Red Alert: Governor Garcia Padilla’s Special Session May Violate PROMESA

As you have no doubt already seen, Governor Garcia Padilla has called a special session for the purpose of passing over 100 bills and appointing 88 nominees to various government positions in a bid to cement his legacy before leaving office.

While details around the many bills are still surfacing, it is already clear that many of them will disburse government funds in spite of the debt crisis. In fact, eleven new government entities will reportedly be created, and other bills are designed to redirect hundreds of millions to various government retirement systems.

This, of course, could be in violation of section 204 PROMESA, which requires the control board to approve a cost-benefit analysis of any bill that disburses government funds. Incoming Senate President Thomas Rivera Schatz has already raised this issue in a letter to the governor, telling him, “As this is about binding and current federal legislation, I request you in fulfillment of your ministerial duty, to include a certification concerning the fiscal impact of each one of the appointments and legislation that you intend to submit for consideration before this Legislative Assembly during the Extraordinary Session.”

Although the bills have yet to be approved, once the bills become law, section 204(a)(2)(A) of PROMESA requires that within 7 days of its approval the Governor send the law to the Board with a “formal estimate prepared by an appropriate entity of the territorial government with expertise in budgets and financial management of the impact, if any, that the law will have on expenditures and revenues.”

With a control board meeting in Fajardo tomorrow, it remains to be seen what will happen.

Red Alert: Legal Update Call TOMORROW

I am pleased to announce that I will be hosting my second legal update call tomorrow, October 27th, at 3:30 pm with University of Puerto Rico Law School Professor Walter Alomar.

The call comes amidst several important legal developments, which Walter and I will discuss, including the control board’s decision to intervene in the consolidated lawsuits, the upcoming hearing on the stay, the recently proposed amendment to the Lex complaint against COFINA, the Puerto Rican Government’s motion in opposition, and the COFINA bondholder motion filed in response.

I am looking forward to the call and hope that you will join us.

When: Thursday, October 27th, at 3:30-4:30 pm EDT
Dial-In: 800‑862‑9098; International Dial-In: 785‑424‑1051
Conference ID: MUDD

The Board’s Intervention in the Brigade Litigation

As promised, the P.R. Control Board filed its motion to intervene on Friday, in the four cases for which Judge Besosa had had a hearing as to the lifting of the PROMESA stay. The Board urged Judge Besosa to deny the motions by different plaintiffs seeking the lifting of the stay since the Boardbelieves that the Commonwealth’s limited resources are better spent working with the Oversight Board and helping the Oversight Board begin its monumental tasks of negotiating fiscal plans and ensuring that Puerto Rico regains access to capital markets, rather than litigating these four cases, the other eight related cases the Commonwealth is currently defending, and the additional cases that will likely follow in the event the stay is lifted.” See page 21.

The intervention is much more than a pat on the back to the PR Government. The Board also stated:

In order to ensure that the Oversight Board is able to realize the full benefit of the PROMESA stay, the Oversight Board requests that the Court include in its order denying the lift stay motions the following requirements: (i) the Commonwealth must account for the funds over which it has already exercised control pursuant to the Moratorium Act and the Executive Orders, for future revenues and expenditures, and for all transfers to and from the Government Development Bank (“GDB”) since April 6, 2016; (ii) the Commonwealth must give the Oversight Board immediate and unfettered access to the Commonwealth’s financial officials and advisors; (iii) the Commonwealth must provide the Oversight Board with proposed cash management guidelines and procedures, including for its prioritization of payments, no later than October 30, 2016; (iv) the Commonwealth must immediately begin rolling production of the information requested by the Oversight Board on October 5 and 20, 2016, with such production to be completed no later than October 30, 2016; and (v) the Commonwealth must provide the Oversight Board with an information production protocol that will establish procedures and timetables for requesting and producing information, sharing information and maintaining its confidentiality as appropriate, and resolving any disputes over the production of information. Page 11 of the filing.

The Board also asks that the Governor refrain from issuing any more executive orders.

As you may notice, the Board has already sought some of this information from PR. The question is why ask for a Court order? Simple, Section 104(k) allows the Board to “seek judicial enforcement of its authority to carry out its responsibilities under this Act.” By asking and obtaining an order from Federal Court forcing PR to hand over the information requested on the time table requested, the Board ensures compliance by PR under penalty of civil contempt. Federal Judges in PR are not shy in enforcing their orders with the threat and sometimes the imprisonment of recalcitrant officials as Judge Fuste and Gelpí have shown.

