Welcome to your weekly Title III update for August 20, 2018. Some important things came about inside and outside the case.

Previously, I discussed the UCC motion on the COFINA deal, which has not been answered by the Board as of Sunday, August 19. To that we must add that El Vocero reported on August 18 that due to demographic changes that seem to increase the number of inhabitants in the island, the Board requested that the Commonwealth amend its Fiscal Plan. El Vocero adds that there will be a greater need for medical services and hence less money for debt service. Given the Board’s alleged new deals of around 75% payment of bond debt, it behooves the mind that now these numbers may be reduced because the population will not decrease as much as expected. Constant changes in the Fiscal Plans do not make it credible and will undermine any plan of adjustment based on it. Seesaw on the Fiscal Plan helps no one.

The Board sent the Commonwealth a friendly reminder of the new perceived power schemes. Its letter says:

Pursuant to Section 204(b)(2), the Oversight Board established the rule, regulation, administrative order, and executive order review policy (the “Policy”) to require prior Oversight Board approval of certain rules, regulations, administrative orders, and executive orders proposed to be issued by the Governor (or the head of any department or agency) to assure that they “are not inconsistent with the approved fiscal plan.”

As relevant here, the Policy applies to any proposed rule, regulation, administrative order, or executive order in connection with (i) the establishment, governance, management, or operation of the Office of the CFO, and (ii) rightsizing of the Commonwealth or related to procurement, contracting policy, or employee compensation or benefits. The Policy states that any rule, regulation, administrative order, or executive order must be sent in English before issuance to the Oversight Board at [email protected] with an explanation of how the particular rule, regulation, administrative order, or executive order is consistent with the approved Fiscal Plan.

On August 13, 2018, the Department of Treasury submitted three letters in Spanish on Administrative Orders, without an explanation of how or whether the Administrative Orders were consistent with the applicable Fiscal Plan, that had been issued prior to the date of adoption of the Policy, and which the Oversight Board had not requested to review. Accordingly, no review or approval by the Oversight Board is required at this time. However, going forward, please abide by the Policy, including by submitting any rule, regulation, administrative order, or executive order in English, prior to adoption, and with an explanation of how it is consistent with the applicable Fiscal Plan.

Why the public reminder of what the governor must do? Simply because the governor said he was not going to comply with this “request.” This way, there can be no doubt the Board is bending over backwards to resolve any controversies with the governor in an “amicable” fashion while at the same time, publicly chastising him for not obeying. A very bad situation in my opinion.

The Board also sent the Commonwealth a letter requesting the submission “by the Department of Treasury of all the contracts, whether in the form of Tax Incentive Decrees or otherwise, that confer tax abatement or tax relief on a taxpayer, entered into since July 1, 2017 and henceforth.” As to each contract, the following information, inter alia, has to be provided:

Budget Questions:

a)Are the funds for the contract included in the budget? i) If yes, in which allotment? Please specify (A) the line item(s) in the budget that this contract will be funded from and (B) what other expenses have been committed or planned for that budget item.

b)Does the existing budget fully cover the cost of the contract? If multiple line items, please specify the amount against each budget line. i) If not covered in the budget, which allotments need to be reprogrammed?

c)If the contract extends past the current fiscal year, does the current budget line item include the full cost of the contract or only the portion applicable to the current budget time period? i) If only the portion applicable to the current budget, how much will be funded from the future budget? Are the budget line items the same and are there sufficient funds within those? Please provide supporting evidence.

Fiscal Plan Questions

a)Is the contract consistent with the applicable Fiscal Plan? Please provide some commentary on why or why not.

b)Does the contract constitute separate and additional disaster aid spending?

i)Will the contract be partially or fully federally funded?

1. ii) RFP information

(1) Name:

(2) Issue date:

(3) Due date:

(4) Award date:

(5) Applicable RFP rules and regulations:

(6) Amendments (Yes or No):

(7) Description of efforts undertaken to advertise the RFP

Although this is clearly important information for the Fiscal Plan and budget, tax policy, tax assessment and tax abatement is one of the most important powers any government can wield. Although the information will probably be provided, what if the Board disallows any of these contracts? Will Governor Rosselló again mount Rosinante and attack the windmills of the Board? Questions, questions.

Also, at the end of the attachment to the letter, the Board requests a certification stating the following for each contract:

1.[Name of Agency], its officials and employees have complied with all applicable conflicts of interest laws, rules, regulations and policies in connection with the procurement and negotiation of the contract2.

2.To the best knowledge of the signatory (after due investigation), no person has unduly intervened in the procurement, negotiation or execution of the contract, in contravention of applicable law.

3.To the best knowledge of the signatory (after due investigation), no person has: (i) offered, paid, or promised to pay money to; (ii) offered, given, or promised to give anything of value to; or (iii)otherwise influenced any public official or employee with the purpose of securing any advantages, privileges or favors for the benefit of such person in connection with the contract.

