Monday Update – April 22, 2019

Welcome to your weekly Title III update for April 22, 2019. This has not only been a busy week but possibly a transcendent one.

As reported last week, the Board wants to conduct discovery as to the identity of the GO bondholders and has served several banks with subpoenas. Magistrate Judge Dein sided with the Board and ordered that the parties get together to protect the confidentiality of the information requested. This order makes one wonder if the Court is aware of how weak the Board’s argument for equitable tolling is? We will know more on Wednesday.  Continuing with discovery, the ERS bondholders, who are also requesting they be named section 926 Trustee, are fighting it out with the Board. Let’s see what happens.

The QTCB Noteholder Group objected Omnibus Conditional Objection of the Ad Hoc Group of General Obligation Bondholders to Claims Filed or Asserted by the Public Buildings Authority, Holders of Public Buildings Authority Bonds, and Holders of Certain Commonwealth General Obligation Bonds, claiming it is not ripe for adjudication since the Board and UCC objections have not been decided. Ambac, National and the UCC filed similar motions, including lack of subject matter jurisdiction. The Ad Hoc Group replied on Saturday April 20, 2019, insisting this is a justiciable issue. The controversy will probably be argued on Wednesday during the Omnibus or shortly thereafter.

On April 16, 2019, the UCC and the Board filed a joint motion for a stipulation where the former would be named a trustee pursuant to section 926 of the Bankruptcy Code. The motion also states:

Following the Oversight Board’s and the Special Committee’s disclosure of the preliminary list on April 5, 2019, the Parties have met and conferred extensively to discuss, among other things, the Debtors’ potential causes of actions against certain parties and the allocation of litigation responsibilities. As a result of the meet and confer process, the Parties have agreed to a framework to pursue the potential causes of action, as set forth in the Stipulation. As part of this agreement, but subject to entry of an order approving the Stipulation, the Committee has agreed to waive its right to file an Omnibus Motion with respect to claims or causes of action of the Commonwealth,5 except (i) to the extent provided in paragraph 18 of the Stipulation with respect to Additional Claims and (ii) with respect to claims or causes of action that are subject to tolling agreements or Court-ordered tolling stipulations other than Tolling Agreements with the Potential Defendants. Additional Claims are defined in paragraph 18 of the Stipulation as Commonwealth claims or causes of action, in addition to those to be asserted by the Oversight Board or the Special Claims Committee, related to or with respect to the offerings of the Commonwealth’s GO bonds, PBA bonds, and ERS bonds against the Financial Party Targets, including on theories of fraudulent transfer, fraud, breach of fiduciary duty, and/or deepening insolvency.

So far so good, until we turn to paragraph 18 of the stipulation;

During the meet and confer process with respect to the joint prosecution of claims and causes of action of the Commonwealth and the allocation of litigation responsibilities, the Committee requested that the Oversight Board pursue Commonwealth claims or causes of action (the “Additional Claims”), in addition to those to be asserted by the Oversight Board or the Special Claims Committee, related to or with respect to the offerings of the Commonwealth’s GO bonds, PBA bonds, and ERS bonds against the Financial Party Targets, including on theories of fraudulent transfer, fraud, breach of fiduciary duty, and/or deepening insolvency. The Special Claims Committee declined to assert the Additional Claims. Therefore, the Committee requested that, as part of this Stipulation, the Oversight Board consent to the Committee being appointed as sole trustee/plaintiff to commence adversary proceedings or lawsuits to pursue the Additional Claims, with the same meet and confer process, and the potential for Court intervention, as set forth in paragraph 13 above (i.e., that the Parties would meet and confer after commencement of the adversary proceeding, and, in the case of disagreement, the Oversight Board would have the ability to seek, by motion to this Court, upon notice and a hearing, to terminate the Committee’s appointment as sole trustee/plaintiff in such adversary proceeding upon a showing of good cause). The Special Claims Committee declined to consent to this request; however, the Parties agreed that, notwithstanding this Stipulation, the Committee may seek, by motion to the Court, to be appointed as trustee/plaintiff to pursue the Additional Claims … (Bold added)

This motion was opposed by certain ERS bondholders, claiming that the “there is a sharp conflict of interest between the UCC, on one hand, and the creditors and the ERS, on the other, due to the pending litigation between the Commonwealth and ERS’ secured creditors over the Commonwealth’s siphoning of ERS assets to the Commonwealth through the Post-Petition Legislation.”  National, also objected but went further:

 The Oversight Board, not the Committee, is the appropriate party to evaluate and bring debtor causes of action against non-Debtors. The Stipulation would permit the Committee to override the Oversight Board’s judgment with its own. Through the Section 926 Motion it filed this morning the Committee affirmatively seeks to supplant the FOMB’s judgment with its own. The Court should not allow this to occur.

