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.


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.


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.


Friday March 3, 2017, the Financial Supervisory Board filed a notice of appeal in the Lex Claims case challenging Judge Besosa’s determination of denying its request for stay This move by the Board is puzzling since the aforementioned order cannot be considered an appealable final decision pursuant to 28 U.S.C. § 1291. As the First Circuit said in the recent decision on Peaje Investment LLC v. García Padilla, at page

In the analogous bankruptcy context, we have held that the denial of relief from a stay is not necessarily a final decision sufficient to confer appellate jurisdiction. See In re Atlas IT Exp. Corp., 761 F.3d 177, 185 (1st Cir. 2014). But such a decision is final where it “conclusively decide[s] the fully-developed, unreviewable elsewhere issue that triggered the stay-relief fight.” Id. It rejected the Movants’ substantive arguments, holding that their interests in the collateral were adequately protected. After that ruling, there was nothing left for the district court to do.

Here, different that in Peaje, Judge Besosa has much to do. He has to determine motions to dismiss the substantive claims in the complaint and if he does not, then he has to determine COFINA’s legal standing and whatever implications it may have. It behooves the mind to think the appealed determination is a final order and if it is not, the First Court of Appeals would have no jurisdiction to entertain this appeal. In addition, generally, orders denying a stay of litigation is not a final order, see, Gulfstream Aerospace Corp. v. Mayacamas Corp., 485 U.S. 271, 275 (1988).

Also, 28 U.S.C. 1292(b) does not grant the Appellate Court jurisdiction. It states:

When a district judge, in making in a civil action an order not otherwise appealable under this section, shall be of the opinion that such order involves a controlling question of law as to which there is substantial ground for difference of opinion and that an immediate appeal from the order may materially advance the ultimate termination of the litigation, he shall so state in writing in such order. The Court of Appeals which would have jurisdiction of an appeal of such action may thereupon, in its discretion, permit an appeal to be taken from such order, if application is made to it within ten days after the entry of the order: Provided, however, That application for an appeal hereunder shall not stay proceedings in the district court unless the district judge or the Court of Appeals or a judge thereof shall so order.

No such determination has been made by Judge Besosa and the Board has not ask him to do so. Therefore, it is unlikely the First Circuit would grant such an interlocutory appeal review. In addition, the mere filing of the notice of appeal does not stay proceedings and set deadlines such as the March 20, 2017 date for the Board and others to file their “pleadings setting out their claims or defenses for which intervention is sought.”

The real questions is why would the Board resort to filing of a notice of appeal if it is unlikely that it has jurisdiction? In the Peaje litigation, Judge Besosa’s decision was issued November 2, 2016 and the First Circuit decided the appeal by January 11, 2017. If the First Circuit takes the same time to decide the issue, the decision would come down by April 11, 2017, only 19 days before the stay expires on May 1.

The only thing I can imagine is that the Board simply does not want Judge Besosa to decide the issue before the stay expires is that he will not issue an opinion and order if the First Circuit entertains the appeal and by the time there is a decision. Even if the Board loses, its is unlikely that Judge Besosa would decide before the stay expires and on May 2, 2017, the whole Government of PR would be in Title III and all litigation would be stayed. The Board can parade this scenario in front of both COFINA and the GO’s during the Title VI negotiations and try to convince them to come to an agreement. Let’s see what happens.


On February 17, 2017, Judge Besosa decided important issues in the Lex Claims litigation. In this case, plaintiffs, a group of GO bondholders, seek an injunction against the use of the sales tax to pay COFINA bonds, claiming they have first lien on “available resources” as per the Puerto Rico Constitution.

Defendants included, inter alia, the Government of PR, COFINA and its Executive Director, who filed various motions to stay the litigation. In addition, Ambac, a monoline that insures COFINA senior bonds, COFINA Senior Bondholders, Puerto Rico based bondholders and Mayor COFINA Bondholders (subordinate COFINA bondholders) filed motions to intervene, as did the Board.

Judge Besosa reviewed all of defendants’ arguments for the stay in great detail and rejected all. Hence, the claims for injunction against the payment of COFINA bonds and violation of civil rights (42 U.S.C. § 1983) will go forward. In addition, Judge Besosa granted intervention to all that sought it, except for COFINA Senior Bondholders since their request was limited to claiming the stay was applicable.

