Making Sense of the Commonwealth and COFINA Agent’s Agreement

Over the last few days there has been a lot of reporting on the Commonwealth -COFINA Agent Agreement, but not much of it was substantive.  Is this return fire from the Agent’s following the GO-COFINA global settlement?  Every step made from here, both in and out of the court, will have huge implications for the case. Here, I attempt to break down the agreement, examine key questions, and look at the road ahead.

First, it might help just to clarify who the Agents exactly are and who they represent.  The Agent for the Commonwealth is actually the Unsecured Creditors Committee (UCC).  The Agent for COFINA is not the COFINA creditors (comprised of COFINA Seniors, COFINA Subordinate (Jrs.) and Capital Appreciation Bonds (CAB), both Senior and Jr.), but Bettina Whyte, appointed to help bring the conundrum of who represents the interests of COFINA (Commonwealth, Board or the creditors themselves) to an end.

Second, while I think the reporting has improved since the deal was first announced, this Agreement is not a GO-COFINA settlement.

Third, this deal raises substantial questions and by no means is it a done deal.  Here’s just some of the questions:

  1. The Commonwealth’s taxing authority; can Board surrender it?
  2. Is this the best possible deal?
  3. What is the role of the Government of Puerto Rico?
  4. What are essential services?
  5. What is the future protection for the SUT (locally and federally)?
  6. What is the GO priority claim?
  7. The Board rejected the voluntary agreement between GO-COFINA creditors but has not rejected this… why?
  8. Finally, how many does it take to tango…? 2 or 3?

Overview of the Agreement

The deal, which is 8 pages long and only an agreement in principle, states as follows:

“COFINA will receive (a) 53.65% of the yearly scheduled PSTBA (beginning with payments made on 7/1/18), and (b) 100% of the cash held in trust at Bank of New York Mellon as of 6/30/18.

COFINA’s 53.65% portion of the PSTBA would be the first dollars of the 5.5% SUT distributed each year.

Securities to be structured subsequently.

COFINA’s Title III  plan of adjustment shall provide that, to the extent permitted under applicable law, all restructured securities issued by reorganized COFINA (or a new entity established pursuant to COFINA’s Title III plan of adjustment) will be tax-exempt, with the COFINA Agent being satisfied (in its sole discretion), prior to execution of the settlement agreement, that this condition will be met.

The PSTBA shall be equal to the sum of “original fixed income” as prescribed in section 3 of Act 91 (as amended and currently in effect), i.e., the amount of $783.2 million for Fiscal Year 2019, growing at 4% annually up to a cap of $1.85 billion by Fiscal Year 2041. In no event shall the make-whole provision of section 5(d) of Act 91 (as amended and currently in effect) operate to fund amounts on COFINA bonds by reason of any purported acceleration or defaults.

The Commonwealth will receive 46.35% of the yearly scheduled PSTBA (beginning with payments made on 7/1/18), any residual of the 5.5% SUT, and the additional 4.5% SUT surcharge.

The Commonwealth’s 46.35% share of the PSTBA would be received by the Commonwealth each year after COFINA receives its full 53.65% share of the PSTBA.

COFINA shall own each year the first dollars of the 5.5% SUT up to the amount of COFINA’s 53.65% share of the PSTBA, and the Commonwealth shall own each year the 5.5% SUT in excess of such amount.

Escrow Account

The Commonwealth’s share of the PSTBA will be held in escrow by an escrow agent selected by the Commonwealth Agent (in its sole discretion, but after consultation with the Oversight Board)  and approved pursuant to an order of the Title III court, with such escrowed funds being allocated to holders of claims against the Commonwealth under a Commonwealth Title III plan of adjustment; provided, however, that the Commonwealth shall have recourse to the funds in escrow (after exhausting its ordinary sources of liquidity) to the extent necessary to pay for essential services, as determined by the Financial Oversight and Management Board for Puerto Rico (the “Oversight Board”) (or a subsequent entity (if any) having similar supervisory authority as the Oversight Board after confirmation of the Commonwealth’s Title III plan of adjustment).

