Welcome to your weekly Title III update for September 18, 2017. As Hurricane María bears down on Puerto Rico, we should recap several important things from the past week. Judge Swain denied the PREPA bondholders’ request to lift the stay to request the appointment of a receiver. Interestingly, the Court based its decision on only one of the Board’s arguments, making it clear that Judge Swain knows who the boss in these Title III cases is. At page 10 she stated:

“Section 305 of PROMESA provides that, “notwithstanding any power of the court, unless the Oversight Board consents or [the debtor’s Title III] plan [of adjustment] so provides, the court may not by any stay, order or decree, in the case or otherwise, interfere with – (1) any of the political or governmental powers of the debtor; (2) any of the property or revenues of the debtor; or (3) the use or enjoyment by the debtor of any income-producing property.” PROMESA § 305. The Debtor here, PREPA, is a government instrumentality of the Commonwealth, exercising governmental powers in providing electrical service to the inhabitants of the Commonwealth, using its property to generate that power and deriving income from the sale of the power so generated. The rates it charges for its services define the magnitude and impact of its principal revenues. The relief that Movants seek – permission to require the appointment of a receiver to manage PREPA’s operations and seek the approval of rates higher than those PREPA has thus far chosen to charge – is facially inconsistent with Section 305 of PROMESA. Section 305 bars the Court, “notwithstanding any power of the court,” from using “any . . . order or decree, in the case or otherwise,” to interfere with such basic functions and assets of PREPA absent the Oversight Board’s consent, which has not been given here.” (underlining added)

At page 13, she made the most important point of the opinion:

“Congress, similarly, denied the Title III court power to displace PREPA’s management, even for misconduct, by omitting Section 1104 of the Bankruptcy Code, which provides for the appointment of a trustee or an examiner in a Chapter 11 bankruptcy case, from the Bankruptcy Code provisions incorporated into PROMESA’s statutory scheme. Instead, Section 301(c)(7) of PROMESA specifically designates the Oversight Board as the sole “trustee” under PROMESA. See PROMESA § 301(c)(7).” (underlining added)

Anyone familiar with a Trustee in bankruptcy knows that when one is appointed for a debtor, she is the one who calls the shots. Hence, Judge Swain has made it clear that the Board, and not Puerto Rico’s elected officials, are in charge of the management of PREPA and the rest of the entities in Title III. Very telling. Board 2, Bondholders 0, but PREPA bondholders have vowed to appeal the decision. Peaje has already filed its notice of appeal.

Also this week, the COFINA agent answered the UCC’s complaint. As you remember from last week’s update, the UCC, as Commonwealth Agent filed a complaint against COFINA with 13 causes of action, including the unconstitutionality of the law. The COFINA agent came out swinging with a 71 page counterclaims, answer and defenses.

In addition to the oft repeated platitudes of legal opinions and legislative statements, COFINA’ First Cause of Action at page 29:

“[S]eeks a declaration that: (i) the statutes creating COFINA and directing transfer of the Pledged Sales Tax and the Dedicated Sales Tax Fund to COFINA are constitutional under the Constitution of Puerto Rico; (ii) the Pledged Sales Tax, including all Pledged Sales Tax revenue collected in the future, and the Dedicated Sales Tax Fund are the property of COFINA; and (iii) the Pledged Sales Tax and the Dedicated Sales Tax Fund are not “available resources” under the Constitution of Puerto Rico. In the alternative, Counterclaim Plaintiff seeks a declaration that: (i) COFINA has a perfected and unavoidable lien.”

Its Second Cause of Action states that Commonwealth actions violate the Takings Clause and Impairment of Contractual Obligations of both Constitutions. The Third Cause of Action that the Compliance law violates PROMESA, the Fourth Cause of Action that Act 84 violates PROMESA. The Fifth Cause of Action claims tortious interference with a contractual relation and the Sixth Cause of Action claims that if COFINA is unconstitutional, PR committed Fraud, which it likely did, since it should have known that the PR Constitution did not permit the surrendering of the power to tax and that GO’s had priority. The Seventh Cause of Action seeks an injunction but the Eighth Cause of Action claims that “GO Bonds, PBA Bonds and Other Debt Issued in Violation of the Debt Limit Set Forth in the Constitution of Puerto Rico Are Not Entitled to Priority Under the Constitution.”