What will happen now? It is clear Judge Besosa wants to resolve the GO/COFINA controversy, which makes it unlikely that he will send it to the PR Supreme Court. Moreover, the case is what we call paper litigation. The issues before the Court revolve around an interpretation of the PR Constitution, the Constitutional Convention, the 1961 Amendment to the Constitution and its legislative record, COFINA statutes, its legislative record and the bond documents. There is no need for a hearing since there would not be any testimony, expert or otherwise as happened in the previous litigation on the stay.

Can PR or other defendants “appeal” Judge Besosa’s decision? Not really. The Federal system is hostile to appeals where there is no final determination of the issues. For example, in the Peaje litigation that recently went to the First Circuit, there was a final order since once the decision favored the stay, “there was nothing left for the district court to do.” Here, however, there is much left to do. Of course, defendants may seek leave from the District Court to appeal and then seek appeal via 28 U.S.C. § 1292(b). The First Circuit, however, is very hostile to this type of appeal and rarely grants it. Hence, defendants will have to continue with this litigation.

How long can it take? I am sure plaintiffs are at this time preparing their motion for summary judgment to have the Court decide the issue quickly and I have no doubt he will do so. Remember that the First Circuit reminded Judge Besosa “In conducting such proceedings, the district court should be mindful of Congress’s explicit direction to ‘expedite’ its disposition of the matter ‘to the greatest possible extent.’” Section 106(d) of PROMESA.

What should PR and the Fiscal Supervisory Board do? Both the Board and PR have said they will not take sides on the controversy but I think they should. GO’s and COFINA amount to half of PR’s bond debt ($18 billion in GO related and $17 billion in COFINA) and there is no chance on voluntarily restructuring GO’s unless the issue is resolved since they will claim, with certain reason, Constitutional priority. A quick decision on the issue would not only resolve the issue but if COFINA is illegal, it would lose any claim to a stream of income from the sales tax, it would not have a pledge and lien and in a Title III proceeding would be an unsecured creditor. The Court could then reduce its indebtedness close to zero. Let’s see what happens.


PR creó una comisión para la auditoría de la deuda bajo la pasada administración pero no le asignó dinero para hacer su trabajo. Así de importante era. En el día de hoy, la prensa puertorriqueña, sin estudiar el punto, se hace eco de los cuestionamientos de esta comisión, aduciendo que son ellos y no la Junta, los que tienen que auditor la deuda de PR. Ha llegado al punto que la Comisión dice que son ellos y no la Junta los que tienen que auditar la deuda. Esto es un soberano paquete, embuste y mentira.

El representante Serrano propone la enmienda a PROMESA que se convirtió en la sección 413 de la misma. Esta dice:

Nothing in this Act shall be interpreted to restrict—

(1) the ability of the Puerto Rico Commission for the Comprehensive Audit of the Public Credit to file its reports; or

(2) the review and consideration of the Puerto Rico Commission’s findings by Puerto Rico’s government or an Oversight Board for Puerto Rico established under section 101.

Como verán, nada ahí habla de que la Comisión es la que tiene que hacer esto o lo otro o que es la que es llamada a hacer una auditoría primero que la Junta. De hecho, el Congressional Record contiene referencias a que la Junta tiene que hacer una auditoría. El Representante Garret nos dice que “[m]ost importantly, the bill creates a seven-member oversight board to oversee their debt restructuring and to conduct financial audits.” Speaker Ryan nos dijo que la Junta “will audit Puerto Rico’s books

and make sure the restructuring is open and fair.” Más aún, cuando el Representante Serrano introdujo la que después fue la sección 413, hizo esta aclaración de la misma:

This amendment simply preserves the ability of this commission to continue their work and for either the government or the oversight board to review and consider any findings that the commission might have.

En otras palabras, los resultados de la “auditoría” de la Comisión de PR podrán serán revisados por el Gobierno de PR y por la Junta. Nada habla el Congressional Record que la Comisión de PR tenga primicia en la auditoría de la deuda de la isla. Más aún, ni la Junta ni la Comisión pueden invalidar deuda alguna de PR. Eso solo lo puede hacer un Tribunal, sea del ELA o Tribunal Federal. Prensa de PR, lean antes de hacer pensar al lector que la Comisión no es más que un embeleco de la pasada administración.