4.To the best knowledge of the signatory (after due investigation), neither the contractor, nor any of its owners3, directors, officials or employees, or its representatives or sub-contractors, has required, directly or indirectly, from third persons to take any action with the purpose of influencing any public official or employee in connection with the procurement, negotiation or execution of the contract.

The above certification shall be signed by the head or general counsel of the agency submitting the contract for review.

In the event that the agency is not able to provide any of the above certifications, it shall provide a written statement setting forth the reasons therefor.

This smacks of the Board investigating whether these contracts are nothing more than favors to political contributors or obtained through fraudulent means. Again, this is a very reasonable request but will the governor comply? We will soon find out.

The GDB filed its “Solicitation Statement” for the Title VI it is attempting. The 300 plus document has this interesting tidbit:

In addition, the New Bonds are complex financial instruments with unique characteristics that are unlike many similarly named instruments. Because of the unique nature of the New Bonds, substantial uncertainty and risk exist with respect to the New Bonds that may not exist with respect to other debt instruments. For example, the Issuer is a newly formed statutory public trust and governmental instrumentality with no existing operations, and the New Bonds will be secured by, and payable solely from, Collections on certain assets of GDB that will be transferred by GDB to the Issuer on or after the Closing Date. Holders of New Bonds should not expect to receive payment in full in cash of principal and interest due on the New Bonds. While there are scenarios that may result in full payment of principal and interest on the New Bonds in accordance with their terms, there is considerable uncertainty as to whether the Restructuring Property will provide sufficient cash flow to pay interest in cash on the New Bonds and amortize the principal amount (and any PIK Amounts) thereof completely. In addition, if the Qualifying Modification is consummated and the Participating Bond Claims are mandatorily exchanged for the New Bonds, rights and remedies under the New Bonds will be dramatically different, and may be less favorable to holders of the New Bonds, than the rights and remedies holders of Participating Bond Claims currently have. For additional information on the New Bonds, see the Offering Memorandum attached hereto. At the same time, there is substantial uncertainty regarding the value of the Participating Bond Claims if the Requisite Approvals are not obtained or the Qualifying Modification is otherwise not consummated. GDB is insolvent and has operationally wound-down and substantially terminated its operations, other than the completion of the Qualifying Modification and the management of certain assets thereafter; the outcome of its liquidation or other resolution is highly uncertain. A holder of Participating Bond Claims could realize more or less value on its Participating Bond Claims in such a liquidation or resolution than in the Qualifying Modification.

In other words, if you vote for the Title VI qualifying modification, you may not be paid but if you don’t vote, we may go into Title III. Since the only asset that the GDB has is loans to public corporations and municipalities, the minute these stop paying, the GDB will not pay its bonds and there will be no recourse since that is the only source of payment. I have always said that this Title VI, if approved, would end in Title III. Might as well do it now with full value of your bonds than later when you have a 45% haircut.

On the litigation side, Judge Swain sided, once again, with the Board and decided that certain ERS bonds did not have a lien because the liens were not properly recorded. Although the Judge may very well be right, this case will be appealed and Judge Swain is 0-3 on appeals at this time.

In Assured v. Board, defendants had requested a stay of proceedings while the Ambac appeal (where Congressman Duffy filed his brie of Amicus Curiae) is decided. Judge Swain, unsurprisingly sided with the Board saying:

The issues on appeal in Ambac are sufficiently related to the issues presented by Plaintiffs’ complaint to warrant a limited stay of these proceedings. Through their complaint in this proceeding, Plaintiffs claim that the April 19, 2018 Fiscal Plan for Puerto Rico violates PROMESA §§ 201(b)(1)(B), 201(b)(1)(M), 201(b)(1)(N), and 407 and § 928 of the Bankruptcy Code; that the Fiscal Plan Compliance Law (Act No. 26‐2017) violates PROMESA §§ 201(b)(1)(N), 201(b)(1)(M), and 201(b)(1)(B); and that the April 19, 2018 Fiscal Plan does not meet the definitions prescribed by PROMESA §§ 5(10) and 5(22). Plaintiffs contend that they are entitled to an order declaring that no plan of adjustment under PROMESA Title III can be confirmed based on the April 19, 2018 Fiscal Plan; that no confirmation hearing will be held on that plan; that a series of moratorium laws enacted by the Commonwealth and corresponding moratorium orders (“Moratorium Laws” and “Moratorium Orders”), the April 19, 2018 Fiscal Plan, and the Fiscal Plan Compliance Law violate the Contracts Clause, Takings Clause, and Due Process Clauses of the U.S. Constitution; that the Moratorium Laws, Moratorium Orders, Fiscal Plan Compliance Law, and the April 19, 2018 Fiscal Plan are preempted by PROMESA §§ 303(1)(3); and that if this Court determines that PROMESA bars review of the April 19, 2018 Fiscal Plan, Plaintiffs are entitled to a ruling that PROMESA violates the Due Process Clause of the United States Constitution and is an unconstitutional delegation of legislative power. See Dkt. No. 1.