Therefore, COFINA surrenders 46.35% of its funding to the Commonwealth, resulting in a possible haircut in that amount. There is no indication in the document of how this 53.65% will be distributed between Seniors, Jrs, or CAB’s. Depending on what each get, this deal could be approved, or not. More on this later. Also, COFINA gets the money held by Mellon Bank, about one year of payments but the agreement does not explain how it is going to be divided within the Seniors and Jrs. Also, the UCC filed today a motion so there will be no further deposits to Mellon Bank, essentially putting a cap on what COFINA will get. In any event, will it all go to the Seniors as payment for what they will not get from the PSTBA? Will some of it go to the CAB’s, which are not supposed to be payed until they mature? Questions, questions.

In addition, the Commonwealth’s 46.35% is going to be used for payment of “holders of claims against the Commonwealth under a Commonwealth Title III Plan of Adjustment.” Notice that it does not say payment of GO bonds, but rather holders of claims. This means that the money’s will be used for the payment of all creditors and even then, it may be clawed back for payment of “essential services” as (finally) determined by the Board, who until today, has refused to define them. What will they be is anyone’s guess but I can assure you it will not make bondholders happy. Also interesting is that the agreement says “or a subsequent entity (if any) having similar supervisory authority as the Oversight Board after confirmation of the Commonwealth’s Title III plan of adjustment.” Does the Board suspect the PROMESA structure will be soon changed by Congress? Questions, questions.

Further down, the agreement states:

“Post-July 1, 2018 Collection of SUT

SUT revenues collected on or after July 1, 2018 (up to the PSTBA amount) shall be deposited into an escrow account at Delaware Trust Company (the “Interim Escrow Account”) pending approval of the settlement by the Title III court, provided that:

upon the effective date of the settlement, such escrowed funds shall be released to COFINA and the Commonwealth (subject to the escrow arrangement above) in accordance with the percentage shares of the PSTBA set forth above; and

in the event that either (i) the Agents do not execute a settlement agreement within 60 days after the date that the Commonwealth Agent and the COFINA Agent agree to the terms set forth herein, or (ii) the effective date of COFINA’s Title III plan of adjustment approving the settlement does not occur within 200 days after the Commonwealth Agent and the COFINA Agent have executed the settlement agreement (as such deadlines may be extended pursuant to the terms hereof), then the ruling by the Title III court concerning the ownership of Pledged Sales Taxes not yet collected by the Commonwealth (as of June 30, 2018) shall be determinative of the disposition of the funds in the Interim Escrow Account (it being understood that neither party is waiving any appellate rights with respect to such determination).”

Apparently, the escrowed account before July 1, 2018 will be handed over to COFINA, which is a substantial amount, and from that date on it will be escrowed until the deal is finalized upon the approval of the Plan of Adjustment. The timetable, which could be extended, is for the approval to come in approximately 260 days, which would be in the beginning of 2019. In addition, the deal states:


The effectiveness of the settlement is conditioned on the following:

An injunction (or some federal legislative action) barring, as part of the settlement, any future challenges to (i) all of the terms of the settlement, (ii) the 5.5% SUT, and (iii) the COFINA structure and its related legislation, with the COFINA Agent being satisfied (in its sole discretion), prior to execution of the settlement agreement, that this condition will be met; provided, however, that any factual or legal findings made by the Title III court in connection with the approval of the settlement (i.e., the order confirming COFINA’s Title III plan of adjustment and the order approving the settlement in the Commonwealth’s Title III case) with respect to the COFINA structure and its related legislation shall have no preclusive, collateral estoppel, res judicata, precedential, or other similar effect on any aspect of the Title III cases of the Commonwealth of Puerto Rico and its instrumentalities (whether such cases are currently pending before the Title III court or to be commenced in the future) (collectively, the “Title III Cases”), (b) no factual or legal inference may be drawn from such findings in connection with any aspect of the Title III Cases, and (c) no party or counsel for any party shall be precluded from taking a position inconsistent with such findings in any other proceeding or contested matter in the Title III Cases, except (in each of (a), (b), or (c)) to the extent necessary to protect or enforce the terms of the settlement (whether in the Title III Cases or in any other court or proceeding). The purpose and goal of an injunction would be to preclude any future challenges to COFINA and the Commonwealth’s respective ownership and other rights to the 5.5% SUT under the settlement.