 National has serious concerns over whether the Committee is the proper representative of the Commonwealth or any other Debtor in these causes of action. It is unclear what interests the Committee currently represents; i.e., whether the Committee members currently hold outstanding, unpaid prepetition claims against the Commonwealth, HTA or PREPA and, even if they do hold such claims, that the parochial interests of certain members are not otherwise represented.

Neither the Oversight Board nor the Committee is the appropriate party to evaluate and bring debtor causes of action on behalf of or against other Debtors (e.g., HTA and PREPA) because they are hopelessly conflicted by virtue of the fact that they sit on both sides of the action and/or do not have a vested interest in vigorously pursuing such causes of action because their recoveries are not at stake.

The Ad Hoc GO Bondholder Group, later joined by Oppenheimer Funds, also raised several technical objections, but also one of great importance:

These specific references to the UCC’s reservation of its rights to object or respond to any settlement agreed to by the Oversight Board or Special Claims Committee could arguably give rise to a negative implication that the rights of other parties in interest are not so preserved. Such a negative implication would plainly be inappropriate. The GO Group therefore respectfully requests that the Stipulation be modified to make clear that the objection rights of all parties in interest are reserved with respect to the settlement or compromise of all causes of action governed by the Stipulation.

Assured and Ambac also opposed the Board/UCC motion, stating, inter alia:

HTA and its creditors hold substantial causes of action against the Commonwealth and certain of its instrumentalities on account of the illegal diversion of excise taxes assigned to HTA and its creditors by Commonwealth law. Because FOMB and the UCC have both actively supported this diversion of revenues, and because FOMB and AAFAF have admitted that this diversion has rendered HTA insolvent and unable to pay its creditors (not merely bond claims), it would be manifestly inappropriate for the UCC, FOMB, or the Special Claims Committee to serve as plaintiffs or co-trustees with respect to such causes of action. These entities indisputably suffer from debilitating conflicts of interest that call into question how they could even pursue claims by HTA against the Commonwealth. As just one of many possible examples, the UCC—which indisputably is dominated by entities with putative claims against the Commonwealth—cannot be expected to take a position on the Commonwealth’s diversion of HTA revenues and whether such a diversion is avoidable.

The Lawful Constitutional Debt Coalition filed a short reservation of rights stating that it was supportive but:

Given the extremely shortened notice on which the Motion was filed, however, the LCDC has had only limited time to review the Stipulation, and has not yet had an opportunity to discuss its potential ramifications or application with the Movants. Accordingly, in an abundance of caution, the LCDC files this limited objection to ensure that nothing in the Stipulation (i) modifies in any way the application of Section 1123(b) of the United States Bankruptcy Code to any plan of adjustment or any Commonwealth Cause of Action, including the ability to create a litigation trust to continue to pursue or commence Commonwealth Causes of Action, or (ii) impairs creditors’ rights to object to the manner in which any Commonwealth Causes of Action are addressed under a plan of adjustment. To the extent that the Stipulation does so, the LCDC hereby objects to its entry.

On April 17, 2019, before 9:00 am, the UCC filed a motion for Order Authorizing Committee to Pursue Certain Causes of Action on Behalf of Commonwealth and Granting Related Relief. And it was a bomb, saying at pages 3-4:

The Special Claims Committee provided its preliminary list to the Committee as required. That preliminary list indicated that the Special Claims Committee would be pursuing a number of the Causes of Action. In the ensuing meet and confer, the Special Claims Committee, through its counsel, “doubled down” on this representation, stressing that causes of action relating to the bond issuances would also be brought against individuals. On April 12, 2019,4 counsel provided the final list required pursuant to the Procedural Order, which confirmed that a number of the Causes of Action would be pursued.

 The Special Claims Committee represented through its counsel that it would assert claims based on, among other theories, deepening insolvency against the various parties involved in Puerto Rico’s debt offerings. The Special Claims Committee’s counsel further stated that it would allow the Committee to join in litigation against these parties to pursue such claims against them. As the meet and confer period continued, however, counsel for the Special Claims Committee gradually reversed course. First, counsel advised the Committee that the Special Claims Committee would not, after all, bring claims against any individuals. Next, counsel revealed that [REDACTED SPACE]. Finally, the Special Claims Committee reneged on its offer to allow the Committee to bring such claims. Notwithstanding these setbacks, the Committee continued its discussions with the Oversight Board and its Special Claims Committee.