In Ambac, Ambac Asssurance Corporation also questioned the legality of the Moratorium Laws, Moratorium Orders, the Fiscal Plan Compliance Law, and an earlier version of the Fiscal Plan for Puerto Rico. See Amended Adversary Complaint (Dkt. No. 35 in 17‐AP‐159). On appeal, Ambac Assurance Corporation presents eleven issues for the First Circuit to consider including, inter alia; whether the District Court erred in holding that the Moratorium Laws, Moratorium Orders, and the earlier Fiscal Plan do not qualify as laws preempted by PROMESA § 303(1); whether the District Court erred in interpreting the Contracts Clause and Takings Clause of the United States Constitution; whether the District Court erred in issuing an opinion on PROMESA § 106(e); and whether the District Court erred in interpreting PROMESA § 106(e) to preclude judicial review of the Fiscal Plan for compliance with the requirements of PROMESA § 201(b).

While this Court appreciates the distinctions and clear differences between Plaintiffs’ complaint here, and the claims brought in Ambac, many of the questions presented on appeal in Ambac either directly overlap with or significantly bear on the determinations this Court will have to make in deciding any dispositive briefing in this proceeding.

If there are “distinctions and clear differences between Plaintiffs’ complaint here, and the claims brought in Ambac” why grant the motion? For Judge Swain clearly states that is not the norm, especially when there are issues that will have to be decided in this case irrespective of what the First Circuit decides. My opinion, however, is of no importance. Judge Swain’s opinion is what counts.

On the Utier challenge to the Board’s appointment, essentially the same argument that Aurelius made, unsurprisingly Judge Swain dismissed the complaint. The next day, Utier filed their notice of appeal. I am sure the union’s counsel will hustle to see if it can join the Aurelius oral argument presently set for September 10, 2018. Irrespective, that is going to be an epic argument. Wish I were there.

In the Pinto Lugo v. USA, a hodgepodge of legal claims, the USA filed a motion to dismiss challenging standing and the actual causes of action, saying among other things that “[t]here Is No Private Right of Action under the Declaration of Independence.” I expect this complaint to be dismissed as it is another attempt by those who refuse to understand or accept Congressional power over Puerto Rico.

As expected the Legislature filed a notice of appeal from the dismissal of their complaint. Once this was done, Governor Rosselló, who is at odds with Senate President Thomas Rivera Schatz, vowed he would also appeal. As of August 19, 2018, he had not, nor requested leave to do so.

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 Commonwealth Agent in the Commonwealth v. COFINA adversary proceeding – the Unsecured Creditors Committee (UCC) –filed an informative motion on Monday on the Oversight Board’s agreement with COFINA bondholders and monolines.

The motion states that the UCC-COFINA Agent deal was done with the May 2018 certified Fiscal Plan, meaning that the deal was feasible based on the numbers projected in that plan. On June 29, 2018, a new Fiscal Plan was certified with entirely different numbers and economic calculations. Instead of using those new numbers, the Board used the May 2018 to reach the COFINA deal.

The UCC claims a $28 billion cash flow deficit as a result of the deal.

Furthermore, the UCC claims in footnote 4 of their motion the following:

The Commonwealth Agent was not included in the negotiations between the Oversight Board, the COFINA bondholders, and monoline insurers regarding the terms of a COFINA plan of adjustment. In fact, the Commonwealth Agent only received a copy of the COFINA Plan Presentation when it was made public.

Right there, you know something is wrong.

The UCC negotiated the first agreement in principle but wasn’t included in the most recent COFINA deal orchestrated by the Board. Although the Board is obviously the one who deals with the Plan of Adjustment – where the payment of the debt is outlined – not having the Commonwealth Agent involved raises suspicions and with good reason.

Revisiting Conflicts of Interest

Moreover, if it is such a good deal for COFINA, it raises the significant, but dormant issue of potential conflicts of interest of the Board members.

To recap the potential conflicts of interest for new readers of the Control Board Watch, here they are. First, José Carrión’s relationship with Banco Popular, which had significant involvement with COFINA. Second, Carlos M. García, a former Santander executive and GDB President who issued a huge chunk of COFINA debt under former Governor Fortuño. Third, Ana Matosantos’s company, Matosantos Commercial Corporation, has a Banco Popular executive on its Board of Directors. And finally, José Ramón González, another Santander executive deeply involved with COFINA.

Is there a conflict of interest?