I am sure Congress can change the Puerto Rico Constitution (not that they will necessarily), but I am not inclined to believe that the Court can or would be inclined to do so. Also, those confined to the COFINA litigation could be bound by res judicata etc., but then it says it cannot be used against the agreement. The rules of res judicata, collateral estoppel, etc., in Federal Court are established by the federal common law but in Commonwealth law, they are ruled by statute and civil law. The rules on the application of those doctrines from federal court to Commonwealth courts are have been delineated in case law. Moreover, a prohibition from ever challenging the ownership of the SUT seems illegal to me, although of course, I have not made any research on this.

Commonwealth Debt Priority

Moreover, this seems to violate the priorities clause of the Puerto Rico Constitution, Article VI, section 8 and priority established for the GOs in PROMESA section 201(b)(1)(N). Furthermore, without a doubt, Congress can pass legislation that destroys that priority but it is questionable whether the Court can, under these circumstances, issue an order steamrolling the Puerto Rico Constitution.  And as I stated, they already addressed priority of the Commonwealth debt in PROMESA.

Also important, the deal states:

Non-Recourse to Commonwealth and 40-Year Maturity

The restructured COFINA securities will (a) be non-recourse to the Commonwealth (including the portion of the PSTBA allocated to the Commonwealth under the terms of the settlement) and (b) have a fixed maturity of not more than 40 years commencing on July 1, 2018.


Treatment of monoline insurance policies and commutation will be addressed in COFINA’s Title III plan of adjustment.

As it is now, the COFINA bonds can only be paid from the PSTBA, now shrunk by 46.35%. It is important, however, that the deal does not mention or have anything to do with how the insurers will be dealt with. They will probably be reimbursed from the escrowed accounts but what happens later? Will they accept these deep cuts? If they are not mentioned here, somehow I doubt they’ll have a right to vote in the Plan of Adjustment. The agreement continues saying:

Conditions to Effectiveness

  1. Effectiveness of settlement to be conditioned on:

Title III court enters (a) an order in COFINA’s Title III case confirming COFINA’s Title III plan of adjustment that incorporates the settlement and (b) an order in the Commonwealth’s Title III case approving the Commonwealth’s entry into the settlement. Entry of the settlement order in the Commonwealth’s Title III case shall be a condition to confirmation of COFINA’s Title III plan of adjustment.

The settlement shall terminate automatically if the effective date of COFINA’s Title III plan of adjustment approving the settlement does not occur within 200 days after the Commonwealth Agent and the COFINA Agent have executed the settlement agreement; provided, however, that the Commonwealth Agent may extend, in its sole discretion, the outside date for the effective date of COFINA’s Title III plan of adjustment. If the Oversight Board determines it is impracticable to schedule a timely confirmation hearing on a Commonwealth Title III plan of adjustment embodying the settlement, then the Commonwealth Agent shall use reasonable best efforts to seek approval by the Title III court of the settlement agreement in its Title III case (by filing a motion in its Title III case on or before the later of (a) three days after the deadline to vote on COFINA’s Title III plan of adjustment or (b) the day that is 45 days before the date scheduled for the hearing on confirmation of COFINA’s Title III plan) contemporaneously with confirmation of COFINA’s Title III plan of adjustment incorporating the settlement. The COFINA Agent shall use reasonable best efforts to obtain confirmation of its Title III plan of adjustment incorporating the settlement (accounting for the fact that the Oversight Board is the only party that may propose a Title III plan of adjustment).

At or before execution of the settlement agreement, the Commonwealth Agent shall be satisfied (in its sole discretion) that a sufficient number of holders of COFINA debt will support COFINA’s Title III plan of adjustment incorporating the settlement.

  1. The settlement would not be conditioned or tied to the confirmation or effectiveness of a Commonwealth Title III plan of adjustment.

I think the above needs to be more thoroughly addressed.  It has huge implications for the case.

The settlement becomes effective when the COFINA Plan of Adjustment is approved but it is also necessary that a settlement order be entered in the Commonwealth case. Bankruptcy Rule of Procedure 9019(a) deals with settlements and states:

a) Compromise. On motion by the trustee and after notice and a hearing, the court may approve a compromise or settlement. Notice shall be given to creditors, the United States trustee, the debtor, and indenture trustees as provided in Rule 2002 and to any other entity as the court may direct.