On January 4, 2017, Governor Rosselló officially asked the Supervisory Control Board for at least a 45-day extension of the January 31, 2017 deadline to have the approved Fiscal Plan in place. The letter also seeks that the Board extend the PROMESA stay for 75 more days as section 405(d) allows.

There are many conflicting viewpoints about the stay, and, as I have noted, some of those issues are being litigated right now in the Peajes/Altair/Brigade case. In my mind, however, everything really flows from the FEGP. If the governor is given time to develop a satisfactory plan, I think the various creditors are likely to support that effort and engage in negotiation.

Therefore, as the governor notes in his letter, there is every reason for the Board to grant the FEGP deadline extension. The Rosselló administration is just taking over the Government and needs time to ascertain its financial situation. The letter also explains that good faith negotiations are needed and rushing to certify a plan would make this difficult. At page 5, the letter states:

Moreover, we are very concerned that a rushed process to certify a fiscal plan by January 31, 2017, and a view that the movement of the PROMESA stay on February 15, 2017 is an intractable deadline, could prematurely precipitate Title III filings for some or all of Government’s issuers without any significant support from bondholder groups. In our view, accelerated Title III proceedings would be akin to a “free fall bankruptcy filing” which would: (i) lead to contentious litigation and disputes with bondholders and other parties; (ii) cause prolonged delay; (iii) create massive professional fees; and (iv) jeopardize the Government’s access to a free flow of capital at market rates. Such an outcome would be at odds with the congressional intent behind the passage of PROMESA—i.e., good-faith negotiations with Puerto Rico’s bondholders based upon credible financial information seeking at first a consensual voluntary agreement as provided for under Title VI.

On January 3, 2017, in Control Board Watch I discussed the same preoccupation of the Board’s apparent rush to Bankruptcy. I have litigated cases for over 30 years and, trust me, a settlement is better and cheaper than litigation. Any Title III filing would mean hundreds, if not thousands, of adversary proceedings being filed to determine who gets paid first and when. It would also be extremely expensive. In the Detroit bankruptcy, Jones Day, the firm representing the city in an $18 billion debt, was allowed $50 million in fees.

Moreover, for PROMESA to achieve its dual purposes of achievement of fiscal responsibility and access to the capital markets, the Government of PR and the Board will have to cooperate. The Government of Puerto Rico is the one authorized by statute (the PR Constitution is a federal statute after all, seeCommonwealth v. Sánchez Valle) to conduct the business of governing the island. Hence, it has to take the important decisions on the governance of the island, and there are few tasks more important at the moment than the certifying of an FEGP. There cannot be a power struggle between the present administration and the Board. If the Board were to deny the Governor’s request to extend the January 31 deadline, the People of PR will lose any trust in the Board and without this trust, it can never achieve its statutory goals. Let’s see how the Board responds.


As of this writing, the PR Supervisory Board insists on having a fiscal plan approved on or before January 31st. This gives the new administration, which will bear the brunt of the start of the fiscal plan, very little time to contribute to the final version. Today, new Governor Ricardo Rosselló has asked the Board to extend both its deadline for the fiscal plan and the PROMESA stay, which is set to expire on February 15 as things stand.

To me, the governor’s request makes perfect sense. It’s also perfectly in line with what PROMESA actually says. Why should the Board rush to have the Fiscal Plan in place, without giving the new administration time to assess the situation and weigh in? After all, Congress has made clear that the true goal of PROMESA is to promote and facilitate consensual negotiation between the government and its many creditors – something that would be made all the more difficult if that government is rushed to adopt a plan with which it is not comfortable.

Though I have heard some say the Board wants a Fiscal Plan in place BEFORE it can seek an extension of the stay, this is contrary to the clear language of PROMESA.

