Weekly Update – October 9, 2018

Welcome to your weekly Title III update for October 9, 2018. Although not much happened, what did happen is very important.

On October 3, 2018, National, Assured and Syncora, insurers of PREPA bonds, filed a renewed request for the lifting of the stay in order to seek the appointment of a receiver as per Puerto Rico law and the 1974 Bond Agreement. The insurers claim they possess 27% of the outstanding bond debt of PREPA. The motion came out swinging and says:

PREPA remains today, as it has been for decades, a dysfunctional entity. It serves only the political forces that control it, at the expense of everybody else. And PREPA’s perceived invulnerability to reform efforts fuels its worst practices. Since the denial of the Chief Transformation Officer motion filed by the Financial Oversight and Management Board (the “FOMB”), the pace of mismanagement and bad decision-making at PREPA has only increased, and it is rapidly approaching escape velocity. The wrong turns PREPA is taking today will harm its creditors and the people of Puerto Rico long after this Title III case is finished. Now, more than ever, PREPA needs a receiver for the benefit of all stakeholders. The long history of mismanagement at PREPA is well-documented. PREPA was run not by business people with knowledge of public utilities, but by bands of political loyalists that shifted with each new election. It began expensive projects and then abandoned them when political winds changed direction. As of 2014, it had failed to collect receivables adding up to some $1.75 billion. A movement to reform PREPA briefly held sway from 2014 to 2017—with the creation of an independent regulator, an agreement with bondholders, and laws requiring independence and professionalism. But reform succumbed once again to improper political interference after only one election cycle. PREPA’s Title III case followed.

Since the Title III petition, PREPA’s problems have grown even worse. PREPA tragically bungled the response to the hurricanes, exacerbating and prolonging a humanitarian crisis. PREPA’s systems have not been properly managed, hardened, or maintained for future hurricanes. It has churned through five different leaders in the past year. All its independent directors were forced to resign in July 2018 under intense pressure from Governor Rosselló, leaving PREPA’s Board of Directors (the “Board”) without a lawful quorum. Its collection efforts remain abysmal. As of June 2018, PREPA reports uncollected accounts receivable of almost $3.4 billion. It obstructs its independent regulator at every turn, foiling efforts to develop reliable and low-cost electricity service. And its political entanglements have left it rife with conflicts of interest. Among others: the new chairman of the PREPA Board also serves as Executive President of the Puerto Rico Aqueduct and Sewer Authority (“PRASA”), and PREPA’s latest executive director was formerly PRASA’s Chief Executive Officer. Meanwhile, PRASA owes PREPA millions of dollars. Instead of collecting that money, PREPA now has an initiative (presumably at the Governor’s behest) to transfer assets to PRASA on secret terms. Indeed, PREPA’s lack of transparency continues in spite of its debtor status.

In footnote 5, the motion also states that the, “$3.7 billion figure includes roughly $1.1 billion in “General clients” accounts receivable and another $2.6 billion in Government accounts receivable.” In other words, the Commonwealth and Municipalities owe PREPA almost a third of the utility’s bond debt.

The motion continues stating later on:

PREPA currently fails to collect enormous sums owed for electricity it provides—particularly by government customers that have come to take free power for granted.30 PREPA’s failure to collect its bills is an egregious outlier in the industry. Indeed, even before Hurricane Maria, PREPA’s reported accounts receivables equaled nearly 100% of its revenues from sales for an entire year—a figure that dwarfed the industry average, in which accounts receivable typically equaled only about 6 to 15% of annual sales.31 Moreover, rather than be transparent about its financial condition, PREPA hides behind vague excuses about its massive accounts receivable balances. Further, instead of taking any meaningful steps recommended by its advisers to improve collections, PREPA has ceased efforts to collect on inactive and severely past due accounts, and it no longer reports the extent to which it cancels service on delinquent accounts. By forgoing industry standard collection practices, PREPA is effectively giving its customers interest-free loans of indefinite duration. . .

PREPA’s workforce also is overstaffed at the administrative level, yet understaffed and under-skilled in key areas such as transmission and distribution.38 At the same time, PREPA’s employees are constantly turning over due to PREPA’s politicized management, and there appear to be no effective succession or training plans in place to staunch the perpetual loss of experience and skills.39 PREPA also has deficient policies and practices in customer service, outage management, bidding, and accounting—all to the severe detriment of the people of Puerto Rico and to PREPA’s bottom line.40 PREPA’s “disorganized and ineffective” customer service costs too much and delivers too little.

