Monday Update – March 18, 2019

Welcome to your weekly Title III update for March 18, 2019. Different from previous weeks, this time a lot happened in PROMESA.

On March 12, 2019, just before the Omnibus hearing, AAFAF objected to the fee examiner’s report for a 5-7% increase in the fees by attorneys in the case. It wanted it capped at 2%. Judge Swain, however, approved the fee examiner’s report. If the Commonwealth wants to control the cost of litigation, all it has to do is reduce its litigation and request that the Board do the same. Just saying.

Also on March 12, 2019, the UCC filed an Omnibus Objection to the ERS bonds saying they were issued ultravires and also filed a separate objection to Oaktree Funds’ ERS bonds. The UCC states:

In 2008, ERS issued approximately $3 billion of ERS Bonds in underwritten public offerings.3 The ERS Bonds were issued as part of the failed implementation of an ill conceived “arbitrage” strategy ostensibly designed to rescue ERS from eventual insolvency. In 2011, the Puerto Rico Legislative Assembly stated that the issuance of the ERS Bonds “was illegally made by [ERS] even though such transaction was submitted to the Legislative Assembly for approval and rejected by the House of Representatives for deeming it detrimental to the System.” Act 116-2011 at Statement of Motives (emphasis added).

As previously raised by the Puerto Rico Fiscal Agency and Financial Advisory Authority (“AAFAF”) and other government parties in ERS-related adversary proceedings, the issuance of the ERS Bonds was “illegally made” in that the ERS Bonds were issued ultra vires. ERS’s statutory “authorization to incur debt” is limited to “seek[ing] a loan from any financial institution of the Government of the Commonwealth of Puerto Rico or the Federal Government of the United States of America or through the direct placement of debts.” (emphasis added). A government entity such as ERS has no inherent power to issue bonds to the public, and any such power must be expressly granted by statute. Furthermore, as commonly understood in the finance world, a “direct placement of debts” means a private placement, not a public offering. Indeed, whenever the Puerto Rico Legislative Assembly has granted bonding authority to a Commonwealth instrumentality (both before and after it authorized ERS in 2008 to “seek loans”), it has done so expressly and specified that the bonds may be sold publicly or privately.

Because the ERS Bonds were issued ultra vires, they are null and void, and the bondholders have no remedy against ERS. Accordingly, all claims asserted against ERS based on the ERS Bonds must be disallowed in their entirety.

I wonder if this move is related to the possibility that the Board at some time soon may be unable to act in the Title III cases. In any event, this is going to very interesting. In a related matter, Judge Swain issued an order to deal with the ERS bondholders’ request for lifting the automatic stay:

This matter is before the Court on opposing motions proposing litigation schedules related to the Motion of Certain Secured Creditors of the Employees Retirement System of the Government of the Commonwealth of Puerto Rico for Relief from the Automatic Stay (Docket Entry No. 289,2 the “ERS Lift Stay Motion”). Movants3 and the Employees Retirement System of the Government of the Commonwealth of Puerto Rico (“ERS”) have provided the Court with dueling schedules, where they have agreed on the events which need to occur before a final hearing on the ERS Lift Stay Motion but disagree as to the applicable timeline. (See Docket Entry Nos. 388 and 389).

The Court has considered carefully the provisions of 11 U.S.C. § 362(e)(1) regarding the prompt disposition of motions for relief from the automatic stay. In light of the complexity of the issues, and the need for adequate time for discovery and related litigation, the Court finds that compelling circumstances require that the Court extend the final hearing date to May 21, 2019. (See 11 U.S.C. § 362(e)(1) (providing that the timing of a final hearing may be extended “with the consent of the parties in interest or for a specific time which the court finds is required by compelling circumstances.”).)

Accordingly, the Court sets the following schedule for the ERS Lift Stay Motion:

  1. March 15, 2019: Deadline for completion of exchange of documents and

exchange of privilege logs with respect to non-ESI production.

  1. March 18, 2019: Meet and confer on outstanding discovery issues.
  2. March 21, 2019 at 3:00 p.m. (Atlantic Standard Time): Deadline for first

round of motions to compel.

  1. March 25, 2019 at 3:00 p.m. (Atlantic Standard Time): Deadline for


  1. March 27, 2019 at 3:00 p.m. (Atlantic Standard Time): Deadline for replies.

As you may see, Judge Swain has given the Board a date after the May 16, 2019 First Circuit deadline, which I am sure will be part of the request to the Supreme Court for a stay on said order. It helps to have an understanding and pro-Board judge.