The COFINA dispute promises to be an interesting slug-fest. The complaint was filed on September 8, but the UCC has already issued 22 subpoenas duces tecum including law firms, Banco Popular, Santander, Barclays and Moody’s, to name a few.

Also last week, Siemens Transportation Partnership, S.E., an HTA creditor, sought permission from the Court to conduct Rule 2004 discovery from the GDB, Carlos Vizcarrondo (GDB) and Hector Betancourt (AFAF). Ambac also sought leave to conduct discovery pursuant to Rule 2004 from the Board as representative of the Commonwealth of Puerto Rico, the Commonwealth; and AAFAF and other parties. More specifically, Siemens, at page 5 of its motions, states:

“Siemens files this Motion to obtain information about the account and the funds therein, including GDB’s funding of the account and any withdrawals or transfers, to determine whether and to what extent: (i) Siemens’ claim against HTA Authority may be paid from funds that are not property of HTA or GDB; and (ii) any third parties have received funds from the account, and if so, whether such transfers may give rise to a claim for fraudulent transfer, conversion or other action, such that Siemens may recover on account of its claim against HTA from parties or assets other than the HTA, which is a Debtor in the above-captioned proceeding, under Title III of PROMESA.”

On this same subject, the UCC reported to Judge Dein that the Board was not cooperating on the coordination of Rule 2004 discovery, which the Board confirmed saying:

“Based on the meet and confer and the Initial Work Plan, the Oversight Board proposes that the UCC’s motion be deferred, and that no decision be made on the UCC’s request to conduct an investigation at this time. The Oversight Board makes this proposal based on its belief that there is no need for the UCC to conduct a separate, potentially duplicative investigation at this time. It would be premature for the UCC to conduct its own investigation given the Independent Investigator’s commitment to maintain open lines of communication with the UCC, to solicit input from the UCC, and to seek documents, including but not limited to those already sought by the UCC. The Investigation should proceed as outlined above and, if there comes a time when the UCC is not satisfied with the speed or substance of the Investigation, it should make an application to the Court to pursue its own investigation on the specific matters on which it is not satisfied.”

Translation: The Board wants to be the only one conducting any investigation on Puerto Rico’s debt and wants no interference. The UCC, in my humble opinion, showed that the Board was conflicted and that it was dragging its feet, which lead Judge Dein to say coordinate because the discovery will be done. Let’s see what happens.

Also this week, PREPA filed a motion requesting an order establishing a procedure to reject power purchasing agreements, of which it states more than 60 exists. Pretty normal procedure in a bankruptcy, except that these contracts are for renewable energy. Why does the Board want to reject them? Is it, as I have been saying, to level the playing field to sell PREPA as free of encumbrances as possible? Is it preparing to sell only the generation part of PREPA? Questions, questions.

On September 11, 2017, Judge Swain listened to oral arguments in the Municipality of San Juan’s request for an injunction against the GDB RSA. Absent from the argument was any real proof of irreparable harm, which is essential to any injunction. In addition, Judge Swain seemed to believe that the monies deposited by the Municipality were a loan and hence could be altered via Title VI. Judge Swain took the arguments under advisement and will render her opinion soon. In the meantime, defendants filed a motion to dismiss the complaint and the one filed by the Municipality of Caguas. Given the Judge’s comments and the Federal Courts view of a municipality, they may be granted.

Finally, on Friday, Judge Dein heard arguments on the UCC’s renewed motion to intervene in the NY Mellon-COFINA bondholders dispute. The UCC has filed motion to intervene in most of the adversary proceedings filed in the Commonwealth and COFINA cases. Judge Dein seems baffled by the arguments and will have to further study them.

Before I leave I want to make one thing clear about these weekly updates. 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.