Predictably, PREPA’s bad management leads to bad outcomes. PREPA experiences outages with 12 times greater frequency than the mainland U.S. average and takes much longer to fully restore power after an outage begins. This problem is exacerbated by the fact that PREPA does not attempt to proactively address the potential for failures—for instance by shoring up the system during periods of low demand—but simply reacts to failures as they occur, and is thus constantly “fire-fighting.” Likewise, PREPA’s practices with respect to bidding and accounting fall below industry standards. Taken together, PREPA’s many failures managing its business and operations have caused it to incur unnecessary expenses and lost revenue.

The insurer’s motion discusses the failed attempt to obtain $1.3 billion in interim financing and the subsidies PREPA gives municipalities via Contribution in Liu of Taxes. It also discusses PREPA’s less than stellar performance after Hurricane Maria:

Even before the hurricanes struck Puerto Rico, PREPA failed to follow well-established industry practices in hurricane preparedness when it did not activate mutual aid assistance to secure necessary resources, as any responsible electric utility would do.61 Moreover, in the wake of the disaster, rather than do the logistical work expected of any utility, PREPA entered into a $300 million contract with a two-person, two-year-old Montana company called Whitefish Energy Holdings, LLC (“Whitefish”) that had no experience with major utility repairs. The Whitefish contract, plainly the result of a deficient selection process,  created an enormous bottleneck at PREPA, starving the utility of the people needed to repair the system efficiently. Public utilities that wanted to help PREPA were told to go through Whitefish, which created major delay in aid. As a result, PREPA fell far behind in its repair efforts, widening the “trust deficit” between PREPA’s stakeholders, including the citizens of Puerto Rico, and its management.65 On top of that, the Whitefish contract charged PREPA exorbitant rates and provided that its profit and compensation provisions could not be audited by any governmental entity, including FEMA. The current Governor and his legal advisors continued to defend the Whitefish contract through October 2017. . . Most egregiously, there were allegations of serious malfeasance, bribery, and corruption in the recovery. “PREPA officials were reportedly paid $5,000 and provided free entry tickets, valued at $1,000 apiece, to restore power to San Juan area exotic dance clubs ahead of the scheduled restoration timeline.” There were also allegations that PREPA officials restored power out of sequence and to their own homes before restoring power to critical locations.

Next, the motion takes on the transformation of PREPA:

According to the government’s January 2018 announcement, the process would take at least eighteen months. That estimate was not remotely realistic. The latest PREPA Fiscal Plan states that: “[t]he ultimate form of the transformation will be informed by many elements currently unknown and beyond PREPA’s control including market appetite for the transaction and legislative action. PREPA, therefore, expects to amend and modify this Fiscal Plan to reflect the inputs received from the transformation process.” The Fiscal Plan shows various changes related to the transformation continuing through at least FY2023. Other officials have admitted that this complex process could take four to seven years. The transformation process contemplated under the fiscal plan is likely to take several years and as many as ten or more years to accomplish.

Related to this, PREPA informed the Energy Bureau that it would not have the Integrated Resources Plan ready for this month as it was required. The submittal to the Bureau did not specify when the document will be completed. In addition, as required by the law for the sale of PREPA,  the Legislature will present the regulatory framework and Public Policy for the energy grid this month.It will be interesting to see if my belief—that politicians really do not want to sell PREPA—will be reflected there.

The insurers’ motion is supported by declarations of experts and a myriad of documents. Obviously, AAFAF announced that it would oppose the motion and Judge Swain ordered that all briefing be submitted by December 12. Movants had requested a hearing on December 19, but the Judge has yet to rule on it.

Interestingly, the next day this motion was filed, the governor announced a 3-4 cent reduction in the electricity rates, allegedly due to administrative economies. That night, the Board sent the governor a letter questioning the reduction, seeking the basis for this reduction and asking whether it violates Puerto R law that establishes that the Energy Bureau, not the Puerto Rican government, as the one who establishes electricity rates. Moreover, not long ago, the same insurers who filed this complaint asked the Board for help appointing management for PREPA. The Board quickly rejected this request but as of this writing, it has remained silent as to the request. Wonder what the Board will decide to do.