On March 13, 2019, the Judge held an Omnibus hearing. The first matter in the agenda was a report by the Board on the status of the cases. Martin Bienestock, the Board’s principal attorney, announced that his client would seek a modification of the First Circuit’s stay and would also request certiorari from the ERS ruling. So much for saving on litigation. Mr. Bienestock also reported the Board was working on the Fiscal Plans, the Budget and the suggestions appeal by the Commonwealth. He also said they were monitoring fiscal reforms (Law 80, maybe), negotiating with creditors and suggested there would be further Title III’s. Judge Swain then asked for the timing of the new plans. Mr. Bienestock then said that the Commonwealth Plan would be filed possibly at the end of April, 2019, depending on creditor support. Suspect timing to say the least.

After this came out, Mark Stancil, for the GO creditors group took the podium. He started by saying the obvious, there is a lot of litigation and the Board had not engaged with creditors (I suppose he meant the GO groups since there are reports Judge Housser had to suspend mediation since the parties would not budge). He stated that the GO’s would file additional litigation having to do with the failure of the Board to impose change on the Puerto Rican Government. Stancil questioned how a Plan of Adjustment could be contemplated without these changes and that these reforms were crucial. He encouraged the Board to nudge and had to put the politicians through their paces.

Mr. Bienestock then said that the GO’s were a gating issue for the Plan of Adjustment. He also mentioned the Board tried to repeal Law 80 but they failed and if Mr. Stancil wanted to tell them how to do it, he was willing to listen. He added that the Board was willing to negotiate with creditors.

There are considerable views out there that believe the Board has simply failed to force change aside from its letter writing campaign to the Governor and the photo-ops at Fortaleza. It is clear to most that this Board has simply resorted to becoming a tool for debt relief and establishing legal precedents for future state bankruptcies rather than a force for fiscal and governmental reform. Once again, the people of Puerto Rico lose.

Later, the Board tried to explain that the problems reported in the COFINA bond exchange was due to market fluctuations and that everything would be fine from now on. Maybe.

Next was Luc Despin of the UCC. He started saying that he agreed with the Board in 98-99% of the cases but since January of 2018 it has been saying Alternate Dispute Resolution (ADR) was needed but nothing had come out it. He complained that the UCC had been excluded from the PREPA RSA and the Committee had a right to be involved. When asked if he had confronted the Board, Despin said yes.

Bienestock answered that there had been more negotiations with the UCC than with anyone else but that he did not see what the Committee had to do with secured creditors. Although Despin believes the Committee had a place at the table, Bienestock does not agree as to secured creditors. Judge Swain asked the parties to meet and confer and if anything has to be resolved, she would deal with it. Mr. Rosen, another attorney for the Board, informed the Court that the Board was working on ADR and would have something ready for the next Omnibus hearing of April 24, which was news for the UCC.

The issue of ADR is important. There are thousands upon thousands of lawsuits stayed because of the Commonwealth’s Title III filing and have to be deal with in the Plan of Adjustment. Almost all are without a judgment. In order for ADR to work, not only must there be a structure but also mediators and time to evaluate each case. This cannot be done by April 2019. But the Board said it would file a Plan of Adjustment by that date. Moreover, the Board just made an RFP for a claims management and reconciliation agent… If it is going to start this procedure at the end of March, how can it have a Plan of Adjustment by April? If the Federal Government is taking over statistics for Puerto Rico because the island’s are unreliable, how can a Plan of Adjustment be seriously considered at the end of April. If the Board insists that the objection to some GO’s issued is a gating issue for the Plan of Adjustment be filed at the end of April? Questions, questions.

Cooperativa de Ahorro y Creditor Vegabajeña filed an adversary proceeding against the Board and ERS claiming it has a lien over individual retirement contributions held by the ERS but belonging to Commonwealth employees and ERS participants. Soon the UCC will seek to intervene, as is its right and this case will go to judgment and whoever loses will appeal to the First Circuit and possibly seek certiorari from the SCOTUS. Thus is the Board’s way.

Finally, and very importantly and very telling, during the night of Friday March 15, 2019, the Board put in its website the Duff & Phelps IFAT Report on the Title III Bank Accounts as of June 30, 2018. Yep, it is not a typo, this report is as of June of 2018. This report is the Board’s response to AAFAF’s revelation in December of 2017 of over 800 accounts with almost $6 billions.

The Report is over 150 pages with its different tables and exhibits. At page 4, it states:

A principal goal of the Project was the publication of a report that would include a description of the processes employed, the results obtained and an opinion from D&P on whether or not procedures performed validate, with a high degree of certainty, that Commonwealth bank and investment accounts were identified and account balances as of the Measurement Date were accurately disclosed (the “Report”).