Finally, the Board mentions that it will “endeavor to open a dialogue with the Commonwealth and all creditors, including the Plaintiffs in these actions and in the other actions pending against the Commonwealth, its instrumentalities, and their officials,” (see page 24) and requests a hearing within 30 days for the parties to report on their progress. This may be an acknowledgement by the Board that PR has not been negotiating with its creditors as it has claimed. Regardless, plaintiffs have until October 28 to oppose the Board’s petition. Moreover, this shows that, contrary to what some have claimed, the Board did not come simply to be a collection agency.

Judge Besosa will undoubtedly grant the Board’s intervention and likely grant the order as to the Government’s reporting. Whether he will leave the stay in place is another matter. As he himself said during the first day of stay hearings, if he decides the Moratorium issue, the cases go away, regardless of the result. Let’s see what happens.

The Assured-Ambac decision, the Stay and the Oversight Board

On October 4, 2016, Judge Besosa issued an important ruling in two almost forgotten bond cases (Assured/Ambac). In these cases, the Government had not claimed, as it could, that they were covered by the PROMESA stay. Apparently, it relied on its claims that the cases were barred by the 11th Amendment and that plaintiffs had no claims pursuant to the US Constitution and section 903 of the Bankruptcy Code.  Judge Besosa denied the 11th Amendment defense, which prohibits suing a state (including PR) in federal court for collection of monies. Since these cases request prospective injunctive relief, that is the exception to the 11th Amendment and Ex Parte Young. As to the rest of the claims, Judge Besosa at pages 21-22 stated:

“While Circular Letter 1300-15-16 created by the Working Group may change the payment priority structure established in the OMB Act by removing express mention of contractual and credit safeguarding obligations from the language of the second priority, see Civ. No. 16-1095, Docket No. 31-3 at pp. 7-8, it does not create a composition. Decreasing the priority of payment does not reduce or abate the obligation. The full amount is still due to the bondholder. Changing the payment priority structure, however, while not preempted by Section 903, may still constitute a violation of the Equal Protection, Due Process, Takings, and Contracts Clauses as asserted by plaintiffs.”

In other words, section 903 of the Bankruptcy Code does not preempt the Moratorium law but it may be unconstitutional pursuant to the U.S. Constitution. Several of the cases that have been filed post PROMESA claim that the Moratorium Act violates section 303, which is nothing more than a verbatim copy of section 903. Therefore, it could be that the Judge may determine that the Moratorium Act is unconstitutional but not preempted.

Also, the parties in the 4 cases in which there was a hearing for the lifting of the stay filed their post-hearing memorandums on October 7. They had two main arguments which sedge into this. Brigade and National strongly argued that the Moratoriums Act frustrated the stay’s purpose of consensual restructuring by creating uncertainty as to the legal priorities of the bonds. On the other hand, U.S. Bank Trust and National insisted that there was cause of the lifting of the stay since the 5th Amendment required that they receive adequate protection, which meant the enforcement of their liens. As I stated during my telephone conference on the cases, I believe the Judge will lift the stay on at least one, but probably two of the cases and rule on the constitutionality of the Moratorium Act, which is also an issue on the Assured/Ambac cases.

Also, the Financial Oversight Board’s request for a 14-day extension (in reality a plea that the Judge not decide the issues yet) to determine whether it will intervene and what position it would take. Since I believe it is unlikely Judge Besosa will rule on these issues before the end of October, he will probably grant the Board the extension and order any objections to it be filed shortly thereafter.

Finally, in the Assured/Ambac decision, there is something most reporters have missed. Judge Besosa quickly made clear 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.’” The PR Government has maintained that due to its “police power”, the first priority of payment is essential services and not the debt. This could be the harbinger of Judge Besosa’s position on these issues. We will soon find out.

Red Alert: GO Bondholders Sue to Clawback Cofina Funds

On Thursday, October 6, 2016, I hosted a conference call for media and the general public on the status of the cases in federal court related to PROMESA and bond litigation in general. During the call, I mentioned that although no case had yet been filed, it was to be expected that some GO bondholders would claim that COFINA funds should be used to pay the island’s default on General Obligation bonds. On Friday October 7, Lex Claims requested from Judge Besosa leave to amend its complaint to include claims against COFINA. This is the proposed amended complaint.

