotiates, the Board or the Government of PR? What happens if the parties reach an agreement? What happens if they don’t reach an agreement?

Title VI of PROMESA provides some of the framework for said negotiations. Sections 206(a) and 405(n) of PROMESA establish that the Puerto Rico Government, not the Board, will conduct these negotiations. That does not mean that the PR Government and the Board cannot coordinate negotiations efforts but the former, not the latter, conducts them. The Board, however, has made it clear to PR that only it can approve the agreements, as I will discuss shortly.

Title VI consists of two sections, to wit, 601 and 602. Section 602 simply excludes foreign and international law from Title VI, therefore, section 601 covers the negotiations process. Strangely enough, section 601 does not establish the manner or form of the negotiations but rather structures how bondholders are to vote for the proposed modifying qualifications (modifications of the bond debt).

Once PR and bondholders come to an agreement to modify the bond debt, the Board, PR or the bondholders may propose a Qualifying Modification to such debt. If the Board likes it, it will order voting on that Qualifying Modification and if it does not like it, there will be no chance to have it approved. Once approved by the Board, officials designated by the Governor will establish pools for the different issuers of bonds. For example, if the bonds issued by the Retirement Fund have differences in preferences, or a lien (as the First Circuit recognized to Altair on those bonds), these bonds have to be put in different pools. Once all outstanding bonds, meaning valid bonds that have not been paid (another reason why the Board will conduct its own audit of PR’s debt), have been accounted for and its owners identified, certain information has to be delivered to them. Section 601(f) establishes the following:

Before solicitation of acceptance or rejection of a Modification under subsection (h), the Issuer shall provide to the Calculation Agent, the Information Agent, and the Administrative Supervisor, the following information—

(1) a description of the Issuer’s economic and financial circumstances which are, in the Issuer’s opinion, relevant to the request for the proposed Qualifying Modification, a description of the Issuer’s existing debts, a description of the impact of the proposed Qualifying Modification on the territory’s or its territorial instrumentalities’ public debt;

(2) if the Issuer is seeking Modifications affecting any other Pools of Bonds of the Territory Government Issuer or its Authorized Territorial Instrumentalities, a description of such other Modifications;

(3) if a Fiscal Plan with respect to such Issuer has been certified, the applicable Fiscal Plan certified in accordance with section 201; and

(4) such other information as may be required under applicable securities laws.

As stated above, once this information is delivered to the bondholders, they will vote and if “the affirmative vote of the holders of the right to vote at least two-thirds of the Outstanding Principal amount of the Outstanding Bonds in each Pool that have voted to approve or reject the Qualifying Modification, provided that holders of the right to vote not less than a majority of the aggregate Outstanding Principal amount of all the Outstanding Bonds in each Pool have voted to approve the Qualifying Modification” the modification will be approved. Section 601(j) of PROMESA.

If the Qualifying Modification is approved by the vote of the bondholders, then the agreement is taken to the US Federal District Court for the District of Puerto Rico for the entry of an order that the requirements of Section 601 have been satisfied. Once this order is entered, the Modifying Qualification is binding on all bondholders but this may be questioned in the US Federal District Court for the District of Puerto Rico due to the unlawful application of Section 601 or that in the judgment of the Court it is “manifestly inconsistent” with Section 601.

Undoubtedly agreements will be reached between some issuers and some bondholders, especially with those with weaker claims, to wit, PFC and GDB, the latter which its bondholders had already accepted 53% haircut. In others, such as GO’s and COFINA, it is likely that a Title III filing will ensue, especially if a quick resolution of that controversy is not made by Court resolution. And those filings will make Detroit seem a walk in the park.