The motion continues stating:

The Oversight Board’s June 29, 2018 certified fiscal plan materially revised certain of the underlying assumptions that formed the basis of the May 30, 2018 certified fiscal plan, which was in effect when the Agents entered into the Agreement in Principle on June 5, 2018 and on which the Commonwealth Agent relied when entering into the Agreement in Principle.

In stark contrast to the cash flow projections in the May 30, 2018 certified fiscal plan, the revised assumptions in the June 29, 2018 certified fiscal plan result in a significant cash flow deficit (when including the COFINA debt service payments under the contemplated settlement) in the aggregate amount of approximately $28 billion (in nominal dollars), even assuming that the fiscal plan contemplated making no plan distributions to Commonwealth creditors. Obviously, assuming that there would be no payments to any Commonwealth creditors is unrealistic and would lead to an unconfirmable plan of adjustment for the Commonwealth.

Given that the Commonwealth Agent must consider the interests of the Commonwealth itself, the Commonwealth Agent does not believe that a settlement can be executed and/or consummated which would lead to a significant cash flow deficit (and thus the Commonwealth’s inability to pay current expenses) of approximately $28 billion (in nominal dollars). The Commonwealth Agent believes that this Commonwealth feasibility issue needs to be resolved prior to execution and/or consummation of a settlement agreement. It also does not appear that this issue was addressed in the COFINA Plan Presentation.

The UCC is warning that Puerto Rico cannot pay the COFINA deal with the currently certified Fiscal Plan. Of course, the Board has not answered this motion and may not do so since it is an informative motion, but it probably will.

In addition, the Board  may amend the current Fiscal Plan to conform it to this and future deals. As a matter of fact, the Board has already stated they may do so. If the Board does amend the Fiscal Plan, and does so in a manner that allows the COFINA deal to comply, is the Board greenlighting a sweetheart deal for COFINA for the benefit of certain interests, and possibly the conflicted Puerto Rican Board members?  Let’s see.

Nevertheless, the UCC’s warning is dire. The UCC is not only the Commonwealth agent in the aforementioned litigation but is also the official committee representing all non-secured creditors, who want to be paid. It cannot abide by a deal that will give all monies to one or more secured creditors and leave none for the non-secured creditors. To this effect, the motion also states:

Furthermore, under paragraph 4(i) of the Stipulation, any settlement requires the consent of at least one of the two Commonwealth Creditor Representatives. At the time of execution of the Agreement in Principle, only the Official Committee of Retirees (the “Retiree Committee”), which is one of the Commonwealth Creditor Representatives, had advised the Commonwealth Agent that it supported the Agreement in Principle. In connection with the negotiation of settlement documentation, the Retiree Committee has advised the Commonwealth Agent that it also views the resolution of the Commonwealth feasibility issue as a pre-condition to execution and/or consummation of a settlement agreement.

The Commonwealth Agent remains dedicated to attempt to resolve this issue to allow for a settlement to proceed, although it recognizes that the formulation and certification of a revised fiscal plan is completely outside of its control. Nevertheless, the Commonwealth Agent will proceed with its discussions of this issue with parties in interest and continue its collaborative process with the COFINA Agent in order to reach agreement on a settlement agreement that conditions consummation thereof on the Oversight Board having certified a fiscal plan that projects Commonwealth net cash flows (after measures) over the next 40 years in an amount not materially less than the net cash flows (after measures) projected in the May 30, 2018 certified fiscal plan.

The Commonwealth agent is saying that for the deal to go through, the Board and COFINA bondholders need either the UCC’s support or that of the Retirees’ Committee (who are owed over $52 billion and are non-secured creditors). Although the Retiree’s Committee is closer to supporting the deal, the UCC makes it clear that they still don’t have their support. Could it be that one of the two important deals the Board has achieved is slipping away?

Options for the GO’s

This development brings us to the another question, what will the GO’s do? Undoubtedly, the GO’s will want a good deal, better than that of COFINA. Question is, will the Board provide one? If the GO’s cannot get a deal, what can they do? There are many avenues. The Commonwealth v. COFINA litigation is stayed until September 13. With the UCC’s motion, it is obvious the deal is in peril. The GO’s were allowed to intervene in the Commonwealth v. COFINA litigation and filed dispositive motions expounding their views on the validity of these bonds. The GO’s may request that the Court decide on their arguments. If denied, they can file an adversary proceeding. Moreover, the GO’s may object to any COFINA Plan of Adjustment and we must remember that Judge Swain has said that at that stage she will be able to review the Fiscal Plan since the Plan of Adjustment must conform to the Fiscal Plan. If she decides that the UCC is right or that COFINA is not constitutional, she may deny the confirmation of the Plan of Adjustment. In addition, even if the GO’s are not allowed to object to the COFINA Plan of Adjustment, as part of the stipulation, the COFINA settlement must be approved in the Commonwealth Title III case, where undoubtedly the GO’s will have a say.