Lex Claims’ First Cause of Action is amended by explaining that the Fiscal Oversight Board will not be in operations anytime soon, and Judge Besosa received testimony that it could take 6 months to be up and running. Hence, plaintiffs aver that only private enforcement of sections 204(c)(3) and 207 can provide relief of Puerto Rico’s illegal actions. Plaintiffs Second Cause of Action claims that Executive Order 2016-30 is preempted by section 303(3) of PROMESA because “it unlawfully subordinates the rights of holders of the Constitutional Debt to the rights of COFINA bondholders.” The Third Cause of Action alleges the Moratorium Law is preempted by Section 303(1). The Twelfth Cause of Action is a claim for violation of civil rights (42 U.S.C. § 1983) due to the violation of sections 204(c)(3), 207 and 303 of PROMESA.

Plaintiffs request in relation to COFINA, the following remedies:

“Declaring that, if given effect, the Commonwealth’s purported diversion of a portion of the SUT to COFINA would constitute an unlawful surrender or suspension of its power to collect taxes in violation of Article VI, Section 2 of the Puerto Rico Constitution . . .

Enjoining enforcement or implementation of the unlawful Executive Order and
the Moratorium Act, with such injunction requiring the Secretary of the Treasury to apply all “available resources,” including revenues previously derived from the collection of the Commonwealth’s SUT, to the repayment of the Constitutional Debt.”

In other words, plaintiffs want the Court to declare that they have a right to the COFINA stream of income to pay GO bonds first or what is more commonly known as clawback. As I said during my conference call, this was bound to happen and is happening now. Expect COFINA bondholders to seek intervention if Judge Besosa allows the amendment, which he probably will.

Plaintiffs are asking Judge Besosa to decide whether pursuant to Article VI, sec. 8 of the PR Constitution, COFINA funds are “available resources” to pay public debt. Judge Besosa could decide the issue or certify the question to the PR Supreme Court. By the certification mechanism, Judge Besosa would ask the PR Supreme Court to decide this important issue of Commonwealth Constitutional law. He may not do so, however, given the need for the issues to be decided quickly. Many federal judges here refuse to certify questions given the time the PR Supreme Court could take to decide such issues.

For those who may not know what COFINA is, it is a public corporation created for the sole purpose of issuing sales tax-backed revenue bonds. Some commentators have described COFINA as extra-constitutional debt, or illegal debt, and others have described it as a pay-day loan scam.

Some commentators such as the former head of the FDIC have said Cofina is extra-constitutional debt, or illegal debt, and others have described it as a pay-day loan scam. Many argue COFINA was created as a workaround to allow the government to continue borrowing without running up against the 15% constitutional debt limit of Article VI, section 2 of the PR Constitution.

COFINA is simply a collector of sales-tax revenue that issues bonds. While it may be, in a technical sense, a public corporation, the central government is the collector of sales tax revenue. It simply transfers that money out of the general fund and into an entity it created called COFINA – those revenues should be treated like part of the general fund just like any other government tax revenue.

What of causes of action Four to Eleven? Plaintiffs want to have these claims in the complaint but agree that they would be stayed. In other words, they are willing to wait for the stay to expire on its own to act on them. Essentially, plaintiffs want the Court to stop the Government’s actions they deem contrary to PROMESA until the stay expires or the Board is up and running. Let’s see what happens.

Red Alert: Legal Update Call on Thursday

In light of the recent legal challenges mounted against the Commonwealth by various creditor groups, several readers of my blog and other professional contacts have reached out for insight into the complicated interplay between those lawsuits, Commonwealth law, PROMESA, and the federal Control Board. As such, I am pleased to announce a new series of MuddLaw legal update calls, on which I will give my own insights into the ongoing legal developments in the Commonwealth and will feature prominent guests involved in the suits and ongoing debt negotiations. The first call will be this Thursday, October 6th, at 10:30 am EDT. Details below:

When: Thursday, October 6th, at 10:30-11:30 am EDT
Dial-In: (877) 876-9174; International Dial-In: (785) 424-1669
Listener Code: 81014

My goal in hosting these calls is to give all Puerto Ricans, as well as stakeholders and observers throughout the island and the mainland, a better understanding of what these lawsuits are really about and how they will be impacted by PROMESA and an eventual debt restructuring and vice versa.