At page 5, footnote 6, the UCC states “[i]n particular, the Committee understands that (a) the Special Claims Committee will not pursue any claims against any individuals involved in the Puerto Rico’s bond issuances and (b)[REDACTED].” At page 6, the motion states:

In sum, the Oversight Board’s Special Claims Committee waited until approximately two weeks before the Causes of Action Deadline to advise the Committee that it intended to abandon certain valuable Causes of Action (some of which it had previously represented it would pursue) and then declined the Committee’s request to be appointed to pursue these Causes of Action. Faced with this abrupt and unexpected turn of events, the Movants had no choice but to file this Motion requesting authorization for the Committee to pursue the Causes of Action on the Commonwealth’s behalf.

In other words, the UCC was duped into believing all was going to be done the way it wanted but then the Board changed its mind. Considering that the Commonwealth’s actions must be filed on or before May 2 and that the Board has not made a good showing for an equitable tolling, this is major stuff. The UCC also requested and obtained leave to file an unredacted motion under seal.

On April 19, 2019, the Board opposed the UCC’s request for section 926 appointment. It started its argument by saying:

Notwithstanding the Committee’s failure to show that its Motion is in any party’s best interest, the Motion fails on a fundamental gating issue. PROMESA absolutely prohibits the Court from interfering with the property of the Commonwealth without the consent of the Oversight Board. This is “notwithstanding any power of the court” granted by elements of the Bankruptcy Code that are incorporated into PROMESA. Litigation claims held by the Commonwealth are property of the Commonwealth. The Commonwealth simply has not consented, and will not consent, to allow the Committee the right to pursue any claims except as provided in the Joint Stipulation. Thus, respectfully, this Court cannot permit the Committee to pursue any other claims.

This is a clear reference to section 305 of PROMESA, but the section has a caveat, subject to Title I and Title XX of PROMESA. In other words, the Board could consent to this if it wanted. This was Judge Swain’s view in the PREPA lift stay decision. Also, In re N.Y. City Off-Track Betting Corp., No. 09-17121(MG), 2011 Bankr. LEXIS 319, at *17 (Bankr. S.D.N.Y. Jan. 25, 2011) the Court determined that the “contention that section 904 prohibits a court from appointing a trustee without the consent of the debtor renders section 926 mere surplusage.” Section 305 of PROMESA comes from section 904 of the Bankruptcy Code. Also, Bankruptcy section 926 legislative history supports this view:

[B]ecause a municipality might, by reason of political pressure or desire for future good relations with a particular creditor or class of creditors, make payments to such creditors in the days preceding the petition to the detriment of all other creditors. No change in the elected officials of such a city would automatically occur upon filing of the petition, and it might be very awkward for those same officials to turn around and demand the return of payments following the filing of the petition. Hence, the need for a trustee for such purpose. (See, S. Rep. No. 95-989, at 68 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5795)

The Board also objects saying that no “draft complaint” or “bullet point summary” was provided of the causes of action. True, but neither did the Board do so in the stipulated motion for the UCC’s appointment, presumably for confidentiality purposes. Moreover, if requested, I am sure the UCC may file a long list of whom it wants to sue and for what. The Board’s motion continues stating:

In fact, as the Committee was advised in black and white, the SCC intend to pursue on behalf of the Oversight Board claims against dozens of parties including underwriters, bond counsel, disclosure counsel, tax counsel, swap counterparties, auditors, and remarketing agents for their respective roles in issuing bonds that are the subject to contentions of being null and void.11 Furthermore, these parties will be pursued under many legal theories including breach of fiduciary duty, aiding and abetting such breaches, professional malpractice/negligence, unjust enrichment and/or fraudulent transfer.12 Given the scope and magnitude of the claims and causes of action that the SCC has advised the Committee it will pursue, it is difficult to understand exactly what the Committee hopes to gain by bringing additional claims (which they have not defined) on theories that are purely speculative. Rather, the Committee appears to be hoping to pressure individuals to implicate other parties in the hope that some real claim or cause of action eventually will come to light.

 As best as the Objectors can discern, the Committee has long favored actual fraud and conspiracy-based claims, seeking recovery for deepening insolvency as a stand-alone cause of action against many of the same institutions that the SCC has already committed to pursue as well as certain unnamed individuals.13 Again, these same or similar theories were raised in the past by the Committee which, it should be noted, has done nothing to investigate the merits of its theories in the many months since they were first articulated.