Moreover, Second Circuit precedent favors settlements. In Cosoff v. Rodman (In re W.T. Grant Co.), 699 F.2d 599, 608 (2d Cir. 1983) states:

“In undertaking an examination of the settlement, we emphasize that this responsibility of the bankruptcy judge, and ours upon review, is not to decide the numerous questions of law and fact raised by appellants but rather to canvass the issues and see whether the settlement “fall[s] below the lowest point in the range of reasonableness”, Newman v. Stein, 464 F.2d 689, 693 (2 Cir.), cert. denied sub nom. Benson v. Newman, 409 U.S. 1039, 93 S.Ct. 521, 34 L.Ed.2d 488 (1972). We shall not attempt to deal with every argument advanced by appellants but will concentrate on what seem the most nearly persuasive.

Even with this easy standard, Judge Swain will be hard pressed to accept a settlement where part of the parties involved cannot agree to said settlement. For example, if the COFINA Jrs. don’t know what their cut is going to be, how will they agree to the settlement? And we have not yet started on the other stakeholders’ position on the agreement. Therefore, the internal COFINA distribution is of paramount importance. In addition, the 200-day period to have the Plan of Adjustment approved may be extended.

As to the settlement not being affected by the Commonwealth’s Plan of Adjustment, seems unlikely since that Plan of Adjustment will be deeply influenced by this agreement and how can the COFINA deal stand if not accepted in the Commonwealth Title III case? Moreover, the COFINA Plan of Adjustment must include the COFINA bondholders as a class in said plan but does it have to include the GO’s as a class? Does the Plan of Adjustment have to include the Commonwealth as a creditor? What if the Commonwealth does not agree to the settlement? Questions, questions.

Also, COFINA may issue future debt, conditioned to this:

Permitted Future Debt Issuances

COFINA may issue securities to refinance the restructured COFINA securities issued under COFINA’s Title III plan of adjustment, subject to the limitations that (a) regardless of the terms of such new securities, COFINA shall not be entitled to an increase of its share of the PSTBA under the settlement and (b) the maturity date of such new securities is no later than the maturity date of the restructured COFINA securities.

To the extent the Oversight Board determines that it is beneficial to the Commonwealth and/or COFINA, the restructured COFINA securities would be callable after a period of time on terms to be negotiated with the Oversight Board.

The Commonwealth may cause COFINA to issue future debt or securities out of COFINA (the “Additional Securities”); provided, however, that COFINA will be prohibited from issuing such Additional Securities, unless (i) the interests of the holders of such Additional Securities in the portion of the 5.5% SUT in COFINA’s 53.65% share of the PSTBA under the settlement, or subsequently transferred to COFINA by the Commonwealth, is subordinate to the interests of the holders of restructured COFINA securities (or any securities refinancing such securities) in the portion of the 5.5% SUT allocated in COFINA’s 53.65% share of the PSTBA under the settlement, (ii) the preceding year’s collections of the 5.5% SUT (grown annually at a percentage that is equal to (a) for the fiscal years 2019 through 2023, the SUT growth rates as stated in the Certified Fiscal Plan dated April 19, 2018, and (b) for the fiscal years after fiscal year 2023, the average SUT growth rate for the preceding 5 years) is at least 1.75x times the COFINA debt service for each year (pro forma for any new debt/securities), (iii) the preceding year’s collections of the 5.5% SUT is at least 1.10x the maximum COFINA debt service for any year (pro forma for any new debt/securities), and (iv) such Additional Securities are included for purposes of calculating the Commonwealth’s debt limitation under Article VI, Section 2 of the Puerto Rico Constitution.

The new COFINA bonds would be subordinated to the COFINA bonds now issued and they would be subject to the 15% limit of Article VI, section 2 of the Puerto Rico Constitution. At least something positive.

The settlement releases are as follow:


Except as set forth in the settlement agreement, the settlement fully, finally, and forever resolves and releases all claims against and ownership interests in any SUT revenues, including without limitation all claims, causes of action, and counterclaims (i) that were or could have been asserted consistent with the Stipulation and (ii) concerning or relating to the Pledged Sales Taxes or the Commonwealth-COFINA Dispute.