The UCC’s motion has thrown a monkey wrench into the COFINA deal, one which unless carefully explained by the Board could well derail it. Much more is to come. Stay tuned.

Welcome to your weekly Title III update for August 13, 2018. Many important things came about this week, but I discussed Judge Swain’s decision on the Commonwealth and Legislature’s complaints and the Commonwealth-COFINA deal in separate postings. The First Circuit, however, reversed Judge Swain in two cases and developments in and outside the Title III have developed.

In the first of the Circuit opinions, the Court (Judge Kayatta writing the opinion) decided that Peaje did not have a statutory lien—however, that did not end the discussion. The First Circuit affirmed Judge Swain’s determination not to allow evidence of any other type of lien in the adversary proceeding but hinted that if raised in another case, it could be litigated. In addition, Judge Kayatta reversed her findings, “that Peaje failed to establish irreparable harm and that defendants established adequate protection of Peaje’s interests.” Since the Court had already decided the main issue of the case, it did not have to analyze this topic. Nevertheless, anticipating further litigation, it reversed the “brief treatment” of these essential issues. I project either further litigation or a prompt settlement of these bonds by the Board.

In the second case where the Ad Hoc Group of PREPA bondholders requested the lifting of the stay to permit them to request from another court the appointment of a receiver, the First Circuit (Judge Kayatta also being the author) went one by one over Judge Swain’s reasons to deny the petition and reversed her on all of them. Of note is the following:

The Title III court did try to deflect these problems by stating that its refusal to lift the stay arose in the context of a request for a receiver, certainly a robust form of interference with the debtor’s finances and property. The implication – which the debtor’s brief makes express — is that perhaps the Title III court would lift the stay to allow another court to provide some other type of protection of collateral. But neither the Title III court nor the debtor points to any toehold in the language of Section 305 that would accommodate a distinction allowing the Title III court to lift the stay to allow another court to interfere with the debtor’s property sometimes but not others. Either Section 305 only bars the Title III court itself from interfering, or it bars that court also from lifting the stay to allow another court to do that which it cannot do. And it is only the latter, broader possibility that creates a situation in which the creditor is deprived of any means of protecting its property interest.

The Title III court also pointed out that Section 305 would not bar section 362(d) relief when the Oversight Board consents to the requested relief. But the principal aim of section 362(d)(1) is to protect the creditor when protection is needed, which is customarily when the debtor is not obliging. In short, saying that a creditor can get relief from the stay when the debtor’s representative consents effectively wipes out section 362(d)(1) precisely when it is most likely needed.

We also find no inconsistency between the apparent purpose served by Section 305 and a reading of that section as only barring the Title III court itself from directly interfering with the debtor’s powers or property. Like the Title III court, we read Section 305 as respectful and protective of the status of the Commonwealth and its instrumentalities as governments, much like section 904 of the municipal bankruptcy code respects and protects the autonomy of states and their political subdivisions. See 11 U.S.C. § 904. When a bankruptcy or Title III court acts directly, it impinges on that autonomy. But when it merely stands aside by lifting the automatic stay, it allows the processes of state or territorial law to operate in normal course as if there were no bankruptcy.

In addition, Judge Kayatta stated:

For these reasons, we hold that Section 305 does not prohibit as a matter of course the Title III court from lifting the stay when the facts establish a creditor’s entitlement to the appointment of a receiver in a different court in order to protect a creditor’s collateral should that protection otherwise be necessary and appropriate. Although we share the Title III court’s concerns about the deleterious impact that a robust receivership outside the Title III court’s control might have on the efforts of the Title III court to consolidate and adjust the debtor’s affairs, those concerns are best addressed in deciding whether, precisely to what extent, and for what purpose relief from the automatic stay might be granted. In other words, it might be possible to grant tailored relief for the creditor to seek a receivership provided that the receiver only take specific steps necessary to protect the creditor’s collateral. Further, concerns about moving the locus of the debtor’s protections outside the Title III court are greatly ameliorated by the fact that the Oversight Board itself can always, through consent, opt for a regime held more tightly within the federal forum’s direct control. (emphasis supplied)

To me, it is obvious the First Circuit is inviting Judge Swain to allow the receiver but to tailor what it can or cannot do. In their briefs and during oral argument, plaintiffs emphasized that this receiver would substitute the PREPA governing board and would not only be subject to the Board’s Fiscal Plan, but also to its budget and its general powers. Moreover, the last sentence above from Judge Kayatta hints that the Board could consent to a receiver with specific duties and responsibilities. After I heard the oral arguments in this case, I wrote that the First Circuit was likely to reverse Judge Swain. This may have been a catalyst for the Board’s agreement with PREPA bondholders. Food for thought.