 In the end, the Objectors do not believe the Committee’s theories are colorable or that their prosecution would be cost-effective or yield greater recoveries for the Commonwealth than the claims the Objectors already intend to pursue. . .

 Most recently, the Objectors gave the Committee a full download of the claims the SCC intends to bring, consenting to add the Committee as co-plaintiff and co-trustee. Despite the spirit of compromise that is reflected in the Joint Stipulation, ultimately, the Objectors could not conclude that the theories of liability espoused by the Committee were sound and the Objectors were not prepared to allow the Committee to expend estate resources on claims that it does not believe are likely to enhance recoveries for the Commonwealth. (Bold added)

Here we see the “justification” of the Board, to wit, its attorneys do not believe the causes of action championed by the UCC will not succeed or will bring little money to the pot. This certainly may be true but the UCC could be allowed to bring the causes of action subject to success and payment via section 316(a) of PROMESA, which specifically contemplates section 926 appointments and payments.

The Board’s motion continues criticizing the UCC’s claims, which had been previously dismissed as not being detailed. True, but if they are not detailed, you can’t complain they don’t comply with federal pleading rules. Finally, the motion states that “[n]owhere in the Motion does the Committee state that it believes the Commonwealth would have an ability to collect material amounts in damages from any of its contemplated targets, or that revenge is an appropriate motive for a bankruptcy trustee to expend estate resources in litigation.” Again, this could be handled by tying the UCC’s compensation to the recovery of funds. I have been hired by bankruptcy trustees in more than one occasion to recover moneys for the estate on a contingency fee basis. Something similar can be done, here. Moreover, since the UCC implies causes of action against banks, Board members could have a conflict of interest and as the ERS bondholders argue in other motions, a conflict of interest is a good reason for the appointment of a section 926 trustee.

AAFAF also filed an opposition, echoing the same arguments made by the Board. There is no reason AAFAF should be siding with the Board, in my view.

Aside from the Board and AAFAF, other parties filed oppositions on April 20, 2019. National filed technical objections and states:

The Committee has filed a sweeping and overbroad motion requesting relief that would give the Committee unfettered authority over claims and causes of action. The lack of transparency in the Motion leaves parties in interest without a full understating of the scope of the requested relief. It is difficult to fully evaluate the legal ramifications of the Motion because National simply does not have any visibility into what avoidance actions or other undefined “causes of actions” the Committee plans to pursue. National has no way to know how the Motion will affect its recoveries or legal rights. Indeed, granting the requested relief may have a significant impact on the Commonwealth’s ability to reach a global settlement with its creditors—presumably, the Oversight Board has or will exercise its judgment in determining that the Causes of Action should not be pursued, which is a decision that ultimately impacts settlements embodied in a proposed plan. Granting the relief requested in the Motion would permit the Committee to second guess that judgment and give the Committee undue leverage in plan negotiations with other creditors and the Oversight Board.

The Official Committee of Retired Employees of the Commonwealth of Puerto Rico filed a limited objection, exhorting the Court to grant the tolling motion by the Board and if not:

In the event the Court denies the Tolling Motion, the Trustee Motion should be granted but only with the addition of certain procedural safeguards. Specifically, the UCC should be allowed to file solely its identified avoidance-action Causes of Action, since only avoidance actions are subject to appointment of a trustee under Bankruptcy Code section 926(a) (and only avoidance actions are subject to the urgency of the statute of limitations under section 546(a)). Further, the filing of such actions should be subject to this Court subsequently making findings through a structured process that the FOMB’s refusal to bring the Causes of Action was not motivated by reasonable and appropriate considerations but “by reason of political pressure or desire for future good relations with a particular creditor or class of creditors”—the scenario Congress envisioned requiring the appointment of a trustee when it created section 926(a). S. Rep. No. 95-989, at 111 (1978). In addition, to ensure that only material claims are brought, the Court should require that any Cause of Action brought seek the avoidance of at least $25 million in alleged transfers or at least $25 million in alleged damages for non-avoidance Causes of Action (or some similar materiality threshold as the Court determines appropriate), from a set of defendants that can reasonably be expected to satisfy such a judgment.