Except as to the rights expressly set forth in the settlement agreement, COFINA, all insurers of COFINA bonds, and all holders of COFINA bonds shall be barred from bringing or pursuing any and all claims (a) in the case of the insurers of COFINA bonds and holders of COFINA bonds, arising out of their capacities as COFINA bondholders/insurers in any way related to the COFINA structure, the SUT, or the Pledged Sales Taxes and (b) in the case of COFINA, in any way related to the COFINA structure, the SUT, or the Pledged Sales Taxes, against the Commonwealth, its instrumentalities, the Commonwealth Agent, the COFINA Agent, the Oversight Board, and each of their respective current and former officers, directors, agents, attorneys, employees, affiliates, advisors, consultants, attorneys, and members.

For the avoidance of doubt, there shall be no release of any claims by any party against the underwriters of the COFINA bonds or the GO bonds, including their current and former officers, directors, agents, attorneys, employees, affiliates, advisors, consultants, attorneys, and members.

Again, monolines and GO’s are not part of this agreement, at this time. Moreover, both GO’s and Assured, a monoline, expressed objections to the agreement and insisted in being part of the negotiations. The GO’s stated, inter alia:

The GO Group does not object to the requested 60-day delay, with the expectation that this period will be used not merely to document the terms of the Agents’ agreement but to engage in good faith with all affected constituents—including the GO Group—regarding those terms. As we explain below, the Agents’ agreement in principle in its current form represents a breach of the Commonwealth Agent’s duties to its constituencies and suffers from a number of serious flaws: Certain of its provisions are simply unlawful, such as the conspicuous attempt to surrender the sovereign power of the Commonwealth to wield its own taxing authority. Indeed, the agreement in principle appears to elide this fundamental gating issue, laying claim to 40 years of future tax revenues while simply declaring that some (unspecified) way will be devised to prevent the sovereign from disturbing those future taxes. . .

What is more, there were serious shortcomings regarding the process pursuant to which this agreement in principle was reached. The so-ordered stipulation governing this litigation (Dkt. 996 in Case No. 17-03283-LTS) (the “Stipulation”) guaranteed a representative selected by the GO Group a right of consultation with the Commonwealth Agent, but the Commonwealth Agent ignored multiple requests for information regarding the key terms of the agreement. The Commonwealth Agent thus denied itself the input and expertise of the parties most able to assist in this process. This course of conduct has resulted in an agreement in principle in which COFINA will receive first-dollars recourse to the Commonwealth’s sales and use tax (the “SUT”), which will lead to a massive diversion of value to COFINA that may exceed $3 billion over and above what COFINA’s bondholders would have received under a prior, pari passu settlement framework that commanded the support of key COFINA stakeholders. This value grab is likely to result in COFINA’s senior bondholders receiving approximately 125 percent of the face amount of their bonds. The GO Group cannot countenance the waste of Commonwealth’s resources, which is precisely why the Stipulation included consultation rights. Indeed, the massive diversion of value will make any consensual restructuring of the Commonwealth’s obligations nearly impossible.

Our hope and expectation is that the period of abeyance requested in the Motion will be used to address these provisions—as contemplated by the terms of the Stipulation affording the GO Group and others consultation and other rights in connection with these proceedings—and present a settlement to the Court that does not suffer from these fundamental defects. In its current form, the agreement in principle is a recipe for further litigation, not the constructive solution this case so urgently needs.

Here’s the GO’s explanation as to what they mean by the 125% of face amount of bonds:

This distinction is of vital economic significance. Because the stream of future cash flows that would be paid to COFINA under the Agents’ deal is substantially more secure than the ones that would have been earmarked for COFINA claimholders in the creditor-initiated framework, the appropriate discount rate for valuing that stream is substantially lower than the one used to value recoveries under the creditor-initiated framework. Depending upon the appropriate discount rate, the Agents’ deal may represent an incremental recovery for COFINA’s bondholders of $3 billion (or more) beyond what numerous COFINA stakeholders were prepared to accept as part of the creditor-initiated framework—an increase in value of approximately 25% (or more) for the COFINA entity. And that, in turn, is likely to translate to a recovery for COFINA’s senior bondholders well in excess of 100 percent of their claim amount. Following the senior-subordinate split in the creditor framework, for example, the Agents’ agreement in principle would lead to a recovery for COFINA’s senior bondholders in excess of 125 percent of the face amount of their bonds.

