Monday Update – March 12, 2018

Welcome to your weekly Title III update for March 12, 2018. Judge Swain held an Omnibus Hearing on March 7, which was the highlight of the week.

While giving the report from the Board, its attorney, Martin Bienenstock stated that there was not an impending need for a new loan for PREPA. His statement was that instead of a probability, it was only a possibility that PREPA would need to seek a new loan due to increased collection of its bills. Given that the Board first asked for $1.3 billion, then $1 billion and when it was only given a $300 million loan, it asserted that in 2-4 weeks it would seek more, two things are clear.

First, Judge Swain knows her numbers and the Board and PR are not transparent in their financial information. This brings us to another point. It was reported in the news that fuel expenses for PREPA increased but the Governor refused to increase rates (via de fuel adjustment clause).  Rather, he believes he can force President Trump and the Federal Government to provide the Community Disaster Loan to make up the difference.  That is an interesting political calculation.  This is another example of why PREPA has problems; political decisions (increasing rates will be electorally unpopular) that undermine the continuity of services. PREPA was totally unprepared for the hurricanes in part due to its lack of funds. Less than 90 days from the next hurricane season, it seems it will be as unprepared.

Also this week, the Governor revealed the legislation for the sale of PREPA. If one examines it, as I carefully did, although it allows for the sale of assets, one can see that it favors Public Private Partnerships (3P) over the sale and that has bee echoed by some legislators and the Governor. The Board on the other hand, has been clear that it wants it sold. Who will prevail? I think the Fiscal Plan will resolve the issue. If the PREPA Fiscal Plan, the new version which has not been released by the Governor, includes the outright sale of the utility, the FOMB’s view will prevail. Section 305 of PROMESA, which precludes the Court from interfering with the Commonwealth’s use of its property, has an exception, “[s]ubject to the limitations set forth in titles I and II of this Act.” The Fiscal Plan is in Title II of PROMESA. Hence, if the sale is in the fiscal plan, it is likely PREPA will be sold.

Last Monday, Judge Swain issued an order scheduling Omnibus hearings for different dates up to April of 2019. This coupled with hear statement during the March 7 hearing that the “PROMESA cases were in their infancy,” makes us believe the earliest the Commonwealth Title III gets resolved is May of 2019. Moreover, if the GDB and PRASA are added to the Title III, we could have these cases drag until late 2020.

Judge Swain approved the fee examiner’s report and most of the requested fees, totaling around $50 million. For the most part, these amounts had already been paid and date from before the start of the case until September of 2017. A number of the requested fees were left for the April Omni. Clearly, this bankruptcy is costing PR tax payers a pretty penny.

In addition, the parties to the PBA motion for payment of certain leases was “settled” by providing claimants with an administrative expense status for the rents, but with a caveat:

“Unless and to the extent the PBA Leases are subsequently adjudged not to be leases for purposes of Bankruptcy Code section 365(d)(3) and subject to paragraph 3 below, the PBA shall have allowed administrative priority claims against the Debtors with respect to unpaid rent accruing under any leases of nonresidential real property from and after each Debtors’ respective petition date, pursuant to Bankruptcy Code 365(d)(3), 503(b), and 507(a)(2) (including, for the avoidance of doubt, any amounts due from the Commonwealth’s agencies and departments) arising under PBA Leases currently due and owing to the PBA, which shall continue to accrue, but not require payment absent further court order, until each such PBA Lease is either assumed or rejected by the applicable Debtor (collectively, the “Administrative Rent Claims”).”

Section 3 of the settlement states:

“Any and all Administrative Rent Claims and their allowance or disallowance shall remain subject to all rights, claims, defenses, and setoffs available to each Debtor, as applicable, and the Debtors and the Official Committee of Unsecured Creditors retain all rights to assert objections or defenses to the Administrative Rent Claims, provided, however, the Debtors shall not be entitled to assert that any of the Administrative Rent Claims have been waived as not timely asserted. For the avoidance of doubt, the issues of whether the PBA Leases are “true leases” entitled to treatment under section 365(d)(3) of the Bankruptcy Code, the validity or enforceability of the PBA bonds or PBA guarantees, and whether a debtor-guarantor who is not the tenant under the subject lease is subject to the performance obligations of section 365(d)(3), are expressly preserved.”