On Wednesday, October 3, the Court was to hear arguments as to the UCC’s motion to be named representative of the Title III debtors in the GDB restructuring. On that day, the parties announced that they were close to getting to an agreement and asked for a hearing on Friday, October 5. When that day came along, the agreement was announced. The important parts are:

  1. On the Closing Date, the Government Development Bank for Puerto Rico (“GDB”) shall transfer $20 million in cash (the “Fixed Settlement Cash”) to the Public Entity Trust (as defined in the GDB Restructuring Act).
  1. In addition, GDB shall transfer to the Public Entity Trust any cash retained by GDB on the Closing Date that remains after satisfaction of the obligations pursuant to the Cash Adjustments for which such cash was retained (such excess, if any, “Excess Adjustment Cash”), in an aggregate amount up to $10 million (such Excess Adjustment Cash so transferred, the “Contingent Settlement Cash” and together with the Fixed Settlement Cash and the Excess Litigation Cash (as defined below), the “Settlement Cash”). The Public Entity Trust shall be entitled to receive the first identifiable Excess Adjustment Cash amounts, and the GDB Debt Recovery Authority shall not receive any such Excess Adjustment Cash until the Public Entity Trust receives Contingent Settlement Cash in the amount of $10 million
  1. The Designated Deposit (as defined in the GDB Restructuring Act) of (i) the Puerto Rico Electric Power Authority (“PREPA”) in the amount of $114,108,631 (the “PREPA Designated Deposit”) and (ii) the Employees Retirement System of the Government of the Commonwealth of Puerto Rico (“ERS”) in the amount of $32,948,612 (the “ERS Designated Deposit” and, together with the PREPA Designated Deposit, the “Title III Debtor Designated Deposits”) shall be allowed claims against the Public Entity Trust. The Title III Debtor Designated Deposits shall be transferred to the Public Entity Trust, in accordance with the GDB Restructuring Act, and the Public Entity Deed of Trust shall provide that the Title III Debtor Designated Deposits shall be
  1. with respect to the Settlement Cash, first priority claims, senior to all other Designated Deposits;
  1. with respect to all other assets of the Public Entity Trust, pari passu (but for the avoidance of doubt, not including any federal funds) with all other Designated Deposits, provided that the Title III Debtor Designated Deposits shall be reduced on account of the Settlement Cash received.
  1. Any distributions from the Public Entity Trust to the Title III Debtor or other Government Entity made hereunder shall be distributed and used in accordance with applicable law, including, but not limited to, the Law to Guarantee Payment to Our Pensioners and Establish a New Plan for Defined Contributions for Public Servants, Act No. 106 (2017).2
  1. For the avoidance of doubt, the Title III Debtor Designated Deposits shall not be subject to any additional claims for setoff, netting, recoupment, or reduction, including in respect of any causes of action for preferential transfers, asserted by GDB, which shall be deemed settled as of the Closing Date.
  1. GDB acknowledges and affirms that the Legal Claims (as defined herein) are property of the applicable Title III Debtor or other Government Entity (other than GDB).
  1. Regardless of whether the affirmation in Paragraph 6 hereof is accurate, to the extent GDB has any property interest in the Legal Claims, such interest shall be transferred as of the Closing Date to the applicable Title III Debtor or other Government Entity (the “Transferee”).
  1. Legal Claims” shall mean all legal rights, claims, and causes of action, including contingent or unknown causes of action, in law or in equity, that GDB may assert or be a party to, in its capacity as fiscal agent or financial advisor, or such other representative capacity to a Title III Debtor (or the entity that became a Title III Debtor) or other Government Entity other than GDB (including claims relating to the issuance of bonds by the Title III Debtors or Government Entities other than GDB), and for which the intended or actual primary economic beneficiary of the transaction or series of transactions giving rise to the cause of action was a Title III Debtor (or the entity that became a Title III Debtor) or other Government Entity other than GDB, but shall exclude (i) any legal right, claim or cause of action relating to the issuance of any bond by GDB (or any of its subsidiaries or successors, including the GDB Debt Recovery Authority) and (ii) any legal right, claim or cause of action released or to be released under the GDB Restructuring Act (as in effect on the date hereof, and reflecting the modifications set forth in the Informative Motion Regarding Releases Under Article 702 of the GDB Restructuring Act [Docket No. 151 in Case No. 18-1561 (LTS)]).