The claim of 125% is at the heart of this settlement. The Oversight Board was quick to reject the GO-COFINA settlement framework, but they have not done so here.  How so, if the 125% is accurate?

The GO motion also objects to the agreement in other areas:

“The Agents’ agreement in principle also attempts to glide over a crucial gating issue. More particularly, the agreement promises to insulate COFINA not only from the core legal challenges in this case (whether the Commonwealth’s SUT revenues were transferred to COFINA, and whether such a transfer was constitutional) but also to deprive the Commonwealth of its core sovereign authority over the remaining 40 years of the COFINA structure. It does so by providing that, as a term of the Agents’ deal, the COFINA Agent must be satisfied that the SUT “would not be subject to repeal [or] limit.” Term Sheet 3. In other words, the Agents appear to anticipate that this Court’s approval of their arrangement would prevent the Commonwealth from repealing the SUT or reducing its amount—in effect, stripping the Commonwealth of its sovereign power for the next 40 years.

By purporting to bind the Puerto Rico legislature’s hands in this manner, the Agents’ deal is inconsistent with the basic principle that, because “one legislature cannot abridge the powers of a succeeding legislature,” Fletcher v. Peck, 10 U.S. (6 Cranch) 87, 135 (1810), a statute is “alterable when the legislature shall please to alter it.” Marbury v. Madison, 5 U.S. (1 Cranch) 137, 177 (1803); see also, e.g., Dorsey v. United States, 567 U.S. 260, 274 (2012) (explaining that “statutes enacted by one Congress cannot bind a later Congress, which remains free to repeal the earlier statute, to exempt the current statute from the earlier statute, to modify the earlier statute, or to apply the earlier statute but as modified”). The Agents’ agreement on this point asks the Court to exceed its own authority and lacks any lawful basis. It must be removed.

  1. Finally, the Agents’ agreement in principle would inappropriately prejudge the priority of stakeholders’ claims on the Commonwealth’s share of the SUT, by providing that these funds may be invaded by the Commonwealth to fund whatever the Oversight Board (or any successor entity) deems to be “essential services.” Term Sheet 1-2. Whether, and to what extent, the Board’s unbounded view of essential services may justify compromising the claims of prepetition creditors is sure to be a hotly contested issue when this Court is asked to confirm a plan of adjustment for the Commonwealth.

The message being sent here by the GO’s is very clear; the agreement, as it stands, invites substantial litigation by this group as well as others. Better to negotiate a deal in which we all can agree upon. Cleverly, the GO motion discuss such a deal:

Under the creditor-initiated framework announced in May, a new trust would be created and would be stipulated to take ownership of the full 5.5% Commonwealth SUT. Dkt. 3140-3 in Case No. 17-03283-LTS, at 1-2. The trust would hold all COFINA bonds contributed to the trust pursuant to a plan of adjustment for COFINA, and would make an exchange offer for Commonwealth general obligation bonds and general unsecured claims. Id. at 1. Importantly, all holders of the resulting trust certificates—including holders of COFINA claims and Commonwealth claims—would share in the trust’s distributable value on a pari passu basis. In other words, the creditor-initiated framework does not include any senior-subordinate structure, under which a shortfall in SUT receipts would affect only a subordinated class of securities, while leaving senior recoveries intact. Thus, holders of COFINA claims and Commonwealth claims shared equally in the risk that the Commonwealth’s future SUT receipts might fall below expectations, because in that instance all creditors’ recoveries would be reduced proportionately.

The recovery for holders of COFINA securities under the creditor-initiated settlement framework—an amount that key stakeholders on the COFINA side publicly acknowledged they would accept in settlement of their claims—was approximately $12.132 billion in present value terms, using an appropriate discount rate for a pari passu securitization structure of this sort. Dkt. 3140-3 in Case No. 17-03283-LTS, at 7. The settlement framework was publicly criticized

by the Commonwealth and Oversight Board as providing creditor recoveries that were too generous. See, e.g., Financial Oversight and Management Board for Puerto Rico, Press Release, Oversight Board States Terms Of GO-COFINA Creditor Proposal Are Unaffordable, Do Not Align With Certified Fiscal Plan, May 14, 2018 (stating that the “economic terms” of the settlement framework were “completely unaffordable”); Puerto Rico Fiscal Agency and Financial Advisory Authority, Press Release, Response To Joint Settlement Proposal From Commonwealth-COFINA Creditors, May 14, 2018 (stating that the debt-service requirements contemplated by the settlement framework “are not sustainable”).

