Monday Update – January 22, 2018

Welcome to your weekly Title III update for January 22, 2018. Things in the Puerto Rico bankruptcy are picking up, but developments outside the case, which were for the most part political in nature, dominated the week.

On January 17, 2018, El Nuevo Día reported that FEMA and the US Treasury were denying PR’s requests for a loan pursuant to the Community Disaster Loan Program, commonly known as CDL. The letter, however, has a print of received on January 9, 2018, more than a week before it was reported. In the letter, the agencies told AFFAF Director Gerardo Portela that the Commonwealth, PREPA and PRASA projected in late September that they would exhaust their operating funds by October 31, 2017, but as of December 29, the Commonwealth had $1.7 billion cash balance and “discovered” $6.875 billion in over 800 accounts. The letter continued saying:

“Because the Commonwealth’s central cash balance, as publicly reported, has consistently exceeded $1.5 billion in the months following hurricanes, and considering the implications of the reported $6.875 billion of total cash across the Commonwealth, the Federal Government will institute, as a matter of policy, a Cash Balance Policy, that will determine the timing of CDLs to the Commonwealth and its instrumentalities, including PREPA and PRASA. Under this Cash Balance Policy, funds will be provided through the CDL Program when the Commonwealth’s central cash balance decreases to a certain level.”

In response to FEMA and US Treasury, Mr. Portela attempted to downplay these newly discovered monies writing in a response to the Federal Government, “The disclosure in the Initial Report reflects a preliminary analysis of hundreds of bank accounts of the Commonwealth and Commonwealth instrumentalities, but it does not provide an accurate picture, or should not be construed as indicative, of governmental liquidity for unrestricted general use.”

Similarly, Mr. Portela told Politico late Friday that PREPA and PRASA faced severe liquidity problems and that the Commonwealth had provided the Federal Government all that it requested. Politico reported, however, that a “Treasury spokesperson pointed the finger back at Puerto Rico’s government for failing to provide information that the administration wans to fulfill the loan request. ‘We are closely monitoring Puerto Rico’s liquidity and stand ready to support the island’s needs,’ the spokesperson wrote. ‘The Government of Puerto Rico has the responsibility to demonstrate liquidity needs in a transparent fashion to ensure appropriate program use and stewardship of taxpayer dollars.” Yet, another sign that the Trump administration is not buying the claims of the Commonwealth or the Board.

Predictably, the Oversight Board, on that same date of January 17, announced a hearing to discuss the “discovered” cash. The meeting was nothing more than a blatant attempt to whitewash the Commonwealth’s cash situation. The AFFAF presentation, has several caveats that make it of questionable use for either the Federal Government, the mediation team or Judge Swain. In its disclaimer section, AFFAF states that the information contained in the presentation is preliminary and subject to further analysis, the account balances have not been confirmed through an audit in accordance to the generally accepted auditing standards and it makes no representation with respect to the information it presents.

“Discovered” Monies: What the Board Knew and When

The Board’s attempt to whitewash the “discovered” funds, however, fails for several reasons. Andrew Scurria, a reporter for The Wall Street Journal, wrote an article in the Bankruptcy section of the daily, revealing that the Board knew of these accounts not in December of 2017 but in July 2017. See here for the proof. There are several email exchanges between the Board and AFFAF pertaining to these accounts. This begs the question of why the Board continued to tell Judge Swain in the summer of 2017 that the Commonwealth’s finances were so bad that it would have to borrow from COFINA in November. Later the Board changed its tune to December, but after the hurricanes, upped the ante. On November 7, 2017, Natalie Jaresko told Congress PR needed $3.6 billion before the end of the year and between $13-$21 billion for the next 7 quarters. Clearly, the Board has some explaining to do to Congress and Judge Swain.

Without a CDL, Puerto Rico Seeks to Finance PREPA Directly

This leaves the Rosselló administration in a bind. It desperately needs to reestablish electrical power in Puerto Rico in order to run again in 2020. Hence, it needs to fund PREPA and PRASA. Since the Federal Government told the Governor, for now, to use his own funds, it has decided to lend these corporations money. This was previously reported by The Wall Street Journal, and I have examined this draft Commonwealth-PREPA term sheet.

In short, the Commonwealth would provide for and initial $250 million loan and up to $1.5 billion, but the latter only if there is a CDL. The loan would be secured by a lien on the net revenues of PREPA and would not be for payment of debt. Although the loan would be secured, its payment would be as an administrative expense, after lawyers and experts are paid. The loan will be without interest unless Puerto Rico has to pay interest from the CDL and then the same rate will apply.

Profound Implications for Title III Case

All this mess has profound implications for the Title III litigation and PROMESA in general. For example, if the Treasury demands a lien over Commonwealth funds, and it probably will, this would affect the GO Bondholders claim they have a lien over the same funds. Hence, pursuant to 11 U.S.C. § 363(c)-(f), Judge Swain would have to intervene, determine the validity of the GO claim and if she finds they have a lien, make sure this is paid in full in the Plan of Adjustment before she can grant the US any lien. Even with this guarantee, it is questionable if Puerto Rico could pay the Federal Government and GO’s. In addition, the Federal Government could claim a lien on the SUT, angering the COFINA bondholders who claim they have a lien and to which there is ongoing litigation.