  1. To the extent a Legal Claim is asserted and any defendant(s) to such claim asserts an indemnification claim against GDB on account of such transferred Legal Claims, the Transferee shall assume such indemnification obligations, but only to the extent of GDB’s interest, if any, in the transferred Legal Claims. To the extent a Transferee assumes any indemnification obligations of GDB, it shall control the defense of any indemnification claims asserted on account of such obligations.
  1. GDB shall be required to provide reasonable cooperation to the Transferee in connection with the Transferee’s prosecution of the Legal Claims and, as applicable, the defense of any indemnification claims, including, but not limited to, reasonable cooperation in responding to any Transferee discovery efforts; provided, however, nothing herein shall obligate GDB to provide any privileged information to any Transferee; provided further, that the applicable Transferee shall be responsible for all costs associated with GDB’s reasonable cooperation.
  1. The Title III Court shall have jurisdiction over any dispute with respect to the allocation of the Legal Claims among the Title III Debtors. The rights of the Oversight Board and AAFAF under PROMESA, including under section 305, with respect to such issues are expressly preserved.
  1. Nothing herein gives the UCC or its constituents any rights or standing with respect to the Legal Claims or any of the rights of any Transferee under this Stipulation. For the avoidance of doubt, nothing herein shall be interpreted to grant the UCC authority to prosecute the Legal Claims; provided, however, that nothing herein shall preclude the UCC from seeking derivative standing in the Title III Cases to bring such claims on behalf of the Title III Debtor; provided further, nothing herein shall prevent AAFAF or the Oversight Board from objecting to such relief.
  1. The indebtedness owed by the Commonwealth to GDB that is to be transferred to the Public Entity Trust pursuant to the GDB Restructuring Act shall, as of the Closing Date, be reduced by the amount of the federal funds on deposit at GDB restored by the Commonwealth (which is, approximately, $312 million). The claims of GDB against the Commonwealth in respect of such indebtedness shall remain subject to allowance in the Commonwealth’s Title III Case, provided that such claim may not be allowed in an amount greater than $578 million.
  1. In exchange, GDB shall transfer to the Public Entity Trust the first cash or cash equivalents that constitute net proceeds of Causes of Action that remain after, or are received by GDB after, in GDB’s sole determination, all contingent and unliquidated claims against GDB arising on or before the Closing Date have been satisfied, up until ERS and PREPA obtain net proceeds totaling 55 cents on the dollar of the Title III Debtor Designated Deposits (without reduction for payments from the Fixed Settlement Cash or the Contingent Settlement Cash) (such excess, if any, the “Excess Litigation Cash”). For the avoidance of doubt (i) GDB shall have the sole authority and absolute discretion to commence, prosecute, settle, offset against claims against GDB, or release any such Cause of Action and (ii) the UCC shall not have the right to, and shall not have or seek standing to, directly, indirectly or derivatively, commence, direct, compel the prosecution of, settle, resolve, sell, transfer or dispose of any such Cause of Action or any litigation, other enforcement action or resolution thereof. For the avoidance of doubt, the causes of action described in this Paragraph 14 are Causes of Action other than the Legal Claims.