Importance of Pari Passu

The pari passu aspect of the deal is important. Right now, pursuant to the agents’ deal, the COFINA Jrs. do not know how much they stand to lose and they should be concerned because it could be a lot. Under the GO-COFINA proposal, they would get equal shares. This is politically very important since the COFINA Jrs. bonds were only sold in PR, although it is unknow how many locals are holders at this moment. In addition, there are more outstanding COFINA Jrs. bonds outstanding than COFINA Senior.  Also, if COFINA Jrs. are essentially wiped out, it is likely they would sue the Commonwealth for fraud, since the sale documents made clear assurances as to the legality of the structure and now the Commonwealth claims it is the owner of the SUT and not COFINA.

Assured is a monoline that ensures GO bonds, among others. It stated in its motion:

“Assured does not oppose the Agents’ request in the Motion for a 60-day delay in the Court’s issuance of a decision on the summary judgment motions in the Commonwealth-COFINA Dispute, provided that the Agents use the requested 60-day abeyance period to (i) involve Assured and other GO Bond creditors in the negotiations and (ii) remedy a number of important defects in the preliminary Terms and Conditions of Agreement in Principle to Resolve Commonwealth-COFINA Dispute (the “Term Sheet”) disclosed by the Agents on June 7, 2018.

See Exhibit A to Joint Informative Motion of Commonwealth Agent and COFINA Agent Disclosing Agreement in Principle, Adv. Proc. No. 17-257-LTS, ECF No. 486-1.

For example, the Term Sheet provides for the establishment of an escrow account

to hold the Commonwealth’s share of PSTBA, with “such escrowed funds being allocated to holders of claims against the Commonwealth under a Commonwealth Title III plan of adjustment.” Adv. Proc. No. 17-257-LTS, ECF No. 486-1 at 1. The Term Sheet then goes on to provide that “the Commonwealth shall have recourse to the funds in escrow . . . to the extent necessary to pay for essential services, as determined by the Financial Oversight and Management Board for Puerto Rico.” Id. at 2. This provision raises several substantive and procedural problems, and, accordingly, requires additional discussion.

As another example, the Term Sheet in its present form contains various overly broad releases that—inadvertently or not—could be read to undermine the GO Bonds’ constitutional first-priority claim to all “available resources” (including PSTBA). Id. at 5-6. These releases need to be significantly narrowed and refined before they could be incorporated into a viable settlement or Title III plan.”

Puerto Rico Government Position

It doesn’t seem the Puerto Rico Government is entirely on board with this proposal. Gerardo Portela has stated that he had not been part of the negotiations but welcomed any effort to solve differences.On Monday, however, the motion filed by AAFAF was anything but welcoming. It stated:

“The Government does not oppose the Court holding its decision in abeyance for a period of 60 days to allow discussions among all parties regarding the proposed agreement in principle reached by the Commonwealth and COFINA Agents. These discussions must include the Government and various bondholders and other constituents that are not party to the proposed agreement in principle.

The Government is evaluating whether the proposed agreement in principle serves the best interest of Puerto Rico, and will actively work with all parties to reach consensus on a comprehensive restructuring solution.

If consensus is not reached in the next 60 days, decisions on critical issues such as whether the Pledged Sales Taxes are property of the Commonwealth or COFINA should move toward judicial resolution. AAFAF therefore reserves the right to oppose further motions to hold such decisions in abeyance.”

Global Resolution

The Commonwealth wants all of the SUT—that is clear.  It also seems to me that AAFAF wants to sit down with all parties and come to a Global Settlement. That’s smart politics, and Governor Rosselló understands this. As it stands, this agreement is only with COFINA. By contrast, the GO-COFINA deal included the two strongest bonds and $35 billion of the $72 billion PR owes. If such a deal could be had, it would create momentum for other deals to be completed. Once you have the first one, and the bigger the better, the others fall in line.