Oppenheimer Funds also filed an objection echoing the Board and AAFAF’s arguments. Ambac filed a limited objection, agreeing with the UCC as to the filing of the causes of action but said:

At the same time, however, Ambac objects to the Committee’s Motion because the Committee is the wrong entity to prosecute the Causes of Action. The parties most directly impacted by the challenged debt issuances are not the relatively small-dollar creditors that the Committee has added as movants as a means of addressing the fact that the Committee itself is not a “creditor” within the meaning of Section 926(a), and thus likely may not serve as a trustee under that provision. Rather, the parties most directly impacted by the challenged debt issuances are the holders and/or insurers of bonds that were issued in earlier years with proper constitutional authority. Debt service on those challenged bonds—and monies that were paid to financial and other professionals in connection therewith—are funds that would have been available for other purposes, preventing (or at least mitigating) the catastrophic bond defaults that have occurred since 2016 and caused Ambac alone to pay tens of millions of dollars in claims on its applicable financial guaranty insurance policies (with no end in sight). This is especially so with respect to vintage bonds that Ambac insures and owns, including pre-2012 GO bonds, pre-2009 PBA bonds, and revenue bonds issued by the Puerto Rico Highways and Transportation Authority, Puerto Rico Infrastructure Financing Authority, and Puerto Rico Convention Center District Authority, to which Ambac has a collective exposure exceeding $1 billion. The Committee and its constituent members seeking trustee status and/or derivative standing are not remotely comparable in terms of their motivation to pursue the Causes of Action to their appropriate conclusion.

Oppenheimer requests the denial of the UCC’s motion but if granted, requested from Judge Swain the following:

In the alternative, should the Court conclude that appointment of the Committee as trustee/derivative plaintiff is proper, it should do so without prejudice to creditors’ rights to move to intervene as co-plaintiff, seek appointment as co-trustee, or otherwise join in the prosecution of the Causes of Action. Such a structure would have the added benefit of ameliorating “Aurelius risk”—i.e., the possibility that the acts of the Oversight Board following the First Circuit’s decision in Aurelius Investment LLC v. Commonwealth of Puerto Rico, No. 18-1761, including the acts of any statutory committee prosecuting claims on the Debtor’s behalf, might be undone, with valuable claims being lost in the process.

Complications upon complications. Assured and Financial Guaranty also filed objections on April 20, 2019. They essentially say that the statutes cited by the UCC do not provide the UCC with a remedy. Could be but my worry is that valid causes of action may be otherwise lost if the motion is not granted. The UCC will probably file a reply some time on Monday April 22. We will know on Wednesday what is the Court’s opinion.

On Thursday, April 18, 2019, Judge Swain heard argument on the original motion and stipulation between the Board and the UCC. She seems inclined to grant the motion, asked the parties to come to an agreement and if not, she will rule during the Omnibus. I am sure she will grant it. Not sure what she will do with the UCC’s motion.

Finally, the Association of University Professors and individual UPR retirees, filed an adversary proceeding and requested the Court issue the following:

enter a Declaratory Judgment decreeing that any oversight act by the Oversight Board in relation to the University of Puerto Rico Retirement System is null and void;

 grant injunctive relief staying any involvement of the Oversight Board with the operation and benefits of the Retirement System;

 enter a Declaratory Judgment decreeing that the Governing Board cannot obey the instructions of the Oversight Board regarding the Retirement System;

 grant injective relieve staying further compliance of the Governing Board with the instructions of the Oversight Board regarding the Retirement System;

 order the Governing Board to comply with Certification 146 (2014-2015);

 order the University of Puerto Rico to repay any loss or depreciation of trust property and any profit made by trustee resulting from the breach of fiduciary duties of the Governing Board, and any profit that would have accrued to the trust property if there

The complaint has a few good points. Although PROMESA supersedes any Commonwealth law, including the Puerto Rico Constitution (see Judge Lynch’s opinion in the Legislature decision), I don’t think a Board order is sufficient to stop the UPR’s requirement to comply with the local law. Of course, the Board may sidestep all this by sending the UPR into Title III as it has intimated in the past. Let’s see what happens.

In other news, the Board announced that it expects the Commonwealth to begin paying debt by fiscal year 2020-21, which begins on July 1, 2020, little over a year from now. Given everything that is going on, I doubt very much the plan of adjustment will be approved by then or that the Government of PR will want to pay anything more than a token of what it owes.

Today there are 22 days remaining for the appointment of the new Board. President Trump has failed to send any names to Congress, even though it seems he will re-nominate the current members. Let’s see what happens.

Finally, with deep regret I am announcing that I will file my last Monday Update on April 29, 2019. As you all know, I have been providing this newsletter to keep those interested abreast of what is going on in PROMESA but it has gotten so complicated that I am spending many, many hours doing it. Hence, my next Monday update will be my last. I will keep the website open for a while and maybe I will occasionally inform you of momentous happenings in the PROMESA litigation. Perhaps.

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.