José Ortiz, the new executive director of PREPA gave an interesting interview to Caribbean Business . Caribbean Business reports Ortiz admitted that the “Ad Hoc deal comprises $5 billion in unsecured debt. “And we negotiated with 35 percent of them [the creditors], or about $2.7 billion. The rest we are going to have to pay…that has not been said publicly,” he told Caribbean Business.’” Since the Board has admitted that this group does have a lien, I assume that Mr. Ortiz meant the insured bonds, which I pointed out before would probably get a better deal. Here, he is saying they will get paid in full and the only way this can be achieved is with an increase of the rates. WOW! So much for the Board’s insistence on a 20 cent per K/H rate!

Finally, on Friday, the Board sent a letter to Puerto Rico’s Secretary of Corrections, informing him that the Comprehensive Management Agreement with Correctional Health Services Corporation was in excess of $10 million, was not sent to the Board before signing, and hence was invalidated. Also, the letter states:

 Please be advised that the new contract, scheduled to commence October 1, 2018 with Physician HMO, Inc., must be submitted to the FOMB prior to execution and with sufficient time to review (e.g., two weeks minimum). It should be noted that given that the contract extension is expected to generate $840,000 in savings, it is the expectation of the FOMB that DCR must generate a further $4,159,731 of healthcare related savings through both procurement and personnel measures.

In addition, the submission from DCR, must answer the following questions:

1. Are “difficult recruitment employees” (as such term used in the original documentation) covered under the new agreement?

2. The Fiscal Plan requires that $3,309,151 savings be generated by the procurement of healthcare for inmates and a further $1,690,579 in personnel savings related to inmate healthcare for FY19. Please outline how you will achieve these savings – inclusive of the extension and new contract and other related contracts

3. The savings for FY20 increase to $13,236,605 for procurement of healthcare services for inmates and $6,762,317 for personnel related to these healthcare services. Can you please provide the pathway to deliver these savings?

Right after the Board announced it was not going to appeal Judge Swain’s decision on Zamot but announced it would require new Fiscal Plans, I said the Board wanted to rule from the Fiscal Plan. After Judge Swain’s decision on the Commonwealth and Legislature’s challenges, that is exactly what it is doing. I frequently criticize the Board for its actions but it is trying to put some limits to political spending in Puerto Rico. Politicians continue to believe that they can spend without limit, without understanding that at some point in the near future, debt service will recommence. Then what?

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.

On August 8, 2018, the Commonwealth and COFINA Agents announced a new, more lucrative deal on COFINA.

In fact, this is a coup for the COFINA bondholders: the aggregate recovery is almost 75%, and a 93% for COFINA Seniors.

This is a stunning turn of events. COFINA faced months of heavy attacks both from the GOs questioning their constitutionality, and from the Governor, who wanted access to the lockbox monies.  Moreover, in April 2017, COFINA holders were offered a 39.2% recovery.

Deal Details

Essentially, 53.65% of the “Pledged Sales Tax Base Amount (“PSTBA”) cash flow through and including 2058 (40 years) is fully allocated to the New COFINA Bonds.” The Commonwealth will keep the remaining 46.35% of this PSTBA, plus any excess of up to 5.50% of the SUT, which the Board calculates will increase in value. Hence, the new bonds will be secured (senior pledge) but by a decreased part of the SUT. The Board still believes it is a large amount of money. Also, from the terms of the agreement, it seems the monolines are on board with the deal.

Interest rate as to CIB’s is Total/Avg $9,249,560,000.00 @ 4.543%, but which works out as follows (page 5):

2028 995,875,000.00    4.350%

2032 1,206,510,000.00 4.500%

2038 3,212,925,000.00 4.550%

2043 3,834,250,000.00 4.600%

Interest rate as to CAB’s is Total/Avg $2,697,682,642.20 $15,401,229,579.75 5.500%

2058 2,697,682,642.20 15,401,229,579.75 5.500%

The breakdown of the recovery is as follows (page 8):

Aggregate Par + BNYM Recovery (in %)

COFINA Sr. Recovery 93.000% COFINA

Sub. Recovery 56.399% RSA Acceptance Charge 2.000% Aggregate Recovery 74.505%

Looming Questions

This tentative agreement, however, leaves a lot of questions unanswered.

Is the deal a result of pressure from Congress?

Is the deal a realization that the Board and Governor lack credibility in Washington?

A big question will be what the GOs do, if anything? Can the Commonwealth afford such a sweetheart deal after 2 years of non-stop claims by the Board and Governor that Puerto Rico is broke, and unable to pay her debts?  We should assume the confirmation of the COFINA Plan of Adjustment will be challenged in the Commonwealth Title III confirmation hearing. Although I am sure Judge Swain will sweep aside any objections, the First Circuit may not.

