Monday Update – February 26, 2018

Welcome to your weekly Title III update for February 26, 2018. After last week’s blockbuster PREPA fiasco, this week has been seemingly slow but important issues have arisen.

It seems that my opinion that the PREPA loan was simply a ploy to reduce the PR Treasury TSA account was true. Caribbean Business reported that PRASA could seek a $400 million loan. Since PRASA is not currently in Title III (although my bet is that it will be soon), it is unlikely Judge Swain will be involved to deal with the inflated claims of the Commonwealth. It will be interesting to see how the Commonwealth will lend without a lien or a superpriority as it claimed it needed in PREPA.

In the Commonwealth v. COFINA adversary proceeding, the UCC filed a 54-page motion for summary judgment against defendant. Its preliminary statement is important and states:

“Created in the wake of Puerto Rico’s 2005-2006 fiscal crisis, the COFINA structure is essentially an “off balance sheet” financing transaction collateralized by a specified portion of the Commonwealth’s general sales and use tax (“SUT”) revenues. Although purportedly independent from the Commonwealth, COFINA is “attached” to the Government Development Bank for Puerto Rico (the “GDB”) and governed exclusively by the GDB’s directors, who are also the directors of COFINA and who are appointed by the Governor. COFINA’s only authorized purpose is to issue bonds backed by the Commonwealth’s own tax revenues and to use the proceeds to pay the Commonwealth’s own debts and expenses and to provide funding for certain economic development and emergency relief funds of the Commonwealth. The COFINA structure is just one of various “structures” created by the Puerto Rico government and its advisors to stave off the day of reckoning for the government’s fiscal irresponsibility. The court has already encountered one such structure in the Employees Retirement System litigation and will soon have to address a structure involving the issuance of billions of dollars of Public Buildings Authority bonds.”

The UCC motion for summary judgment also claims the transfer of property of SUT revenues to COFINA is unconstitutional for violating the debt limit, violating the debt priorities and violation of the balanced budget provision of the PR Constitution. As to the debt limits, the motion states, inter alia:

“Thus, the COFINA structure created by Act 91 provided an indirect means for the Commonwealth to issue debt payable solely from general Commonwealth tax revenues without having to comply with the Constitutional Debt Limits. . . Such “off balance sheet” financing constitutes an unconstitutional evasion of the Constitutional Debt Limits, which would be rendered meaningless if such financing structures were constitutionally permissible.”

As to the debt priorities, the UCC states, inter alia:

“There can be no dispute that, prior to the Commonwealth Petition Date, the SUT revenues specified for COFINA would, but for the purported transfer to COFINA, be “available revenues” of the Commonwealth (which would first be paid to holders of lawfully issued Commonwealth public debt).9 Accordingly, the purported transfer of SUT revenues to COFINA reduced the revenues that would otherwise be available to the Commonwealth to pay its creditors. . . Stated bluntly, if the Puerto Rico Legislative Assembly can render general tax revenues “unavailable” simply by “transferring” them to a special purpose entity that does nothing but issue bonds to pay the Commonwealth’s own debts and expenses or provide funding for Commonwealth funds, there is no principled limit on the ability of the Puerto Rico Legislative Assembly to undermine the Constitutional Debt Priority.” (emphasis in the original)

Interestingly, the UCC makes this clarification in footnote 9 of the previous paragraph:

“In its capacity as the Commonwealth Agent, the Committee takes no position on whether the same priority is applicable after the Commonwealth Petition Date. The Committee is not a party to this adversary proceeding in its individual capacity and reserves all rights in such capacity.”

Does this mean that the UCC will oppose the GO’s obvious position that they have first dibs on Commonwealth funds? Sometime this will have to be clarified.

Finally, the UCC claims a violation of the balanced budget requirement of the PR Constitution and says:

“Thus, while the Spanish version of the constitution uses a term that is broader than “total revenues” and was meant to include some form of bond proceeds, the English version uses “total revenues” just like the Jones Act. Since “revenues” does not include borrowings (which are a form of expense when repaid), the constitutionality of deficit financing depends, as an initial matter, on which version of the constitution controls. The answer to that question is found in Public Law 600 of June 4, 1951, which is the law by which the U.S. Congress “provide[d] for the organization of a constitutional government by the people of Puerto Rico,” and Public Law 447 of July 3, 1952, which is the law by which the U.S. Congress approved the Puerto Rico constitution conditional upon certain amendments not relevant here.