Section 405(d) of PROMESA states:

(CONTINUATION OF STAY.—Except as provided in subsections (e), (f), and (g) the stay under subsection (b) continues until the earlier of—
(1) the later of—
(A) the later of—
(i) February 15, 2017; or
(ii) six months after the establishment of an Oversight Board for Puerto Rico as established by section 101(b);
(B) the date that is 75 days after the date in subparagraph (A) if the Oversight Board delivers a certification to the Governor that, in the Oversight Board’s sole discretion, an additional 75 days are needed to seek to complete a voluntary process under title VI of this Act with respect to the government of the Commonwealth of Puerto Rico or any of its territorial instrumentalities; or
(C) the date that is 60 days after the date in subparagraph (A) if the district court to which an application has been submitted under subparagraph 601(m)(1)(D) of this Act determines, in the exercise of the court’s equitable powers, that an additional 60 days are needed to complete
a voluntary process under title VI of this Act with respect to the government of the Commonwealth of Puerto Rico or any of its territorial instrumentalities; or
(2) with respect to the government of the Commonwealth of Puerto Rico or any of its territorial instrumentalities, the date on which a case is filed by or on behalf of the government of the Commonwealth of Puerto Rico or any of its territorial instrumentalities, as applicable, under title III.

From reading this section it is clear that it is the Board who, in “its sole discretion” (more on this later) determines whether to extend the stay, but only if it is need to “complete a voluntary process under title VI.” This also explains why the Board has not yet extended it; PR has not conducted yet any good faith negotiations with its creditors since PROMESA was enacted. Conscious of this, the Board has notifiedcreditors in a letter of December 20, 2016 “it will start coordinating good faith conversations with creditors…”
Why is all this important?
Section 206 of PROMESA states:

(a) REQUIREMENTS FOR RESTRUCTURING CERTIFICATION.—The Oversight Board, prior to issuing a restructuring certification regarding an entity (as such term is defined in section 101 of title 11, United States Code), shall determine, in its sole discretion, that—
(1) the entity has made good-faith efforts to reach a consensual restructuring with creditors;
(2) the entity has—
(A) adopted procedures necessary to deliver timely audited financial statements; and
(B) made public draft financial statements and other information sufficient for any interested person to make an informed decision with respect to a possible restructuring;
(3) the entity is either a covered territory that has adopted a Fiscal Plan certified by the Oversight Board, a covered territorial instrumentality that is subject to a Territory Fiscal Plan certified by the Oversight Board, or a covered territorial instrumentality that has adopted an Instrumentality Fiscal
Plan certified by the Oversight Board

The Fiscal Plan must be in place BEFORE PR or its instrumentalities go into Title III Bankruptcy and they must have negotiated in good faith. Take note that the statute says “the entity” which means the Government of PR. Moreover, section 405(n) states of the purposes of the stay:

PURPOSES.—The purposes of this section are to—
(1) provide the Government of Puerto Rico with the resources and the tools it needs to address an immediate existing and imminent crisis;
(2) allow the Government of Puerto Rico a limited period of time during which it can focus its resources on negotiating a voluntary resolution with its creditors instead of defending numerous, costly creditor lawsuits

As you can see, sections 206(a) and 405(n) require PR, not the Board, to use the stay to conduct good faith negotiations to reach voluntary resolutions with its creditors. What would be the impact of the Board doing the negotiating and not PR when the Rosselló administration, who has signaled it is willing and able to come to agreements with the island’s bondholders? Let us see.

The language of sections 206(a) and 405(n) are quite plain. As the Courts frequently say, “[i]f the statute’s language is plain, “‘the sole function of the courts—at least where the disposition required by the text is not absurd—is to enforce it according to its terms.’ ” Lamie v. United States, 540 U.S. 526, 534, (2004), quoting Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1, 6, (2000) and In Re Rudler, 576 F.3d 37, 44 (1st Cir. 2009). Although the certification by the Board that PR can go into Title III is not subject to District Court review, see section 106(e) of PROMESA, section 206(a) does not mention certification with respect to good faith negotiations, only that it is in the Board’s sole discretion. In ERISA cases, the First Circuit has found that the language “in the sole discretion” means that the review of these cases is under the standard of “arbitrary and capricious.” See, Denmark v. Liberty Assurance Co. of Boston, 481 F.3d 16, 27 (1st Cir. 2007) and Denmark v. Liberty Assurance Co. of Boston, 566 F.3d 1 (1st Cir. 2009). What does arbitrary and capricious mean? “The operative inquiry under arbitrary, capricious or abuse of discretion review is ‘whether the aggregate evidence, viewed in the light most favorable to the non-moving party, could support a rational determination that the plan administrator acted arbitrarily in denying the claim for benefits.’” See, Wright v. R.R. Donnelley & Sons Co. Grp. Benefits Plan, 402 F.3d 67, 74, quoting Twomey v. Delta Airlines Pension Plan, 328 F.3d 27, 31 (1st Cir.2003), citing Leahy v. Raytheon Co., 315 F.3d 11, 18 (1st Cir.2002)). In addition, the decision must be “reasoned and supported by substantial evidence.” Gannon v. Metro. Life Ins. Co., 360 F.3d 211, 213 (1st Cir. 2004).