The Commonwealth may believe it is entitled to a bigger part of the 5.5% of the pledged SUT. Will it insist on more? What will Judge Swain do?

Moreover, the GO’s were allowed to intervene in the Commonwealth v. COFINA litigation and to file a motion for summary judgment. What if they insist on having a determination on their claims? Seems easier to come up with a deal for them than to continue litigating.

Does the deal have the requisite 2/3 amount majority and 50 +1 number of creditors required by the Plan of Adjustment or are the parties still working on it?

Now that we have almost 75% recovery for COFINA and 77.5% recovery for PREPA, is this the new bench mark? It is true that the GDB agreement has only 55% recovery, but its law states that the Commonwealth is not liable for its debts and has no assets except loans. It is only reasonable to wonder if other bondholders will receive the same deal. If so, the Title III may be resolved quickly and cheaply, and we may have wasted hundreds of millions of dollars and precious time that the Board and Governor cannot bring back. Let’s see what happens.

Well, here we go again. Another day, another PREPA RSA.  We’ve had almost a week to digest the RSA and listen to the myriad of press conferences on whether this will or won’t lead to higher electricity prices.

But here is the most important question we should be asking: Will this time be any different than the previous RSAs?

In the almost 2 years since the Oversight Board came into existence and Governor Rosselló walked backed his campaign pledge to do deals, one thing has become patently obvious: the credibility of these parties is as bankrupt as Puerto Rico.

The Oversight Board and Governor Rosselló need to show progress and to regain credibility. They are also worried about federalization.

To start, the agreement is not much different from the RSA previously rejected by the Board in June of 2017. Nothing in this RSA accomplishes the Board’s original vision when they decided to rebuke the will of Congress, and take PREPA to Title III.  This included wiping out PREPA’s lien and erasing the entirety of the contractual debt of PREPA, raising the specter of a Takings Clause claim. With this RSA, none of that gets accomplished and there is no Taking Clause claim.

Whose In, Whose Out

The bondholders that own or control at least 2/3 of the dollar amount of the outstanding non-insured bonds, section 10.02(a)(vi). Hence, the agreement is not with the insurance companies or the fuel line banks. Like the previous RSA’s, its members cannot transfer (sell) their bonds to any other entity than those involved in it, section 5. The agreement, at Section 8, states:

Without limitation to the provisions of the Term Sheet, the reasonable fees and reasonable expenses of the members of the Ad Hoc Group incurred in connection with the RSA, the Definitive Restructuring Support Agreement, and any documents and transactions (including a plan of adjustment) relating to or implementing the foregoing on or after July 23, 2018, limited to one (1) primary law firm, one (1) municipal bond counsel law firm, one (1) Puerto Rico law firm, one (1) financial advisor, and one (1) utility consultant, shall be reimbursed by PREPA on a monthly basis within forty-five (45) days following submission of an invoice and redacted time detail summary to counsel to the FOMB, PREPA and AAFAF.

Section 10 notes that the agreement may be terminated by mutual consent, or by a breach of the agreement. The only remedy for a breach is the termination of the agreement as listed in section 11.13. In addition, section 10.02(b) says the agreement ends on August 27, 2018, at 5 pm, New York City time, but can be renewed through another agreement. Moreover, New York state law on contracts applies and jurisdiction for any disputes is the Title III court, section 11.03, and the parties obligations are several, not joint and several, as stated in section 11.14.

Economic Terms (i.e. – Electricity Prices)

Where things get interesting is in the economic terms of the agreement, which start at page 33 of the PDF file. It states, inter alia:

 The members of the Ad Hoc Group and any other holders of PREPA Bonds subject to the RSA (the “Supporting Holders”) shall commit to exchange all of their uninsured bonds for Securitization Bonds (as defined below) on the terms and in the manner set forth below.

 The Puerto Rico Electric Power Authority Revitalization Corporation or a new bankruptcy-remote special purpose vehicle as may be agreed upon shall issue Tranche A and Tranche B Securitization Bonds, secured by the Transition Charge.

This is the same system of the rejected RSA. The economic agreement also states as to the bonds:

 The Transition Charge allocable to the outstanding power revenue and revenue refunding bonds issued by PREPA under the 1974 Trust Agreement shall be set at the following levels:

– 2.636 c/kWh for Years 1-5

– 2.729 c/kWh for Years 6-10

– 2.868 c/kWh in Year 11

– Starting year 12, annual 2.500% increases over the prior year’s Transition Charge

 The Transition Charge allocable to the outstanding power revenue and revenue refunding bonds issued by PREPA under the 1974 Trust Agreement shall be capped at 4.348 c/kWh

Similar to the previous RSA, there will be an additional charge for consumers but Governor Rosselló and José Ortiz have claimed, and then backed off, that there will be no increase because the switch to gas will lower rates by 6 cents by kWh. This is difficult to believe for the switch to gas will take time. Moreover, if the agreement is approved as part of the plan of adjustment, it would only start next year. The exchange rate will be as follows:

 67.5% of PREPA Bonds to Tranche A Bonds

 10.0% of PREPA Bonds to Tranche B Bonds

 Tranche A Bonds will extend beyond the stated maturity if not paid in full on the stated maturity, until paid in full, including unpaid interest.