Since the UCC had filed a motion that intimated that the leases were not real leases and that it was investigating whether the bonds were issued illegally, we can expect some time in the future and adversary proceeding by the UCC against the PBA bondholders.

In addition, the unions and the Commonwealth came to an agreement for arbitration and grievances to continue. If the Board feels that any procedure would affect the Fiscal Plan, it will notify the unions and the issue will be brought before Judge Swain. Good settlement for all involved.

Judge Swain has set the hearing on the injunction requested by the PR Energy Board against the FOMB for March 27. The UCC filed a request for intervention stating the following:

“Plaintiff in this Adversary Proceeding claims that “whenever a proposed PREPA Fiscal Plan would impact substantive electric industry matters, [Plaintiff’s] timely assessment and approval is a prerequisite for [Oversight Board]’s certification of such Fiscal Plan.” See Compl. at 50 [Docket No. 1]. In other words, Plaintiff contends that it has the right to review any Fiscal Plan PREPA intends to propose, and either to approve or reject its contents, before the Oversight Board can consider the Fiscal Plan. Thus, PREPA cannot propose, and the Oversight Board would be unable to entertain, any strategies for reorganization except for those that Plaintiff has already blessed. This would do violence to the scheme Congress adopted and sharply curtail the approaches to reorganization the Oversight Board might adopt.

The Committee has a significant interest in this case because the relief that Plaintiff seeks would destabilize Congress’s statutory scheme for title III cases and would undermine the Committee’s efforts to adequately represent the many unsecured creditors in this case. By inserting itself into PROMESA’s statutory scheme, Plaintiff’s involvement in this case would needlessly protract the process of getting PREPA on the path to fiscal responsibility. In addition, the Committee has a vital interest in the issues raised in Plaintiff’s Complaint as they pertain to PREPA’s revenues and expenses, and therefore the funds PREPA will have available to satisfy its general unsecured creditors—the constituency the Committee was appointed to protect. If Plaintiff prevails, the resources available to satisfy the claims of general unsecured creditors would be directly affected. Perhaps most importantly, the Committee has a substantial interest in a just and speedy resolution of this case. Plaintiff’s claim that it must preapprove any Fiscal Plan submitted to the Oversight Board necessarily affects these issues; therefore, the Committee should be allowed limited intervention in this Adversary Proceeding.”

I believe this question sums the issue in this litigation; who certifies the fiscal plan, the FOMB or the PR Energy Commission? Seems to me that for good or for bad, PROMESA is clear that it is the FOMB. Judge Swain has already ruled on this and is likely to rule in a similar fashion.

Lastly, last week I mentioned the GO motion for summary judgment of only 1,399 on COFINA. One of its exhibits has a very interesting discussion, which deserves closer examination. The email is from Lawrence Bauer of Sidley Austin to Jorge Irizarry of the GDB in 2007:

“The sales tax is a tax imposed by and collected by the Commonwealth Dept. of the Treasury not by the Corporation and not “on behalf of” the Corporation, which has no taxing power. As such, the tax revenues are “property” of the Commonwealth until such time as they are transferred to the Corporation (even if it’s only a under a minute until the moneys are transferred to the Corporation). Therefore, during that (admittedly short) period from the time the taxis collected by the Commonwealth until it is transferred to the Corporation, Ithink a court would have a hard time concluding just on the basis of the legislature saying so that the sales tax revenues are not “available” to the Commonwealth should it need the money to pay G.O. debt. Ultimately, the legislation may be upheld (courts uphold conclusions that are reached by incredible legislative gymnastics over a more simple and straightforward analysis – just look at the “separate but equal” nonsense that the U S. Supreme Court upheld and the decades it took to reverse it in Brown v. Board of Education), but the mere fact that I’m having this discussion with you about its validity is the reason you have to disclose that this conclusion isn’t a slam dunk. After all, why – for Constitutional availability purposes – is a sales tax on gasoline any different from a sales tax on men’s flip flops? If the answer is “because the legislature said so.”, then from a disclosure standpoint of giving investors the complete “information mix” they need in order to make an informed investment decision as the U.S. Supreme Court has mandated, you have to disclose this distinction. That is, you have to make reference to the other sales taxes in Puerto Rico that are treated as available and explain why this sales tax is different. Then you have to say: but we’re not sure the P.R. Supreme Court would agree with that view, because under our system of laws, whenever the question is “what does the Constitution mean?” the final answer can only be given by the highest court in the jurisdiction – in this case the P.R. Supreme Court, and just because the legislature or the working group on the sales tax bonds wants it to be another body (i.e., itself) doesn’t change that. Remember, the question of whether an item needs to be disclosed is whether a reasonable investor would have liked to have known of the information while pondering whether to buy the bonds. Do you think this is not important information to a potential bondholder? If you think not, then don’t disclose it and see what happens. If you think it is important, then you have your answer: you have to tell him/her. Think about what information you would like to have before you made a decision to buy (or not to buy) these sales tax bonds.”

The discovery of these emails, and the contents of the exchanges between parties, cannot be overstated.  They directly speak to whether the SUT is an available resource to PR, and will certainly be used to argue against COFINAs constitutionality. I have also said many a time and I repeat it now, if the Court were to side with the UCC and others that the SUT cannot be assigned to COFINA and it is available resources, all those bondholders will be left with claims against a corporation that has no income. They will file dozens of fraud claims against the Government of PR which must be adjudicated in order to have a vote on the Plan of Adjustment. Hence, the Title III case may take well beyond May of 2019.

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 – March 5, 2018

Welcome to your weekly Title III update for March 5, 2018. Judge Swain has decided important issues this time in favor of the Board.

In the Ambac adversary proceeding, Judge Swain dismissed the insurer’s claims for different reasons. She dismissed claims on liens and takings claims as premature, I assume hoping they will be solved in mediation or in the case of taking without just compensation, that it be considered moot once the Plan of Adjustment is presented. As predicted, Judge Swain rejected the challenge to the certified fiscal plans (except for possible Constitutional deficiencies) and said:

“Section 201(b) of PROMESA identifies fourteen specific objectives and requirements that a fiscal plan, whose development is overseen by the Oversight Board, must satisfy. The Oversight Board, pursuant to Section 201(c)(3) of PROMESA, is specifically tasked with reviewing and approving proposed fiscal plans and is granted “sole discretion” to determine in connection with such certification whether such fiscal plans satisfy the Section 201(b) requirements. PROMESA not only grants the Oversight Board exclusive authority to certify fiscal plans, but it also insulates the Oversight Board’s certification determinations, which necessarily rest on determinations that the Section 201(b) requirements have been met, from challenge by denying all federal district courts jurisdiction to review such challenges. See PROMESA § 106(e). To be meaningful, denial of jurisdiction to review the certification of the Fiscal Plan thus must be understood preclude the review of claims that particular aspects of the Fiscal Plan are noncompliant with Section 201(b) requirements.