The second in a series on Puerto Rico’s pensions

On May 3, 2017, the Financial Oversight and Management Board filed the Commonwealth of Puerto Rico’s Title III petition. In the nearly four months since the filing, we have seen the Board develop a legal strategy that relies on elevating pensions over secured bondholders and invalidating contractual liens such as those held by pension obligation bondholders of ERS.   Each of these steps eerily echoes the legal strategy used by the Obama Administration during the Chrysler Bankruptcy.  But what does an automaker’s Chapter 11 bankruptcy have to do with Puerto Rico’s supposed insolvency you may ask?  More than you would imagine, and it’s not confined simply to the court room, either, as we explore.

First, let’s discuss what happened in the Chrysler Bankruptcy.

The Chrysler Bankruptcy

By December of 2008, Chrysler, after years of decline, was in dire straits. It was bloated, inefficient and burdened by labor contracts and pension costs.  The timing – during the midst of the Global Financial Crisis – could not have been worse.  This confluence led Chrysler, along with General Motors, to then start pleading for greater federal financial assistance (i.e. – a bailout; sound familiar?), arguing that liquidation would mean the loss of thousands of good (meaning union) jobs.

In December of 2008, the U.S. House of Representatives voted to bailout Chrysler, but the U.S. Senate voted it down. Then-President Bush proceeded to extend credit but when the credit ran out, then-President Obama intervened, forcing out Chrysler CEO Robert Nardelli and announcing that the federal government would provide additional funds to support Chrysler contingent on the completion of a merger with Fiat within 30 days.

After examining the restructuring plans, the Obama administration decided they were insufficient, thereby forcing Chrysler to file for bankruptcy in April of 2009. Within two months, Chrysler emerged as “The Chrysler Group,” owned by the United Auto Workers (55%), Fiat (20%), the US Government (8%) and Canada (2%). See, The Auto Bailout and the Rule of Law, by Todd Zywicki.

In the years leading to its bankruptcy, Chrysler had been unable to obtain financing and resorted to issuing secured debt to finance its operations. At the time of the filing, Chrysler owed around $6.9 billion in secured debt, but also $10 billion to an unsecured pension plan.

In a bankruptcy, secured debt has the first priority of payment and unsecured creditors get the rest in a pro rata basis. This general principal applies to all Bankruptcy Chapters and hence to Title III. Also, in a Chapter 11, the debtor prepares a Bankruptcy plan pursuant to 11 U.S.C. § 1123 in which it classifies the claims in order of priority and the debtors whose claims are impaired, have a right to vote on the plan. This is the same procedure of a Chapter 9 and hence, of Title III in PROMESA.

In Chrysler, it was done differently.  The U.S. Government created and funded a shell company that, through a § 363 sale, bought substantially all of Chrysler’s assets for $2 billion, giving the secured creditors a paltry return of 29 cents on the dollar. FIAT was brought in to manage the new firm and was given a slice of the new company’s stock. New Chrysler (formally: New CarCo Acquisition LLC) then assumed the old company’s debts to the retirees, most dealers, and trade creditors. The unsecured claims of the retirees’ benefits plan were replaced with a new $4.6 billion note as well as 55% of the new company’s stock.  Assessing the Chrysler Bankruptcy, by Mark J. Roe and David Skeel at page 5.

How the Board is using the Chrysler Playbook in Puerto Rico

In Puerto Rico, the Board has told the Court that COFINA, Peaje (HTA), and Altair (ERS) do not have a lien – essentially ripping up binding contracts. The Board has also told GO bondholders that they do not have a priority in payment structure, evidenced by the elevation of pensions over their constitutional-backed debt.

At the same time, the Board has allowed the Commonwealth to pay 100% of pensions, which will total $2.5 billion a year, as well as pay all suppliers and tax refunds. The Board will ensure a modest haircut of 10% on these pensions at some point in the future, although the details are vague and applies to only certain pensioners.  Even this move by the Board has met resistance from the Rosselló administration, who has rejected any claims that say they will not pay pensions in full.

As we can see, the Board is trying to deprive secured creditors of their security so their claims can be deeply cut while at the same time, favoring non-secured pensions to be paid. Exactly like Chrysler.

Not wanting to waste time while the Title III proceedings unfold, the Board and the Rosselló administration are getting a jump start through legislative actions.