The next question is what could happen if a federal court decides that the Board’s determination that PR has conducted good faith negotiations was arbitrary and capricious? Good faith negotiations is a requirement of 11 U.S.C. § 109(c)(5)(B), but this section was not adopted by section 301 of PROMESA. Hence, one has to conclude that the good faith negotiations requirement of section 206(a) is equivalent to 109(c)(5)(B). If that were the case, the lack of good faith negotiations could entail dismissal of the case since section 304(b) of PROMESA states that “[a]fter any objection to the petition, the court, after notice and a hearing, may dismiss the petition if the petition does not meet the requirements of this title” And obtaining the certification of section 206 is a requirement of Title III, see section 302 of PROMESA. In bankruptcy, if the Municipality does not comply with 109(c)(5)(B), the case is dismissed, see, In Re New York Off-Track Betting Corporation, 427 B.R. 256 (S.D. N.Y. 2010).

Since there are only two things that require the Fiscal Plan to be in place, to wit, the approval of the budget (section 201(c)(1)) and the use of Title III Bankruptcy, the haste in which the Board is signaling seems to signal a willingness to send PR into this abyss is perplexing, if  not alarming.

Bankruptcy should be the last resort, not the first option in PR’s road to recovery.
We must have consensual negotiations and those negotiations must be based off of a Fiscal Plan that the Rossello Administration is comfortable with – not a hastily edited version of the Garcia Padilla Administration’s plan, which would undermine the entire process.  For that, it seems clear that more time is needed.  Governor Rosselló is off to the right start.

Conclusions from the Third Meeting of PROMESA

  1. The Board will not approve the Fiscal Plan for it is lacking on much of what is required by sec. 201(b)(1) of PROMESA, most particularly, the Plan depends on an increase of Federal Funds which has yet to occur.
  2. Since the First Fiscal Plan was a “lost opportunity”, the Board will receive the Government’s second plan by December 15 but will make prepare its own no later than January 31.
  3. At that time, the Board will very likely extend the PROMESA stay until May 1, 2017, since during meeting and press conference it made clear that there can be no negotiations before the plan is in place. I assume it is to assure bondholders that they will get paid what is agreed in the negotiations. As part of the negotiations, it is likely that bondholders will be assured of certain changes to the Government structure. If PR does not want to pursue these “suggested” changes, the Board can achieve them via Title III (Bankruptcy).
  4. Likely after the negotiations, some parts of the Government will be sent into Title III, including the Retirement Funds of the ELA, Teachers and Judiciary. Title III may also be used to push through changes that the Board believes are needed in the Governmental structures but elected officials balk at doing. This will likely include rejection of Union Contracts.
  5. There will be pressure on the Government to sell certain assets. Again, if the Government balks, Title III may be utilized.
  6. Title III will also affect suppliers and all other persons to whom the Government owes money.
  7. There will be cuts in Government budget, either this fiscal year or next fiscal year or both.
  8. It is almost a sure thing that Title III will be used by the Board. The question is what agencies or bond issuers will enter into Title III Bankruptcy

Red Alert: Judge Besosa’s Second Decision on Brigade

On November 15, 2016,  Judge Besosa decided the issue of lifting the stay in the consolidated Brigade cases and denied the petitions. The 55-page, carefully crafted opinion summarizes the parties’ positions and as it did in the Peajes decision, discussed here, made a bankruptcy style analysis of the procedure to lift the stay in PROMESA. He decided that the balance of equities inclined in favor of the Commonwealth (bankruptcy courts and hence this analysis is based on equity). Although three of the plaintiffs claimed constitutional violations, the Judge determined that the stay case law did not consider this cause for lifting of the stay since they must also demonstrate harm from the continuation of the stay, see page 36 of the opinion. He continues saying:

Thus, between the four sets of plaintiffs in these cases, the true harm in upholding the automatic stay appears to be, as National suggested at the evidentiary hearing, allowing the Commonwealth to continue “taking other people’s money away under color of the Moratorium Act.”. . .