The First, Second, and Fourth Claims for Relief of the Amended Complaint expressly seek invalidation of the Oversight Board’s certification of the Fiscal Plan and injunctive relief prohibiting Defendants from taking or causing to be taken any action pursuant to the Fiscal Plan. (Am. Compl. ¶¶ 215, 218, 223, 226, 236, 239.) To the extent these claims rest on contentions that the Fiscal Plan violates Section 201(b) specifications, such as the requirement that a fiscal plan respect lawful priorities or lawful liens under territorial law, this requested relief necessarily implicates review of the Fiscal Plan’s certification and therefore the Court lacks subject matter jurisdiction to consider the merits of the claims. Congress has entrusted the ultimate decision to certify a fiscal plan to the sole discretion of the Oversight Board. See PROMESA § 201(c)(3). PROMESA creates a statutory structure that is protective of the Oversight Board’s authority under Section 312(a) of PROMESA, which grants the Oversight Board the exclusive right to propose a Title III plan of adjustment that must be consistent with the applicable certified Fiscal Plan to be eligible for confirmation. Together, these provisions underscore the central, discretionary role that Congress has assigned to the Oversight Board in the Title III debt adjustment process. See PROMESA § 314(b)(7). Under PROMESA’s statutory framework, it is only at the plan confirmation stage that the Court determines whether a proposed plan of adjustment complies with, among other things, the provisions of Title 11 of the United States Code which have been made applicable to these cases by Section 301 of PROMESA and the relevant provisions of PROMESA.(Bold added)

I have long held the view that it is only at the time of the Plan of Adjustment that Judge Swain may, if so inclined, rule on anything pertaining to the Fiscal Plan. By that I mean it must be determined whether the Plan of Adjustment is confirmable even if the Fiscal Plan does not respect the lawful priorities or lawful liens. It seems that this is the Judge Swain’s view also. In addition to the above, Judge Swain dismissed the claims for violation of the contracts clause, section 407 of PROMESA and the claim of violation of Section 303 of PROMESA by the Moratorium Act. Judge Besosa had also dismissed a similar claim of violation of Section 303 in another case. Judge Swain decided in a similar fashion as she did in the Assured litigation as to sections 922 and 928 of the Bankruptcy Code.

In the Commonwealth v. COFINA litigation, the COFINA representative filed a surprising motion requesting that the question on COFINA be certified to the Supreme Court of Puerto Rico, which was quickly and vigorously opposed by the Board. The COFINA bondholders had attempted the same thing and were rebuked by Judge Swain by stating the question was a mixed one of federal and state law and that the District Court would decide. Judge Swain denied the motion to expedite the discussion of the matter but will hear arguments on the April 25 Omnibus hearing. Seems all COFINA defenders believe the Puerto Rican Supreme Court will be more willing to declare it valid than the District Court. We shall see.

Last week the Board filed a quixotic acceptance to lifting the stay in labor grievance cases and the unions filed a motion pointing out that contrary to what it said, the Board was not acting as if the stay was lifted. We’ll see what the Judge decides.

As I reported last week, the UCC filed summary judgment stating that COFINA was in violation of the Puerto Rico Constitution as to limits on debt issuance pursuant to Article VI, section 2 of the Puerto Rico Constitution. I had not noticed, however that they were investigating whether some of the PBA bonds were also issued in excess of the constitutional limit. Interesting indeed. We shall see what the UCC concludes and how it will handle the issue if it believes the constitutional limit was indeed exceeded. Again, an important constitutional issue for Puerto Rico is to be decided in federal court. In any event, as the GO Bondholder’s reservation of rights points out, the issues presented require a full evidentiary hearing. Hence, it may or may not be resolved on Wednesday’s Omnibus hearing.

Echoing other creditors’ cries for more information from Puerto Rico and the Board, “the American Federation of State, County and Municipal Employees International Union, AFL-CIO (“AFSCME”), American Federation of Teachers, AFL-CIO (“AFT”), International Union, United Automobile, Aerospace and Agricultural Implement Workers of America, AFL-CIO (UAW) (“UAW”), and Service Employees International Union (“SEIU”)” filed a motion requesting leave to conduct discovery via Bankruptcy Rule 2004. Judge Swain quickly sent it to Magistrate Judge Dein. The Unions are seeking the following from the Board, from the Commonwealth and from AFFAF:

“[D]ocuments responsive to the requests listed on Schedule A; (2) compelling the depositions of (i) Oversight Board Executive Director Natalie Jaresko and Chairman José B. Carrión III, and (ii) AAFAF Executive Director Gerardo Portela and Chairman Christian Sobrino; and (3) compelling the Commonwealth to designate for deposition a witness or witnesses knowledgeable about the topics described on Schedule A.”