Please feel free to reach out to me with tips and suggestions for future calls. I look forward to the discussion to come.

NTU PROMESA Panel Recap

As most of you know, I participated yesterday in a panel discussion on PROMESA in Washington, hosted by the National Taxpayers Union, along with House Natural Resources Committee Senior Policy Advisor Bill Cooper, Mercatus Center’s J.W. Verret, NTU President Pete Sepp, American Action Forum’s Gordon Gray, and Mayer Brown’s Warren Payne.

Discussion was lively and wide-ranging. I gave an overview of the various legal cases that are pending on the island, similar to those that I have done here and on my MUDDLAW blog, noting the recent ruling by Judge Besosa that the PROMESA legal stay did not apply to the Lex Claims litigation.  Warren Payne talked at length about the government’s tax reform proposal, highlighting the need to easily repatriate profits from Puerto Rico to incentivize investment on the island. Professor Verret discussed potential reform options including Jones Act and federal minimum wage exemptions.

The most interesting tidbits of the day may have been comments made by Bill Cooper, who noted in his opening remarks that PROMESA was drafted with the two goals of restoring fiscal responsibility on the island and allowing Puerto Rico to regain access to the markets. In his words, the debt restructuring provisions of the bill received “undo focus” because PROMESA is “not a debt restructuring bill.”

This strikes me as noteworthy for a couple of reasons. Firstly, because, as Cooper alluded to, the bill has been discussed almost exclusively as a debt restructuring vehicle by nearly every party involved in this process over the last year. Secondly, because it suggests to me that the drafters did not envision the board being overly involved in any potential restructuring process.

Rather, it seems to indicate that the board’s main goal and focus will be to force the Commonwealth to adopt a fiscal plan that, in the board’s view, restores fiscal responsibility and facilitates access to the markets. This makes the next batch of numbers released by the Commonwealth all the more important since, as long as they comport with those two goals, it doesn’t seem that Cooper envisions the board subjecting too many parties to an all-out bankruptcy.  Any debt restructuring that does come with the plan will presumably be of lesser concern to the board so long as it complies with the rules set forth in PROMESA, which stipulates that the bankruptcy proceedings must comply with the relative priorities established in Puerto Rican law. That would put much of the onus for deciding who and what gets restructured on our own government.

Cooper also responded to a reporter’s question the rampant rumors that he is being considered for the board’s executive director seat (something that makes his comments all the more interesting) by saying that, while he has seen his name thrown around by some observers, any such speculation is premature given that the board has not yet elected its chairperson. That election is the first item on the agenda of the board’s first meeting in New York this Friday, and the first item on a long to-do list for the board over the next several months to come.

Red Alert: Dial-In Added for NTU PROMESA Panel Tomorrow

Given the enormous interest NTU has received for tomorrow’s PROMESA panel event from people outside of Washington, they have added a dial-in so that interested parties can listen in remotely.

Toll Free Dial-In:  800-624-0538
International Dial-In:  +1 303 223 4373
Date: Tuesday, September 27th
Time: 8:30 – 10:30 AM EST
*Breakfast will be served beginning at 8:30 AM; Discussion will begin at 8:50 AM
Location: The National Press Club – 529, 14th St. NW, Washington, D.C. 20045

The event has an excellent slate of panelists including rumored control board executive director candidate Bill Cooper, Mercatus Center’s J.W. Verret, NTU President Pete Sepp, American Action Forum’s Gordon Gray, Mayer Brown’s Warren Payne, and myself.

To register and learn more about Tuesday’s event, click here.

Red Alert: Ex-Officio Control Board Member Richard Ravitch Resigns from BAM Director Position Because of Conflict

As has been reported in the media, Governor Garcia Padilla has announced that Richard Ravitch will be his representative as “ex-officio” member of the control board.

This is a move baffling for several reasons, not least of which is Governor Garcia Padilla’s choice of a non-Puerto Rican to represent the Governor of Puerto Rico on the board. But the biggest problem, as I have noted on more than one occasion, are the deep and well documented conflicts of interest that Ravitch has through his role as an adviser to the Garcia Padilla Administration.