Together, these seemingly ‘opposing entities’ have jointly pushed through legislation in the Puerto Rico House of Representatives and Senate that codifies pensions as a higher priority payment than constitutionally-prioritized debt, and worse, crystallizes entitlements from the date enactment, instead of upon retirement, which essentially attempts to lock in pensions at current rates and not subject them to a restructuring on a pro-rata basis in Title III without creating claims, a flexibility that the Commonwealth might otherwise have enjoyed. At the same time, they do a farcical face-off about a 10% cut in pensions to give the impression there will be some pain.

This action underscores that neither the Board nor the government are just waiting for the courts to act, as was the case in the Chrysler bankruptcy, but rather enacting policies that will lay the groundwork for the outcome they want in court – to give themselves and pensioner’s protection and outright injuring the secured bondholders they owe.

The Link between Puerto Rico and Chrysler

Judge Arthur González is a member of the Board and without a doubt its intellectual leader. He is on the most important committees, attends Judge Taylor Swain’s hearings (an old colleague of his as they used to be bankruptcy judges in the Southern District of New York together) and most importantly, was the presiding Judge in the Chrysler bankruptcy. Moreover, Judge Gonzalez was president Obama’s choice for the Board – a telling sign.

Additionally, the information I have received is that Judge González was adamant on hiring the Board’s law firm of Proskauer Rose, whose principal restructuring lawyer is Martin Bienestock. According to the University of Michigan Law School bio on Mr. Bienestock, he “developed for General Motors the section 363 sale free and clear strategy that the United States Auto Task Force deployed for both Chrysler and General Motors.” As the saying goes, there is no such thing as a coincidence. It is all too true in the case of Puerto Rico.

One closing thought, what bewilders me is how the Board and government believe they can pursue a legal strategy that will simply invalidate liens and contracts, and elevate pensions above and beyond adequate funding as directed by Congress in direct contradiction with PROMESA and the Puerto Rico Constitution.

In the next installment I will discuss the critics of the Chrysler Bankruptcy in detail, including some that will surprise you.

Welcome to Monday Title III update for September 11, 2017. Although Hurricane Irma rightfully drew attention away from the proceedings, several important things happened. Judge Swain issued the Peaje decision, holding that it had not shown during the August 8, 2017 injunction hearing a likelihood of success in its claim that its bonds had a statutory lien over the HTA toll revenues. Judge Swain opined on page 13 of the opinion that:

“Rather, the HTA Enabling Act provides that a ‘contract’ between HTA and a third party may contain a lien, which consensual lien would be enforceable assuming that it satisfied certain conditions. In this respect, the HTA Enabling Act is not meaningfully different from Article 9 of the Uniform Commercial Code, which is a model statutory provision that defines certain conditions under which a lien becomes enforceable. That a lien arising under Article 9 is enforceable does not, however, make that lien a statutory lien under Section 101(53) of the Bankruptcy Code; similarly, that HTA linens trace their validity to the HTA Enabling Act’s grant of authority to create liens does not make liens that HTA subsequently decided to create statutory in nature.”

Judge Swain also decided that Peaje had failed to show that the 1968 Resolution was a law of the Commonwealth or that it would suffer irreparable damage. She determined that Peaje’s expert testimonies by Dr. Hildreth and Thomas Stanford were not credible. On the other hand, she gave credibility to HTA Executive Director González. Hence, even if Judge Swain’s legal conclusions regarding the Peaje lien were reversed on appeal, it is highly unlikely that her decision on the issue of irreparable harm would. A judge’s factual determinations based on testimony she heard are reviewed for clear error and that almost impossible to reverse.

Judge Swain’s decision is consistent with what I have mentioned time and again, she adheres to the letter of the law. If the HTA statute said that a bond created a lien, she would have decided in favor of Peaje, but since it did not, she decided in favor of the Board. This brings us to another important consideration: Judge Swain will give government witnesses great weight. Hence, opponents must come loaded for bear against them. It does not suffice to make them look silly.

Of course, this does not mean Peaje will not try to review her decision but may have to wait until the end of its case since this was only the denial of the injunction. Without a doubt, however, this is a victory for the Board’s continuous effort to destroy all bondholder liens in PR.