None of the Board’s dire predictions, made both to Congress and Judge Swain, has been proven true. In December, AFFAF and the Board stated that each would hire an auditor to determine, what, if anything of those $6.875 billion could be used. But neither had done so. Moreover, AFFAF and the Board knew about these funds since July 2017. Why didn’t they hire an auditor then? Probably because they would have to change the Fiscal Plan and would change the nature of the mediation talks. This lack of transparency has consequences. If a federal judge thinks you lied to them once, it will never again believe a word you say. This applies to Judge Swain and the six federal judges in the mediation team.

Moreover, if the Commonwealth is to lend to PREPA, it also needs to enact new legislation authorizing it to do so and would have to again go through Judge Swain in order to secure a lien. This is not something that can be done in a couple of days and the legal storm will be severe.

In addition, any audit will take time, at least 60-90 more days. This means the middle of March or April before Puerto Rico could come out and seek a CDL loan. It would then have to wait for the FEMA bureaucracy, slow at its best, to disburse the money. Puerto Rico, far from being a pauper, has enough money to operate and lend to its public utilities, if it has not already done so. Not a good scenario for the Governor and the Board.

During the weekend, the Governor Rosselló announced he would address the people of Puerto Rico via TV, later today. The topic will be the CDL, fiscal plan, etc. It is clear the Board will move quickly to approve either the Governor’s plan or its own, probably by February. It will then file the Plan of Adjustment to forestall the economic growth that insurance and FEMA money always brings after a hurricane. In addition, this plan will not reflect any CDL loans or any Medicaid/Medicare future funds. That way, the Board will be able to argue to Judge Swain that PR cannot pay a penny in debt service.

The problem with this scenario is that the audit of the “discovered” accounts will not be finished by the end of February since neither the Board nor the Commonwealth have hired the firms to perform it. Nevertheless, Mr. José Carrión admitted that the Fiscal Plan was a changeable document. Hence, if in June new money comes into PR, the Fiscal Plan should reflect it and more importantly, the plan of adjustment must be consistent with the Fiscal Plan. See PROMESA section 314. The Fiscal Plan may vary but the Plan of Adjustment and the Disclosure statement that accompanies it, should not be changed every couple of months. A quick approval by the Board of an incomplete fiscal plan will underscore their approach is not serious, and further erode what’s left of their credibility before the Court.

In any event, a Plan of Adjustment that has no debt service for 5 years, and even then only growth bonds, is highly unlikely to be approved by creditors. The Board will then request from Judge Swain that she cramdown the plan as in the best interest of creditors. Given the situation, I find that unlikely, although clearly it has been the Board’s plan from the beginning. If Judge Swain does not cramdown the plan, the Bankruptcy would have to be dismissed pursuant to 11 U.S.C. § 930. Then what? PR would not have the automatic stay to hide behind and would be faced by very angry bondholders who have not been paid in two years. That’s why Congress envisioned Title VI as the best option but the Board and Governor Rosselló preferred bankruptcy over negotiations.

Turning now to the actual litigation, the American Federation of State, County and Municipal Employees International Union, AFL-CIO (“AFSCME”) and the American Federation of Teachers, AFL-CIO (“AFT”), International Union sought an order to lift the automatic stay to continue all the labor arbitration that were initiated before the filing of the petition. The Service Employees International Union (“SEIU”) and International Union, United Automobile, Aerospace and Agricultural Implement Workers of America joined the petition. Seems to me a fair request but the Commonwealth is sure to oppose it.

National filed a Rule 2004 request for discovery for the following purposes:

“National seeks authorization to take discovery of the Government Development Bank for Puerto Rico (“GDB”) regarding the existence, historical treatment, and status of a State Infrastructure Bank (“SIB”) trust account (the “PR SIB Trust Fund”) created at GDB for the benefit of Puerto Rico Highway and Transit Authority (“PRHTA”) bondholders pursuant to an agreement (the “Puerto Rico Infrastructure Bank Agreement” or the “Bank Agreement”) between the Puerto Rico Department of Transportation and Public Works (“the Department”), PRHTA, and GDB on June 12, 1998 and to conduct examinations of designated representatives of GDB.”

The Court has been changing its view on Rule 2004 discovery and may very well grant this but likely with limitations. Let’s see what happens.

The Ad Hoc Group of PREPA Bondholders, National Public Finance Guarantee Corporation, Assured Guaranty Corp., Assured Guaranty Municipal Corp., Syncora Guarantee Inc., and U.S. Bank National Association and PREPA came to a stipulation pertaining to Rule 2004 discovery and presented it to Judge Swain. Good to see some good faith cooperation.

As I suspected, Judge Swain granted the UCC’s leave to file amended constitutional claims against COFINA and said:

“The twelfth and thirteenth causes of action, as amended, plead plausibly claims that can properly be litigated in connection with the determination of the binary asset ownership issue framed by the Stipulation. Although they also implicate issues that may be relevant to other, out of scope, questions that were raised in the pleadings filed in this adversary proceeding, such potential overlap is not preclusive of in-scope consideration of the claims.”

The UCC promptly filed its amended complaint and this could be a game changer in the Commonwealth v. COFINA challenge. As we discussed before, not only does the UCC claim the COFINA transfer is unconstitutional but so do the GO bondholders. And if indeed COFINA is unconstitutional, the full SUT would belong to Puerto Rico and the GO’s would be in a perfect position to argue via an adversary proceeding or contested matter, that these funds must be used to pay their bonds. Let’s see what transpires.

The Board filed its motion requesting the entrance of an order as to proof of claim bar dates. The proposed date is May 29, 2018. This is a long motion which must be examined by anyone that has a claim in the case. Those who do not already have one, please hire an attorney. The Board also filed a motion to extend the time to accept or reject leases.

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.