Looking Ahead

There remain key questions, many of which we don’t have answers to. What would happen if the Commonwealth does not agree with the agreement as it stands? Can the Board nevertheless get an approval of the agreement in the Title III via Rule 9019 and the Plan of Adjustment? It is complicated. Rule 9019 states that the compromise may be presented by the Trustee, which is the Board, but the agreement also calls for the Commonwealth to surrender its taxing power to COFINA, which is an inherent power of any territory as long as authorized by Congress. Article VI, section 2 of the PR Constitution unequivocally states “The power of the Commonwealth of Puerto Rico to impose and collect taxes and to authorize their imposition and collection by municipalities shall be exercised as determined by the Legislative Assembly and shall never be surrendered or suspended.” On the other hand, section 108(a)(2) of PROMESA allows the Board to request that the enforcement of said part of the Constitution  “impair[s] or defeat[s] the purposes of this Act, as determined by the Oversight Board.” Would the Board invoke this? Would the Judge agree to it? From her order approving the 60-day extension to finalize the agreement with a provision for extension of the term, it is quite obvious Judge Swain wants a deal. Section 314(b) of PROMESA however, requires that the “the debtor is not prohibited by law from taking any action necessary to carry out the plan” in reference to Plan of Adjustment. If PR cannot surrender its power to tax, and both the UCC and the Retirees Committee argued that it could not, then it is questionable whether the Board can force PR to surrender said power. Would Judge Swain confirm a Plan of Adjustment without the approval of the Commonwealth? Difficult question. Hence, Governor Rosselló may have a veto power over any settlement involving the taxing power of the Commonwealth. Finally, 11 U.S.C. section 1129(a)(3) requires that the Plan of Adjustment be filed in “good faith and not by any means forbidden by law.” If the Plan of Adjustment hinges on illegally surrendering Puerto Rico’s taxing power, how can Judge Swain approve it?

Seems to me the best bet for a settlement to be approved would be a global settlement with GO-COFINA where Board, Commonwealth, UCC, Retirees, COFINA and GO’s all agree. This would require, however, a clear breakdown of what goes to Seniors, Jrs. and GO’s.. That is something we don’t have at this time but can be achieved with some common sense negotiations.

Moreover, who will be able to vote in the Plan of Adjustment? Only those COFINA creditors whose claims are impaired may vote, which brings us to another issue; the Board, as the only one allowed to file a Plan of Adjustment in the COFINA Title III, will group creditors in classes. I have a feeling that it will put all COFINA bondholders in one class since the Bankruptcy Code requires that all classes agree to the Plan of Adjustment. That way, it would need 2/3 of the debt amount and more than half of the number of creditors in that class to approve it. For example, if the Jrs. are in another class, they may vote against the plan but if bunched together with the seniors, it may work out. But where, if anywhere, would the Commonwealth be if it rejects the agreement? No idea.

Does it take Two to Tango or is it Three or Four?

If you are not a lawyer who understands bankruptcy and PROMESA, you may be tempted to believe that this deal only needs some fine tuning and the blessing of the UCC and COFINA. Not quite, though. As you have seen, the GO’s and Assured both say the deal, as it is written, violates Puerto Rico’s Constitution and PROMESA. Moreover, they want to be included in the negotiations. The Commonwealth government, far from giving the deal a ringing endorsement, wants to be included in the negotiations, as well as other interested parties. If they are not included, it is likely they will fight tooth and nail against the agreement, both in the Commonwealth Title III and in the COFINA Plan of Adjustment. Let’s remember that Judge Swain has made it clear she cannot review the Fiscal Plan until the Plan of Adjustment stage, which will open it to claims that section 201(b)(1)(N) is being violated by not respecting 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.” Moreover, the Retirees Committee has endorsed this agreement but if the GO’s and the Commonwealth are invited to the negotiations, will they be invited also? If the Board wishes to avoid further litigation on all these issues it seems logical that they will include all these parties to negotiate the deal, which will increase the chances of a global settlement. Otherwise, all I foresee is more and more wasteful litigation.

I will be working on a new post to explain how the Plan of Adjustment and its approval works. Until next time.