I would like mention an article that came out in Bond Buyer, a publication that I follow, and find very informative. There is a new litigation between the Commonwealth v. COFINA (not GO’s v. COFINA) which was filed on Friday, September 8 (more on that later). Judge Swain, however, has not put anything on hold, as evidenced by the Peaje decision. Moreover, although the Board has requested that Judge Swain decide the issues in the case by December 15^th, this is unlikely to happen. She has set evidentiary hearings on the issues for December 4-8^th. In the Peaje case, after one day of hearing, the post hearing motions extended until August 28^th and she decided the issues 11 days later. The issues in COFINA are far more complex and I doubt the decision will come down before January-February.

Another interesting development is the Board’s Informative Motion to Set Briefing in the Aurelius and UTIER constitutional challenge. Plaintiffs’ claim that the Board members’ appointment violates the Appointment’s Clause of the US Constitution. This challenge signals the Board has taken this motion seriously and notified the Court it would hire Donald B. Verrilli, Jr., Obama’s former Solicitor General. Also, in this motion the Board seeks to extend the time to answer the complaints. It stated at page 4 of its motion:

“On the current schedule, the parties to each case will have completed their entire briefing before the Government is required to notify the Court of its plans to intervene or not. That leaves limited time for the parties to consult and exchange views with the Government before making their submissions. That consultation is a standard and important practice in a case like this one, as it involves a challenge to the constitutionality of a federal statute and implicates the significant interests of a broad range of government agencies.”

Although this is true, it seems to me the Board wishes to make sure the Trump administration does not pull the rug out from under it, which is certainly possible. Consider that if the Board was illegally appointed, President Trump would have the right to name all 7 Board members with only the consent of the Senate. That could be a huge difference in these cases.

In another interesting development, although the Unsecured Creditor’s Committee had requested and been denied intervention in the Mellon Bank interpleader COFINA litigation, it again requested leave to intervene and surprise, surprise, the Board, who claims it has no position on the COFINA issues, supported the request. It is quite clear that the Board wants to destroy the COFINA lien to use those proceeds to continue funding the PR Government as it has until now. Any claim to the contrary is pure hogwash. It goes without saying all COFINA creditors oppose the intervention.

The Unsecured Creditors’ Committee filed its complaint against COFINA in representation of the Commonwealth of Puerto Rico at 11:22pm Friday, September 8^th. The 44 page complaint is a smorgasbord of lamentations against COFINA with 13 causes of action. The causes of action claim, inter alia, that the Commonwealth did not transfer to COFINA ownership of future SUT revenues; that Act 91 did not assign to COFINA any “right to receive” future SUT; that COFINA has no enforceable security interest in future SUT revenues; that any unperfected security interest COFINA may have in SUT receivables is voidable; that any security interest of COFINA revenues is subordinate to the rights of the Board as Trustee; that the commencement of the Title III case cut-off any security interest; that post-petition transfer of SUT revenues to non-Commonwealth entities violates the automatic stay, etc.

Obviously, the complaint takes the shotgun approach: If I don’t hit you with one barrel I’ll get you with the other, but there a few surprises. For example, the Fifth and Sixth Causes of Action states that if the Court determines that any interest of COFINA in SUT revenues is not a security interest or it was unperfected, it may be voidable pursuant to 11 U.S.C. § 544, § 547 or § 548. This would mean that depending on the section of the Bankruptcy Code that the UCC invokes, it could collect COFINA payments from bondholders as far back as two years or as early as 90 days before the filing of the petition. I imagine Mr. Kirpalani burst a vein when he read that.

In addition, the UCC claims in cause of action Twelve and Thirteenth that COFINA is unconstitutional pursuant to the Puerto Rico Constitution, which is a more likely case. Interestingly, the UCC states at page 33, paragraph 146:

“Puerto Rico’s constitution also prioritizes the payment of the Commonwealth’s public debt over all other debts and expenses in the event of a revenue shortfall (the “Constitutional Debt Priority”)”

At page 34, paragraph 147 it continues stating:

“There can be no dispute that, prior to the Commonwealth Petition Date, the SUT revenues dedicated to COFINA would, but for their dedication to COFINA, be “available revenues” of the Commonwealth (which would first be paid to the holders of lawfully issued Commonwealth public debt).52 Accordingly, the dedication of SUT revenues to COFINA reduced the revenues that would otherwise be available to the Commonwealth to pay its creditors.”