Public Law 600 provided that “[u]pon approval by the Congress the constitution shall become effective in accordance with its terms.” Public Law 600, 64 Stat. 319, 48 U.S.C. § 731d (1951) (emphasis added). Public Law 447 provided that:

the constitution of the Commonwealth of Puerto Rico hereby approved [i.e., the English version] shall become effective when the Constitutional Convention of Puerto Rico shall have declared in a formal resolution its acceptance in the name of the people of Puerto Rico of the conditions of approval herein contained, and when the Governor of Puerto Rico, being duly notified by the proper officials of Constitutional Convention of Puerto Rico that such resolution of acceptance has been formally adopted, shall issue a proclamation to that effect.

Public Law 447, 66 Stat. 327-328 (1952) (emphasis added). Accordingly, the “terms” in accordance with which the constitution became effective were the terms of the English version approved by the U.S. Congress; not the Spanish version debated at the constitutional convention. Even if the constitution had become effective in accordance with the terms of the Spanish version, there would be no reason to interpret “recursos totales” to include long-term financing of massive structural deficits through the issuance of bonds by “off balance sheet” special purpose entities. If limited to general obligation bonds of the Commonwealth, any deficit financing would at least be constrained by the otherwise applicable Constitutional Debt Limits. If deficit financing through COFINA-like structures is allowed, the Balanced Budget Clause truly has no meaning to speak of. In deciding to include the Balanced Budget Clause in Puerto Rico’s constitution, the delegates to the constitutional convention could not have intended to leave the door open for unconstrained deficit financing that would eviscerate the purpose of having such a clause in the first place.”

I do not disagree with the UCC’s reasoning but I need to point out a few things. What the UCC does is, maybe inadvertently, put its finger on one of the raw nerves of Puerto Rico’s status debate. The island’s supreme law, its Constitution, is not supreme in Spanish, but rather in English. Also, the UCC makes no mention of the Opinion of the Secretary of Justice of May of 1976 where Francisco de Jesús Schuck, using the Spanish version of the Constitution, opined that the island could borrow to balance its budget. Again, I agree with the UCC but it will bring a storm of protests from certain sectors of the local legal community, but not from me.

Another important issue before the Court is the Board’s quixotic acceptance to lifting the stay in labor grievance cases. In its motion, the Board said:

“The Commonwealth consents to modifying the Title III Stay to allow the Actions, as provided herein and to the extent that such actions do not affect the Commonwealth Fiscal Plan, to proceed to judgment in the ordinary course in accordance with the grievance and arbitration procedures in collective bargaining agreements between the Commonwealth and the CBA Counterparties, or under applicable statutes including, but not limited to, Law 8-2017, Law 184-2004, Law 32-1972; provided, however, that the Commonwealth reserves all rights, defenses, and protections with respect to any matters pending or that may arise in the Title III Cases, including the treatment of any claims arising from the Prepetition Actions under a plan of adjustment or otherwise in the Title III Cases.”

What this may mean eludes me and I think movants and the Court will have the same problem. Let’s see what the Court decides.

In addition, the Board objected to the PBA bondholders claim that they can force the Commonwealth to pay the rents that fund their bonds on the grounds of standing. The Board claims that they are not a party in interest since their claim is derivative and they have no direct claim on the rents. It may be right. Again, let’s see what the Court decides.

Finally, Judge Swain referred to Magistrate Judge Dein Ambac’s November 2017 and National’s January 2018 motions for Rule 2004 discovery. Very soon Judge Dein must rule on them and if she grants them, as I suspect she will, this will bring big implications for the Board and Commonwealth’s usual lack of transparency. Most of us eagerly await her ruling on these documents.

In addition, today, Judge Swain issued a very important order on Rule 2004 discovery, such that I am compelled to discuss it here. She had allowed discovery on certain documents, subject to specific objections to specific documents. After some negotiations, the documents that could fall under the deliberative process privilege and the documents leading to the 2017 and 2018 Fiscal Plans still needed resolution. Judge Swain withheld the deliberative process documents but the Board and the Commonwealth must provide a privilege log with the following:

“i) the basis for withholding each category of documents; (ii) a sufficient description of the subject matter of the category of documents to permit Movants to evaluate the claim of privilege; (iii) the date range for the set of documents in each category; and (iv) an aggregate list of all persons sending and receiving documents in each category. See Joint Report, Dkt. No. 2154 at I(c). The parties shall meet and confer to discuss when the log needs to be produced and the frequency with which the log must be updated. The Court will otherwise adopt the parties’ proposed schedule regarding the procedure for challenging items listed in the log.”