 Unpaid interest on the Tranche A Bonds will accrete.

 PIK interest to accrue annually starting in Year 1.

 Tranche B Bonds shall receive 100% of total excess cash flow after repayment of the Tranche A Bonds. Potential recovery on the Tranche B Bonds shall be capped at the exchange amount, plus PIK interest.

 Tranche B Bonds will mature at stated 45 year maturity, and all unpaid debt service will expire unpaid.

 Tranche A Bonds: 40 year stated maturity, subject to early mandatory redemption from sweep of Transition Charge cash flow (35 year expected maturity under Oversight Board’s May 2018 projections, which may change)

 Tranche B Bonds: 45 year stated maturity

 Tranche A Bonds: 5.25% cash interest

 Tranche B Bonds: 7.00% PIK interest / 8.75% PIK interest to the extent the Tranche B Bonds are not tax-exempt (solely for portion that is not tax-exempt)

According to sources I consulted, this deal gives bondholders a 22.5% discount (67.5 + 10), which is 2.25% more than the rejected RSA from last June. It also extends the life of the bond for many years, with Tranche A being further extended if one year’s payment cannot be made in full. Also, the interest rate for Tranche A is competitive with a securitized instrument. Not bad. In addition, the agreement states:

 No default on either Tranche A or Tranche B Bonds for failure to pay scheduled debt service, so long as full amount collected under the Transition Charge (minus administrative fees) is used to pay debt service. Interest shall continue to accrue (and pay-in-kind, as applicable) and accrete at the original Coupon rate.

 The Transition Charge shall extend, and interest shall continue to accrue (and pay-in-kind, as applicable) at the original Coupon rate, until the later of (1) the date necessary to pay the Tranche A Bonds in full, even if past their stated maturity, and (2) the earlier of (i) the stated maturity of the Tranche B Bonds, and (ii) the date on which the Tranche B Bonds are paid in full.

 Remedies will be mutually agreed upon and will include, at a minimum, the right to replace the Transition Charge servicer and the right to enforce the Securitization Bonds’ trust agreement, the servicing agreement, and non-impairment covenants. Requirements for replacement servicer to be mutually agreed upon as part of Definitive Documentation.

Again, not a bad deal for bondholders. Finally, there is a mention of other creditors:

The Ad Hoc Group shall not object if other legacy debt holders (including fuel line lenders) receive the same treatment with the same terms as the Ad Hoc Group is receiving, so long as such treatment does not adversely affect the Ad Hoc Group’s recoveries. Adjustments to coupons and par are authorized, so long as total cash flow payable each year remains the same (with proportional adjustments for the varying claim sizes of varying legacy debt claims), and so long as such treatment shall not adversely affect the Ad Hoc Group’s recoveries.

In other words, the deal for the insured bondholders may be better as long as the amounts to be received by the non-insured’s does not change. That also applies to the fuel line lenders who are owed around $700 million. Hence, the haircut per bond may decrease further, taking it closer to the 20% of the rejected RSA. In addition, the monolines could get other valuable considerations, as Syncora did in the Detroit bankruptcy (i.e., a parking lot concession worth millions). On July 31, Assured Guarantee rejected the agreement, insisting in the previous RSA they claim is grandfathered. Don’t doubt they will insist on getting a better deal than the non-insured.

Reality Setting In

This deal begs the question, what happened?

Up until recently, the Board and the government were claiming that PREPA bondholders only had a net lien, meaning that the utility’s expenses were paid first. If there was anything left over, only then were the bonds paid–hence they had no collateral. Now, it is given new collateral and will increase the rate consumers pay for electricity. What changed? I think the Board and the government are worried about Congress taking over PREPA in one way or another and want to show that they can get the job done in a way that is very similar to the previous RSA, which Chairman Bishop insisted should not have been rejected. With the COFINA deal pending, this would show that the Board and governor are serious about doing deals.

One of the many unanswered questions is whether this deal will make it more difficult to privatize PREPA. I have mentioned before that I don’t think the politicians in the island want to sell it, not even the generation part, but the Board was insistent on it. We will see.

The PREPA unions and the PDP have already voiced opposition to the deal. Very likely they will sue to block it. The next few months are going to be very interesting indeed.