The Court with the Commonwealth defendants, GDB, PRPFC and UPR that this monetary damage incurred by plaintiffs during the stay could be quantified and therefore would not be “permanent” or “irreparable.” (page 37-38 )

The Court also mentions that the issue of damages could also be handled pursuant to section 407 of PROMESA. Essentially, this only postpones the day of reckoning when PR will have to pay for this illegal diversion of funds.

Additionally, Judge Besosa disagrees that the Commonwealth would suffer “crushing levels of additional work defending these particular cases” (page 40, emphasis on the original) but he is sensitive to opening the floodgates of future cases for the lifting of the stay since granting the relief would embolden others to try. The distraction and expense of these future cases inclines the balance in the Commonwealth’s favor according to the opinion. Moreover, Judge Besosa argues that lifting the stay would undermine the purpose of PROMESA and allow these plaintiffs to jump ahead of other creditors. He also determined that the doctrine of Constitutional avoidance (decide cases for other reasons instead of Constitutionality of statutes)

But not all is lost for bondholders. As he has done in three other opinions, Judge Besosa made findings that in the near future will be very positive for plaintiffs. At page 45, note 12, the Court states:

This is not, of course, to say that the Court gives credence to each of the Commonwealth’s stated harms in its balancing calculus. It is not, for example, persuaded by the defendants’ postulation of an apocalyptic “death spiral” following invalidation of the Moratorium Act. Heeding the expert opinion of Dr. Carlos Colon de Armas that “the Government of Puerto Rico has the revenues to cover essential services and pay its debt commitments,” the Court finds the Commonwealth’s hypothesized catastrophe to be a melodramatic exaggeration divorced from reality. See 9/23 Tr. At 28:11-13. Nevertheless, the Court’s holding regarding the lack of “cause” in these cases is driven by a simple, reasoned determination: that the fixable financial harm confronted by the plaintiffs if the stay remains in effect does not, on balance, outstrip the harm to the Commonwealth and the PROMESA process that a decision vacating the stay would engender. That the defendants advance certain implausible arguments regarding the precise extent of that harm does not change this basic, dispositive conclusion.

The Court discussed the claim of US Bank Trust and states “[h]ere, the evidence unequivocally establishes that the Commonwealth and UPR have engaged in the diversion of pledged revenues that serve as hard collateral for the repayment of UPR bondholders. . .

The Court finds that the existence of this continuing lien on a perpetual source of revenue satisfies the “flexible” standard applicable to determinations of adequate protection. It therefore holds that the Commonwealth has carried its burden of showing that the UPR bondholders will, in due time, receive the “indubitable equivalent” of their current interest in UPR’s pledged revenues. ” (pages 51-52)

What does this mean? It means that US Bank Trust is a secured creditor and its claim cannot be restructured in Bankruptcy. If its claim cannot be restructured in Bankruptcy, what type of voluntary restructuring will it accept in Title VI? Not good for PR in the long run.

Finally, the Judge again warns PR to take advantage of the PROMESA stay and to earnestly “revitalize” the negotiation process. He reminds the Commonwealth defendants that in order to access Title III, it has to negotiate in good faith with its creditors.

PR has won the stay cases but in my view lost the war. Judge Besosa’s rulings have made clear that three of these plaintiffs have a lien and pledge that cannot be altered in Bankruptcy. The Court has also determined in the US Bank Trust that the Commonwealth has diverted pledged funds and that the proper remedy is monetary damages. In other words, not only will US Bank Trust eventually get paid but also it would likely receive monetary compensation for its damages.