Clearly this means that after the log is produced, movants may still challenge individual documents as not covered by the privilege. Moreover, as to the Fiscal Plans, the Court decided in favor of transparency. Judge Swain held:

Movants claim that production is warranted under Rule 2004 and that use of the documents is presently warranted. Respondents contend that the materials exceed the scope of permissible discovery under Rule 2004, and that the materials produced in the data room should remain there subject to existing restrictions. For the reasons detailed herein, this Court concludes that the Fiscal Plan Development Materials are discoverable under Rule 2004. However, Movants have not shown good cause for their immediate use in these proceedings. Therefore, consistent with the parties’ agreement related to the documents in the data room produced in response to other requests, Movants are entitled to the information and may attempt to use documents in the Title III or adversary proceedings, but Respondents are not prejudiced from objecting to individual documents at the appropriate time. See Joint Report,

Dkt. No. 2154, at 1(a). . .

Movants argue that they will need to use these documents later in this Title III proceeding, especially during confirmation of a plan of adjustment. They contend that the confirmation process entitles them to use “all information that bears on how the Fiscal Plan was developed, what assumptions, projections and data were used, and what assumptions, projections and data were rejected.” Movants’ Brief, Dkt. No. 2223 at 3. For their part, Respondents take the position that the issues raised by a plan of adjustment are much more limited, and that much of the Fiscal Plan Development Materials may not be relevant to the issues to be decided in connection with a plan of adjustment. Opposition, Dkt. No. 2274 at 6. For the reasons detailed below, this Court does not have to define the standard that will be employed in assessing any plan of adjustment at this time. Nevertheless, the Respondents’ objections to the relevancy of the Fiscal Plan Development Materials are not persuasive. Movants have successfully shown that the materials are properly discoverable under Rule 2004.

First, Respondents argue that the Fiscal Plan Development Materials need not be produced under Rule 2004 because PROMESA § 106(e) prohibits district courts from reviewing fiscal plan certifications. See Opposition, Dkt. No. 2274 at 4. This argument is unpersuasive. The Movants are not seeking to challenge the fiscal plans. Rather, they are seeking information to understand the past, present and future financial condition of the Commonwealth. This information will form the basis for any plan of adjustment. This is an appropriate purpose for discovery under Rule 2004. In re Enron Corp., 281 B.R. 836, 840 (Bankr. S.D.N.Y. 2002) (“Rule 2004 examinations are appropriate for revealing the nature and extent of the bankruptcy estate.”). For the same reasons, Respondents’ contention that Movants’ “effort to deconstruct the Fiscal Plans would not give them the insight into the Commonwealth’s financial condition they purport to seek” is equally unavailing. See Opposition, Dkt. No. 2274 at 5. Respondents claim that a fiscal plan is “a blueprint for further fiscal and economic action by the Commonwealth. It is not a plan of adjustment designed to identify the treatment of each class of claims.” Id. However, even if just a blueprint, the 2017 and 2018 Plans undeniably describe the existing and projected financial condition of the Commonwealth. Such information not only

falls squarely within the purpose of Rule 2004, but is instructive in developing an understanding of any future plan of adjustment. Rule 2004 allows parties to broadly examine the financial Respondents also disagree with Movants’ description of the standard for confirming a plan of adjustment. Movants claim that “for any plan of adjustment to be confirmed over the objections of a dissenting class of creditors, it must be, among other things, fair and equitable . . . provide creditors with the maximum that the debtor could reasonably pay under the circumstances . . . [and] be consistent with the applicable Fiscal Plan.” Movants’ Brief, Dkt No. 2223 at 23 (internal quotations, citations, and punctuation omitted). In contrast, Respondents argue that “. . . PROMESA [] does not require the debtor to pay prepetition claimholders as much as it can. Rather, it provides the Court should consider what creditors could recover under applicable nonbankruptcy law, i.e., what a race to the courthouse would produce for the creditors under nonbankruptcy law.” Opposition, Dkt. No. 2274 at 6 (internal punctuation omitted). Respondents’ argument, however, does not destroy the relevance of the Fiscal Plan Development Materials. Under either the Movants’ or Respondents’ proposed standard, the correct interpretation of which the Court need not decide today, the Fiscal Plan Development Materials are important for the Movants to have so that they can assess the financial condition of the debtor and participate in a plan confirmation process. Fiscal projections of the debtor are relevant no matter how one interprets the plan confirmation standard.

Seems Judge Swain is not buying the Board’s arguments as of late and is opting for greater transparency in the case, something that all other parties welcome. Again, major defeat for the Board.

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.