Does this mean that the Board, through its agent the UCC, recognizes that the money from COFINA belongs to the GO bondholders? Very much doubt it since the Board has said GO bondholders have no priority. Time will tell.

Welcome to the weekly Title III update for September 6, 2017. Let’s recap a few important things from the last week.

First, the Board finally filed its complaint against Ricardo Rosselló for the implementation of the furlough of public employees, as per the March 13 certification of the fiscal plan. The Board seeks that the Court declare:

“[T]hat the Commonwealth Fiscal Plan certified by the FOMB includes the Amendments;”

 “[T]hat the Amendments are mandatory and binding parts of the Commonwealth Fiscal Plan;”

“[T]hat the Governor must enforce and comply with the entire Commonwealth Fiscal Plan, including its Amendments;”

And that it issue “an injunction prohibiting the Governor from refusing to enforce or comply with the Commonwealth Fiscal Plan (including the Amendments) and otherwise treating the Amendments as not part of the Commonwealth Fiscal Plan.”

As I have said many times, I believe the Board is correct in its claim that the furloughs are part of the Fiscal Plan (see here at page 2). The Board’s motion, however, has an interesting tidbit that anticipates its position in all the litigation. On page 9 of its motion the Board states, “Regardless of the path by which the FOMB certifies a fiscal plan, Congress provided it sole and complete discretion regarding fiscal plan certification decisions. PROMESA § 201(c)(3). Congress also provided that such certifications are beyond challenge, depriving the federal courts of subject matter jurisdiction to hear any challenge to a certification decision by the FOMB. PROMESA § 106(e).” Since several challenges to the Board’s Fiscal Plan have been filed, here we see that the Board is unwavering in its position: The Fiscal Plan cannot be changed. Now, we will see if Judge Swain agrees.

Adding to the theatrical atmosphere of the case, the American Federation of State, County and Municipal Employees, who mere days before this complaint had asked the Court to determine that the Board could not order the furloughs, filed a motion to stay the Board’s complaint, to consolidate cases or to intervene. This will further delay the prosecution of the issue of furloughs.

Another interesting tidbit: The Board did not file a motion for an injunctive relief hearing. As I stated above, the Board is seeking an injunction from the Court but did not ask for a hearing on the issue. In the case of the Municipality of San Juan, for example, Judge Swain quickly sent a schedule following the August 25 request for a hearing, giving PR until September 1 to answer and setting a hearing on September 11. Since both President Carrión and Ms. Jaresko have said that if furloughs were not started on September 1, there would be a need to have them further extended and even increased from 10% to 20%, it can be argued that the Board, as the representative of the Commonwealth in the Title III filings, can take “any action necessary on behalf of the debtor to prosecute the case of the debtor” (Sec. 315(a) of PROMESA). Clearly, the Board feels no urgency to proceed with the case, meaning that it could take months for Judge Swain to decide the issue.

Is this controversy a Kabuki Theater? Time will tell.

Although the final order is yet to come, the parties in the Commonwealth v. COFINA controversy filed a schedule whereas the Unsecured Creditors Committee on behalf of the Commonwealth will file a complaint no later than September 8 and discovery will move quickly with a trial December 4-8. On October 27, there is a fact discovery deadline followed by the expert discovery deadline on November 3. All interventions will be discussed in the omnibus on November 15. Given the fact that in the Peaje hearing post evidentiary hearing documents were filed as late as 20 days after the hearing and given the complexity of these issues, I don’t expect a decision before January or February of 2018, with appeals still to come later in the year. Moreover, if Judge Swain finds in favor of the Commonwealth, then GO’s will be able to claim they are entitled to the SUT proceeds.

Finally, in a slew of media interviews, José Carrión gave during the week, he said that PREPA must be privatized quickly. On the other hand, Ramón Rosario, the Commonwealth’s Public Policy Secretary, said that the Government is looking for public-private partnerships and PREPA’s executive director said there would be no privatization of the agency.

Who is telling the truth, I wonder? Again, only time will tell.