Monday Update – January 29, 2018

Welcome to your weekly Title III update for January 29, 2018. Things in the Puerto Rico’s bankruptcy are picking up and important activity in the political sphere is strongly impacting the litigation.

On January 22, 2018, Governor Rosselló gave a televised speech announcing that PR would sell PREPA. The short 15 minute speech only stated that legislation would be presented to allow the sale, that a period of negotiations would ensue and then the sale, all in the period of 18 months. It was also stated that the generation would be sold but transmission would be leased.

Immediately, political analysts in PR showed their ignorance of bankruptcy law and PROMESA by stating that Governor Rosselló could not sell PREPA without Court permission or the Board’s agreement. As to the first, PROMESA, the same as Chapter 9, did not adopt section 363 of the Bankruptcy Code which requires Court approval of any sale outside the ordinary course of business. As to the Board, let’s just remember what Judge Swain said in her opinion on the appointment of Mr. Zamot as CEO of PREPA, at page 16:

“The FOMB’s assertion that Title III creates or reinforces direct managerial power granted by Titles I and II rings hollow as well. PROMESA section 303 reserves the territory’s political and governmental powers to the territory or “any territorial instrumentality thereof,” subject only to Titles I and II. See id. § 303.6 As the Court has explained, nothing in Titles I and II permits the FOMB to displace local government structures and authority by declaration. Similarly, sections 305 and 306 do not empower the FOMB to interfere unilaterally with the debtor’s political and governmental powers, or with the debtor’s property or revenues.”

Since PREPA is owned by the Government of Puerto Rico, the Board’s agreement to the sale is not needed. The way the Governor wants to sell PREPA, however, free of liens and debts, however, requires the Board’s agreement since it is the only entity allowed by PROMESA to file a Plan of Adjustment, see PROMESA section 312 and page 18 of the Zamot opinion. But any Plan of Adjustment that impairs creditor classes must be approved by said creditors and if no such approval ensues, the Court may, but does not have to, cramdown the Plan, see, section 314(c) of PROMESA. If the Court does not allow the cramdown, however, the Title III petition must be dismissed, see, 11 U.S.C. § 930.

In addition, this sale creates many questions. Will the monopoly be extended to the purchaser or purchasers, creating then an oligopoly or cartel? What will happen to the employees? What will be the sale price? The new PREPA fiscal plan states that it has assets of $9.4 billion and debts of $11.4 billion. This was contradicted by the Board and AFFAF’s motion on Saturday for interim financing for PREPA where it states that the utility has debts of over $14 billion. It would be nice if the Government and the Board would make up their minds as to the actual numbers.

Also during the week, separate from the litigation, PREPA, PRASA and the Commonwealth filed their Fiscal Plans. Although Governor Rosselló insisted on January 10, that he was ready to hand in the plans, the three documents are clearly marked as drafts, something that is not what the Board wanted. The PREPA and PRASA fiscal plans are also filled with disclaimers which puts doubts as to the reliability of their numbers. The Commonwealth fiscal plan is long on what it is going to do, but short on how it will be done.

In addition, it postpones a balanced budget until 2022, making the Board a permanent fixture until at least 2026. In addition, the Commonwealth fiscal plan has no employee furloughs or reductions of pensions as was required by the Board in the past. Moreover, the fiscal plan does not define essential services and hence does not explain how they will be funded nor does it explain how it 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.” (Section 201(b)(1)(N) of PROMESA).

My view is that the Board will reject the plan for various reasons and will order the furloughs and the reduction of pensions. Since the Government will reject these changes, the Board will certify its own fiscal plan in order to dictate policy. The same will happen with the PREPA and PRASA fiscal plans for only that way will the Board ensure that it will call the shots. The Government will go to Judge Swain and the vicious cycle of infighting will continue to the detriment of the people of PR.

Meanwhile, creditors have become increasingly vocal about their own concerns with the revised fiscal plan. Given the plan’s lack of debt service, and mounting evidence of ample liquidity, this is not surprising. Assured Guaranty released the following statement, which points to their view of the broader implications of the plan, beyond just further litigation and delay in returning the Commonwealth to capital markets:

“This disregard for creditors’ rights would shake, on a nationwide basis, investors’ confidence in the enforceability of their contracts, the rule of law and public officials’ willingness to abide by the commitments they have made. In doing so, they will make it more expensive for municipalities throughout the United States to fund essential services and infrastructure for their taxpayers.”

Turning now to the litigation. As was to be expected, the Board opposed the GO’s motion to conduct discovery pursuant to Bankruptcy Rule 2004. What is new is the Board, the Commonwealth and AFFAF’s position as to the payment of prepetition debts. At page 6 of their motion they stated:

While, as a practical matter, the Oversight Board and Commonwealth want to repay as much debt as is consistent with carrying out PROMESA’s directive to create fiscal responsibility and access to the capital markets, PROMESA § 314(b)(6) does not require the debtor to pay prepetition claimholders as much as it can. Rather, it provides the Court should “consider” what creditors could recover under applicable non-bankruptcy law, i.e., what a race to the courthouse would produce for “the creditors” under non-bankruptcy law.”

My take on this is that the Board and the Government of PR are taking the position they do not have to pay what they can but what they want to creditors. Doubt this was missed by all the bondholders who claim a lien on bond payments.

Finally, on Saturday, the Board and the Commonwealth filed a motion for interim financing of PREPA. As we have discussed before, FEMA and the US Treasury informed PR at the beginning of January that according to its own documents, it had too much money in its accounts to qualify for a CDL loan and that they would not lend to PREPA directly. The letter mentions that after the hurricanes, the Government account did not go below $1.5 billion and that recently it had informed the “discovery” of over 800 accounts with $6.875 billion. The Board and the Commonwealth, however, claimed in its motion that given the allegedly precarious economic condition of PREPA, they decided to proceed pursuant to 11 U.S.C. § 364 for an emergency approval of a loan. The motion states that the lender will be the Commonwealth of Puerto Rico and the debtor will be PREPA. The loan will have senior secured priming super-priority not to exceed $1.3 billion but initially the Commonwealth will only provide $550 million.