In exchange for this agreement, the UCC dismisses with prejudice its objections to the GDB restructuring, including its adversary proceeding, appeal, etc. While this may not seem like much, both AAFAF and the Board questioned the UCC’s standing to raise objections to the deal and there is money being transferred to the Public Entity Trust to pay the Title III creditors. Also, PREPA and ERS claims against the Public Entity Trust are being allowed. Not a homerun, but at least a double.

This settlement leaves only Siemens and a couple of non-profits as objecting parties to the restructuring. I do not include, Cooperativa de Ahorro y Credito Abraham Rosa, et al. v. Commonwealth of P.R., et al., Adversary Proceeding 18-0028, since this party did not file an objection in case 18-1561, as it should. It will be interesting to see if Judge Swain dismisses this case or simply considers that since it was filed before the qualifying modification, it should be considered as an objection. Don’t think she will, though. The Cooperativa should have filed an objection.

In the COFINA deal, the Board filed a motion for establishing the schedule for the approval of the disclosure statement, plan of adjustment and the Rule 9019 settlement:

The Commonwealth of Puerto Rico (the “Commonwealth”), the Puerto Rico Sales Tax Financing Corporation (“COFINA”), the Puerto Rico Highways and Transportation Authority (“HTA”), the Employees Retirement System of the Government of the Commonwealth of Puerto Rico (“ERS”), and the Puerto Rico Electric Power Authority (“PREPA,” and together with the Commonwealth, COFINA, HTA, and ERS the “Debtors,” and each individually a “Debtor”), as Title III debtors, by and through the Financial Oversight and Management Board for Puerto Rico (the “Oversight Board”), as the Debtors’ representative pursuant to section 315(b) of the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”), respectfully submit this urgent motion (the “Urgent Motion”), for entry of an order, substantially in the form attached hereto as Exhibit A (the “Proposed Order”), scheduling a hearing (i) to determine the adequacy of information in the COFINA disclosure statement for November 20, 2018, at 10:30 a.m. AST (9:30 a.m. ET) in New York, New York, and (ii) to (A) approve the Rule 9019 settlement of the Commonwealth-COFINA dispute in the Commonwealth title III case, and (B) confirm the COFINA plan of adjustment, for January 16, 2018, at 9:30 a.m. AST (8:30 a.m. ET) in San Juan, Puerto Rico, and continued, if necessary, on January 17, 2018 at 9:30 a.m. AST (8:30 a.m. ET) in San Juan, Puerto Rico.

This means that by early next year, PR may have settled over $21 billion of its debt. Not bad for the Board, AAFAF and its lawyers. Finally, the Board and AAFAF are soliciting feedback from the parties to the Amended and Restated Plan Support Agreement for COFINA with respect to consideration of an alternative securities design based on the same available cash flows. It will be interesting to see the feedback on this.

And talking about the deal, Antonio Weiss, one of the architects of PROMESA in the US Treasury, criticized in Bloomberg the COFINA deal. Mr. Weiss states:

The COFINA restructuring doesn’t go nearly far enough.  It saddles Puerto Rico with escalating debt payments for the next 20 years, even though the economy has been in a decade-long slump.  It also sets a dangerous precedent.  If Puerto Rico’s government and the oversight board created by Congress agree to similar terms with creditors who hold General Obligation bonds,  it will be just a question of time before the commonwealth is forced to default yet again or curtail public pension payments upon which more than 325,000 workers depend.

Mr. Weiss continues saying:

The implications of the proposed COFINA deal for restructuring the remainder of the island’s debt obligations are also a concern. The old COFINA bonds were a fast path to deep insolvency, with debt service rising from $0.7 billion to $1.8 billion over the next 25 years. The new bonds offer some relief, with debt service starting at $0.45 billion and reaching $1 billion. The restructured bonds also offer the junior COFINA bonds enhanced security in exchange for the fall in debt service, and the new bonds will be harder to restructure in the future. And by the end of the 2020s, the proposed payments on the COFINA bonds alone would push Puerto Rico’s debt burden — assessed using the standard municipal bond metric of debt service against the entity’s own revenues — over that of an average U.S. state.  

With Puerto Rico’s limited ability to repay, generosity to one set of bondholders necessarily reduces what the commonwealth can reasonably offer to other bondholders and claimants.  The sustainability of Puerto Rico’s debt restructuring needs to be assessed comprehensively, not by looking narrowly at each piece of the bigger puzzle.

Mr. Weiss seems to forget he no longer calls the shots in PROMESA. In addition, he pontificates and assumes, without saying, that Judge Swain can in fact eliminate with one stroke the COFINA debt or at least convert its bondholders into non-secured creditors. The reality is that COFINA could be declared unconstitutional (as is my opinion) and hence the debt be unsecured; or it could be constitutional and the whole debt be owed to secured creditors. A settlement takes care of this uncertainty. In addition, at the beginning of the negotiations, before the Title III commenced, the Board in a cavalier fashion was pushing for over 70% haircut of the debt but got nowhere in settlement. Once it began upping the ante, we have the COFINA and GDB deals, probably PREPA and PRASA also. So much for Mr. Weiss rhetoric.

Having said that, Mr. Weiss, without knowing it, has put his finger on the real issue: the way the settlement on presumptively secured debts have been going, over 70% on average, there will not be much left to pay unsecured creditors. Moreover, in a Plan of Adjustment, unsecured creditors vote and could reject the plan. But that is something we will leave for another time.

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.