As I stated before, this ruling on US Bank Trust lien is consistent with Judge Besosa’s ruling in the Peaje litigation with respect to its lien and the lien held by Altair. This lien, however, has to be balanced with Judge Besosa’s ruling in the Assured Guarantee, Corp. v. García Padilla, where he said at page 4 that “[i]n cases of an unbalanced budget, the Commonwealth Constitution establishes a priority system detailing in what order appropriations will be paid. P.R. Const Art. VI § 8. First priority is assigned to ‘interest on the public debt and amortization thereof.’” This may be of vital importance in the remaining case, Lex Claims v. García Padilla, where plaintiffs are claiming that the funds paid to COFINA are available resources that can be clawed back to pay the GO bonds. COFINA, on the other hand, claims it has a valid lien and that the legislature made it clear that these funds cannot be clawed back to pay the GO bonds.

Whether Judge Besosa, or the PR Supreme Court in a certification proceeding decides the issue, sooner or later, it has to be decided. The COFINA bondholders are hoping that the Board will help reach a consensual agreement or that it will allow the Government to file for Title III PROMESA bankruptcy. They are also betting on the Chapter 9 principle that liens are secured creditors and GO bonds are not. That is all fine and dandy in a Chapter 9, but Title III is not Chapter 9.

Judge Besosa or the PR Supreme Court will have to decide whether COFINA is a valid public corporation and that the stream of income that it receives from the PR sales tax is not available resources pursuant to Article VI, sec. 8 of the Constitution. If they are available resources and can be clawed back, the result in a Title III bankruptcy would be very different from a Chapter 9 of the Bankruptcy Code.

Pursuant to section 201(b)(1)(N) of PROMESA, the Fiscal Plan must “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 this Act.” As you may see, the constitution is put forth before laws (COFINA is a law), consistent with the idea that in PR, like at the national level, the Constitution is the Supreme Law of the land. When we go to section 314(b)(7) of PROMESA states that the Judge will confirm the Bankruptcy plan if the plan is “consistent with the applicable Fiscal Plan certified by the Oversight Board under title II.” Moreover, the House Natural Resources Committee Report on PROMESA, at page 50, in discussing section 314, stated that “[b]y incorporating consistency with the Fiscal Plan into the requirements of confirmation of a plan of adjustment, the Committee has ensured lawful priorities and liens, as provided for by the territory’s constitution, laws, and agreements, will be respected in any debt restructuring that occurs.’’

Hence, if the Courts decide that COFINA funds are available resources to be used to pay public debt, Title III will not protect its bondholders even if its lien survives, since the Constitution is the supreme law of the land and lawful priorities and liens as provided by the constitution, laws and agreements has to be respected.

Moreover, Lex Claims filed a motion in response to the Board’s request for intervention in its case. In explaining why COFINA is invalid, Lex Claims said at page 16:

A judicial finding that the assignment of SUT revenues to COFINA is invalid would thus free up vast quantities of current and future revenue, which the Commonwealth could use to fund essential services, other current expenditures, capital improvements, and payments on its lawful Constitutional Debt. If plaintiffs are correct that the assignment of SUT revenues to COFINA to facilitate the servicing of COFINA’s debt violates the various limitations in Puerto Rico’s Constitution on ceding tax revenue for the benefit of creditors, COFINA would lack any enforceable interest in the SUT revenues, and the COFINA bondholders’ claim against COFINA would suffer accordingly.

When I read this, I puzzled since if COFINA is unconstitutional, the bonds could be declared invalid and pursuant to Article 1247 of the Puerto Rico Civil Code, 1930 ed, 31 L.P.R.A. § 3496, the parties would have to hand back what they received, i.e., bondholders give back what they have been paid and PR hands back the billions it received. Not a good deal, but then it dawned on me that in Title III setting where secured creditors get paid and Constitutional priorities must be respected, the money owed to bondholders would be akin to a personal injury judgment, to wit, a non-secured credit devoid of any priority and would likely be reduced to near zero by a Bankruptcy Judge. Little comfort for these creditors.

What will Judge Besosa or the PR Supreme Court decide, I don’t know, but at some time next year the issue will be decided and if COFINA funds are “available resources” then GO’s will likely be paid first. Let’s see what happens.