He also faced a significant conflict as a member of the board of directors of a bond insurance company, Build America Mutual, which stands to gain from the demise of their competitors that have insured Puerto Rican bonds. No doubt anticipating outcry over this conflict, Ravitch resigned from this board seat yesterday, but this does not ultimately change my opinion that he is a counterproductive board appointment.

Given Ravitch’s clear conflicts of interest, it is difficult to view this appointment as anything other than purposefully antagonistic to creditors.  It also reflects governor’s profound lack of seriousness in solving our crisis and returning the island to growth.

Red Alert: The Stay and the Control Board

Though much of my time at Control Board Watch has focused on the control board candidates, longtime readers of my work will know that I enjoy covering various legal developments, from the Recovery Act to the Wal-Mart decision, on my original MuddLaw blog.  Because there are so many lawsuits being filed in relation to PROMESA and the control board, I plan to carry some of that work over into the CBW space, and will start by examining Judge Francisco Besosa’s significant ruling from last week in the Lex Claims v. Garcia Padilla case.

On Friday, Judge Besosa ruled that legal stay did not apply to the Lex Claims litigation, which has been brought by plaintiffs comprised of General Obligation bondholders. In the complaint, plaintiffs argue that Governor Garcia Padilla has broken the law in making several budget appropriations which violate the protections given to their bonds in the newly-passed PROMESA legislation.

While Judge Besosa’s ruling that the stay does not apply is not a ruling on the merits of this case, it is a clear and significant signal that he believes the case has merit – and that he thinks there is, in fact, a chance that the governor has violated the newly-enacted federal law.

The ruling comes no less than two days after President Obama appointed the 7 board members, and presents a new dynamic for the Board to grapple with before it is fully functional and staffed.

Judge Besosa stated in his short opinion:

Section 405(b)(1) of PROMESA stays two types of suits. First, it stays judicial actions “against the Government of Puerto Rico that w[ere] or could have been commenced before the enactment of [PROMESA].” PROMESA § 405(b)(1), 48 U.S.C.A. § 2194(b)(1). Plaintiffs commenced this action by filing a complaint on July 20, 2016, (Docket No. 1), after PROMESA was enacted on June 30, 2016. In their amended complaint, plaintiffs seek a declaration that measures taken by the Commonwealth of Puerto Rico after PROMESA’s enactment violate sections 204(c)(3) and 207 of PROMESA. (Docket No. 25 at pp. 22-28.) They also seek an injunction enjoining the Commonwealth defendants from enforcing these measures until the PROMESA Financial Oversight and Management Board determines their propriety. Id. Plaintiffs could not have commenced this lawsuit before PROMESA’s enactment because their claims are to enforce provisions of PROMESA by challenging conduct that occurred after PROMESA’s enactment. Accordingly, this case does not fall into the first type of suit stayed pursuant to section 405(b)(1) of PROMESA.

The second type of suit stayed by section 405(b)(1) of PROMESA are judicial actions “to recover a Liability Claim against the Government of Puerto Rico that arose before the enactment of [PROMESA].” PROMESA § 405(b)(1), 48 U.S.C.A. § 2194(b)(1). “Liability Claim” means, “as it relates to a Liability,” “right to payment” or “right to an equitable remedy for breach of performance if such breach gives rise to a right to payment.” Id. § 405(a)(2). In their amended complaint, plaintiffs expressly state that their lawsuit “does not seek to compel payment on Plaintiffs’ bonds.” (Docket No. 25 at p. 5.) Rather, plaintiffs seek only declaratory and injunctive relief. Id. at pp. 22-28. Although plaintiffs request in their amended complaint an “order awarding . . . costs and attorneys’ fees, as authorized under 42 U.S.C. § 1983,” (Docket No. 25 at p. 28), the right to payment of costs and attorneys’ fees in this action did not arise before PROMESA’s enactment because plaintiffs brought this action after PROMESA’s enactment. Thus, plaintiffs do not seek to recover a right to payment that arose before PROMESA’s enactment. Accordingly, this case does not fall into the second type of suit stayed pursuant to section 405(b)(1) of PROMESA.

Again, while this does not dispose of the complaint’s principal issue, it is a clear sign that Judge Besosa believes that the case is worthwhile and, from my own review of the complaint, I can say that I agree. In fact, I believe Judge Besosa will ultimately rule against the government.

Defendants filed their motion to dismiss on September 2 and plaintiffs will have until September 30 to oppose.