The security interests, liens and superpriority administrative claim will be subject only to a carve-out for professional fees and costs of administration incurred during the Title III Case (defined below) of the Debtor (as approved by the Court), any state matching requirements of Federal grants and loans and certain fees due and owing to the Office of the United States Trustee as set forth in the Title III Order.

In addition:

The proceeds of the Loans shall be used to make expenditures and disbursements: (i) for the Debtor’s operations including, without limitation, employee payroll and benefits, facilities maintenance costs that are not capital expenditures or infrastructure improvements, and normal operational materials, supplies, fuel and power supplies, vendor, and services payments (collectively, “Eligible Uses”) and (ii) for reimbursement of amounts expended for Eligible Uses from September 6, 2017 until the funding of the Loans. . .

“Unless otherwise specifically consented to in writing by the Lender and the Oversight Board, the proceeds of the Loans shall not be used for debt service; capital improvements; repair or restoration of damaged public facilities; paying the non-federal share of any Federal program; tax refunds; lobbying; Title III costs including but not limited to judgments arising from Title III cases and related cases, and legal or advisory fees; deposits, transfers, or payments to accrual accounts, reserve funds, or contingency accounts that do not represent an actual, immediate cash disbursement to continue current government operations for essential services; administrative costs of Federal disaster assistance grants and loans; or disaster related expenditures eligible for reimbursement from the Federal Government; or any expense that is not a “Current Expense” under the Trust Agreement (collectively, the “Ineligible Uses”). . . “

The motion also foresees the parties positions as to this loan. It states:

“Prior to filing this Urgent Motion, certain holders of general obligation (“GO”) debt of Puerto Rico advised the Oversight Board in writing that they oppose any lending from the Government of Puerto Rico to the Debtor without court approval, and that they oppose the concept of the Government of Puerto Rico borrowing from the federal government to lend to the Debtor. While the Government of Puerto Rico and the Debtor never intended to enter into this loan transaction without court approval in the PREPA Title III case, the Government of Puerto Rico cannot necessarily assuage the GO debtholders’ general opposition or their statements that they might seek stay relief and oppose any plan of adjustment.”

The motion dispenses with PREPA bondholders claims of lien in the following fashion:

“As explained below, the existing lien securing bonds under the Trust Agreement already provides for “Current Expenses” (including a sixty-day operating reserve) to be paid from revenues. Because the Lender’s loan to the Debtor can only be used to pay Current Expenses, the existing lien is not diminished or impaired by the first lien to be granted to the Lender because Current Expenses already have a prior right to be paid from the Debtor’s revenues before any positive net revenues exist that could go to creditors. This situation is unique because the priming lien the Lender is requesting, does not subordinate the existing creditors’ lien to anything to which it is not already subordinated. For example, in the ordinary course, if the Debtor had $1 billion of revenue and $1 billion of current expenses, the revenues would pay the Current Expenses, not creditors. If instead, the Debtor has $200 million of revenues and $1 billion of Current Expenses, the $200 million of revenues and the next $800 million of revenues would be paid to cover Current Expenses before there would be collateral available to creditors.”

In other words, the Board claims that PREPA bondholders have only a net lien; that is, they get paid only after all expenses are paid. PREPA bondholders on the other hand, claim a gross lien, meaning that they get paid from the stream of income irrespective of expenses. What this means is that before the loan is approved, Judge Swain will have to weigh on these objections.

The motion also alleges there are no other alternatives but it only mentions one offer from a group of bondholders. On the other hand, the motion mentions that “[b]eginning on January 21, 2018, the Debtor, through Rothschild, initiated a marketing effort to obtain alternative financing.” If, as the motion states, AFFAF has been negotiating with Treasury for the CDL loan, whose funds were appropriated by Congress in October, why the delay in searching for other sources? Could it be that the Board and the Government of PR have been playing hide the potato (funds) and now have been caught in their own web of deceit? After all, as mentioned in the last update, the Board and the Government knew about the “discovered” accounts since July of 2017 and did not then proceed with an audit to determine what part of those funds were available. In fact, neither of the two have proceeded with the hiring of said auditors. Interesting indeed.

In any event, there are 7 entities that have signed non-disclosure agreements to have access to a data room to commence the process  The interest rates of 0% for the first semiannual period, .50% for the second semiannual period, 1% for the third semiannual period, 1.5% for the fourth semiannual period, 2% for the fifth semiannual period, 2.5% for the sixth semiannual period and 3% thereon.  This does not appear to be a serious effort on behalf of the Commonwealth or the Oversight Board in seeking private financing for PREPA.  Perhaps they still believe the Trump Administration will provide a CDL directly to the Commonwealth or PREPA itself.

All of this leaves me with many other questions. How does the Commonwealth lend to PREPA if its agencies and the Municipalities still owe PREPA more than the $550 million? What happens if Judge Swain determines that PREPA bondholders have a gross lien? Will the sale still go through? Does the lien follow the stream of income if PREPA is sold? If the Commonwealth is broke, how can it lend to PREPA? Given the Board’s statements as to the net lien, do the pension funds in PREPA have to be paid as part of the “current expenses” definition of the 1974 Bondholders Agreement? These and many other questions will have to be answered and soon.

In addition, the parties have been filing slight modifications to the Board’s motion for Bar date. It is likely that the Board will accommodate any reasonable suggestion since it is in everyone’s interest that this issue be dealt with without litigation.

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