The Unions justify their request in the following manner:

“The Unions require information from the Oversight Board, AAFAF, and the Commonwealth (collectively, the “Government Parties”) necessary for the Unions to understand whether and how the Commonwealth and AAFAF, with the implicit blessing of the Oversight Board, have violated the rights of tens of thousands of Commonwealth employees by taking money through employee contributions deducted directly and involuntarily from their wages without, it appears, depositing those funds immediately into individual employee accounts controlled and investable by the employees as required by law. Notably, the draft fiscal plan submitted by the Commonwealth and AAFAF to the Oversight Board on February 12, 2018 (the “February 2018 Draft Fiscal Plan”) fails to make any disclosure concerning the status, location, segregation, investment, and management of ongoing mandatory public employee contributions to their individual retirement accounts. This Motion therefore seeks information necessary to determine whether there has been post-petition wrongdoing with respect to public employees’ property and to protect their rights.

It is simply offensive to the Commonwealth’s public servants—many of whom have since 2000 suffered mandatory deductions from their pay which were supposed to be contributed to individual retirement accounts (without any matching employer contribution)—that in July 2017 the Government Parties admitted that those funds were not, in fact, deposited into the employees’ segregated accounts, as they should have been, but instead were spent to satisfy other obligations.

It adds insult to injury that, even after the subsequent passage of a Commonwealth pension reform statute, Law 106, on August 23, 2017, and numerous commitments that ongoing employee contributions would be properly segregated into individual 401(k)-style accounts, the Commonwealth (through AAFAF) publically released a report of its 2017 end-of-year bank account balances on January 19, 2018 (the “2017 EOY Bank Account Balances”) which states (at pp. 8-9) that approximately $133 million in “employees/participants withholdings . . . for defined contribution retirement accounts” are being commingled with other “Pension Related” assets in a single government account, rather than individual employee retirement accounts as is required by Law 106.”

Given this scenario, I think Judge Dein will be hard pressed not to grant this relief and if it is granted, another adversary proceeding challenging this conduct is almost assured.

On Sunday, at 9:44 pm, the Puerto Rico Energy Commission filed an adversary proceeding for injunctive relief seeking the following:

A Declaration that FOMB may not mandate or authorize substantive electricity actions that are within the Commission’s jurisdiction but that the Commission has not approved, including but not limited to the following: actions affecting resource mix; asset ownership, operations, maintenance and retirement; market structure; integrated resource planning; and rates (including but not limited to revenue requirement, revenue allocation, cost allocation and rate design).

A Declaration that when FOMB exercises its fiscal powers over PREPA, it shall do so consistently with Commission actions, orders and regulations on substantive electricity matters, and on fiscal matters unless inconsistency is unavoidable.

A Declaration that whenever a proposed PREPA Fiscal Plan would impact substantive electric industry matters, the Commission’s timely assessment and approval is a prerequisite for FOMB’s certification of such Fiscal Plan.

Preliminary and permanent injunctions against FOMB, prohibiting FOMB from mandating or authorizing PREPA to take substantive electricity actions if those actions are jurisdictional to the Commission but not authorized by the Commission.

Preliminary and permanent injunctions against PREPA, prohibiting PREPA from taking substantive electricity actions mandated or authorized by the FOMB, if those actions are jurisdictional to the Commission but not authorized by the Commission.

This sounds suspiciously like the Energy Board is challenging the PREPA Fiscal Plan and given Judge Swain’s previous ruling, that will not fly. Let’s see what happens.

In other news, Andrew Scurria from The Wall Street Journal tweeted out that Governor Rosselló was to meet the Board last Friday to discuss the fiscal plan. Given the Board’s insistence on furloughs and pension reduction that culminated in a law suit last year, it is possible the Board will give the Commonwealth one last chance to amend the fiscal plan before it imposes its own at the end of the month. That will mean another major clash of the Board with the Commonwealth, but given Judge Swain’s ruling on the fiscal plan certification, it is unlikely the latter will prevail. Food for thought.

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.