The report states that it depended on the voluntary cooperation of the Puerto Rican Government and its dependencies, but not all cooperated. At page 4, footnote 6, the Report makes clear this is not an audit. Curious. Also interesting, at page 4:

Based on a classification (a “Classification”) asserted by Commonwealth entity account holders regarding whether bank account funds were subject to certain types of restrictions, certain legal due diligence and financial analytical procedures were performed to identify the support for, nature of, and terms of such Classifications. As part of the Commonwealth bank account holders’ (“AH”) response, the entity was asked to provide supporting documentation for the Classification. The results of the legal due diligence and financial analytical procedures performed are set forth in Section III.

Guess who did the legal due diligence? O’Neill & Borges, the Board’s local counsel. Talk about a conflict free and impartial evaluator!

Continuing at page 7, the Report states that “[a]nalytical procedures peformed on the Restricted-Selected accounts is ongoing. The work regarding analytical procedures is not sufficiently developed to indicate whether or not AH cash flows do or do not support the Restrictions.” WHAT!!!??? This Report does not even state that the funds that the Commonwealth claims are restricted for another use are in fact restricted? Amazing!

Moreover, the Report at page 10 states that “D&P regards the CE not identified by Counsel or not covered by the Report, as described in paragraph 10 of Section I,  as described in paragraph 10 of Section I, such as the Puerto Rico Aqueduct and Sewer Authority (PRASA) and municipalities are outside the scope of this Report.” Paragraph 10, which is at page 5, makes clear that D&P must:

[F]ocus on those Commonwealth instrumentalities identified by counsel as Title III entities or covered by the Commonwealth Fiscal Plan certified by the FOMB as of October 23, 2018, and set March 12, 2019 as the Report issuance date. The University of Puerto Rico (“UPR”) is also included in the Report because the UPR relies heavily on funds provided from the Commonwealth to sustain its operations.

In other words, PRASA, the Municipalities could have billions in accounts but we will never know from this report. Unbelievable. Total waste of taxpayer dollars.

At page 14, the Report states that in unreconciled accounts, there are $11,575,189,236 in different accounts, of which $4,806,456,332 are unrestricted, $1,245,598, 957 as to which no representation has been made, $5,356,298,000 as restricted and $166,935,947 in a Commonwealth pooled account. In other words, the Commonwealth is sitting on at least $6 billion in cash with could be used for debt payment. That is without the benefit of a review of why over $5 billion is considered restricted. That is almost two years of full debt service of Puerto Rico’s debt.  If we look at the reconciled accounts at page 15, we have over $10.2 billion, of which over $5.7 billion are unrestricted or no representation has been made. Mindbogling.

Moreover, at page 23, the Report states that it could not “validate the claims of AH who reported that GDB was holding funds for them as of the Measurement Date. The sum of bank account balances (Table 10) which were reported as held at GDB cannot be validated, and therefore have been excluded from the values reflected in the Table 1 and Table 2.

At page 24, the Report states that neither the Judiciary nor PREPA had responded to D&B requests for information. Pages 25-26 makes recommendation as to work needed to be performed.

At the time of the revelation of these secret bank accounts, the Board sought to blame the Governor for withholding this data from the Board, and commenced the Duff & Phelps inquiry. Nothing could be farther from the truth. At the time, I released a secret [communications log] between AAFAF and the Board, which demonstrates there was no deception on the part of the Puerto Rican Government. Rather, why then did the Board go to great lengths to hide these accounts, and then when caught red-handed, attempt to paper over them with outside counsel report?  Why after spending hundreds of thousands of dollars to hire Duff & Phelps we still don’t have all of the answers? The involvement of O’Neill and Borgess raises even more questions, especially considering that one of the architects of PROMESA, former Resident Commissioner Pedro Pierluisi, remains a lawyer and lobbyist for the Board. Moreover, this report raises more questions than provides answers. Why are certain accounts restricted? What will be done for the unrestricted accounts? How could these accounts not be known by the García Padilla Administration and hence the Obama administration when they went to Congress claiming a humanitarian crisis? How can you justify not paying bondholders and unsecured creditors when the Commonwealth is sitting on this pile of cash? Why was this report not an audit, where an opinion would be issued? These questions only reinforce what I have been thinking for a while; the objections to any Commonwealth Plan of Adjustment will be monumental, both by bondholders and unsecured creditors. Litigation will go on for years and there will be no end to it, unless the Board sits down and settles with creditors, both secure and unsecured. The likelihood of this happening, however, is slim to none.

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.