Monday Update – July 2, 2018

Welcome to your weekly Title III update for July 2, 2018.

In a surprise move, Rob Bishop, Chairman of the House Committee on Natural Resources and architect of PROMESA, filed request of leave to file a brief of amicus curiae in the First Circuit in the Ambac Assurance appeal, 18-2118. With the request, Congressman Bishop filed the proposed amicus. Congressman Bishop stated that he “has an interest in ensuring that PROMESA is interpreted by this and other courts consistent with legislative intent.” The petition continues stating:

During the course of that argument [Peaje], Judge Kayatta requested that, “in cases going forward,” parties to proceedings concerning Puerto Rico’s restructuring put PROMESA “in context” and explain both how PROMESA operates and the differences between PROMESA and the Bankruptcy Code. Rep. Bishop possesses special knowledge of PROMESA and its legislative history, which, if allowed to be presented in an amicus curiae brief, is likely to assist the Court in both placing PROMESA “in context” and interpreting PROMESA consistent with legislative intent.

In the brief itself, Congressman Bishop lays out the Committee’s view of PROMESA in clear contrast to the views and actions of the Board, the Puerto Rico Government (Governor and Legislature) and even Judge Swain.

Congress determined that, along with providing access to restructuring support, the Commonwealth’s financial house must be placed in order to remedy the decades of financial mismanagement that led to the present crisis. Congress also required the Commonwealth to deal fairly with its existing creditors and respect their rights, to enable conditions by which Puerto Rico could reach access to credit at reasonable rates of interest in the capital markets. The purpose espoused in Section 101 governs all of PROMESA’s provisions. 48 U.S.C. § 2121(a).

The purpose espoused in Section 101 governs all of PROMESA’s provisions. PROMESA prioritizes consensual resolutions, makes a nonconsensual restructuring available only as a last resort, and provides that creditors’ rights must be protected during negotiations and any restructuring process.

The Brief continues explaining:

[T]he Committee included protections for creditors’ rights before, during and after a Title III case to ensure any nonconsensual restructuring would not be adverse to Puerto Rico’s future access to capital markets. During the pendency of a Title III proceeding, creditors’ rights are protected by key provisions of the bankruptcy code incorporated into Title III in Section 301(a), 48 U.S.C. § 2161(a). Specifically, 11 U.S.C. § 362(d)(1) permits the Title III court to lift the automatic stay to let creditors seek relief if their collateral is not adequately protected. Furthermore, 11 U.S.C. §§ 922 and 928, the “special revenue” provisions of Chapter 9 of the Bankruptcy Code, are intended to ensure that revenue streams pledged to bondholders continue to pay out during a Title III proceeding just as they would during a Chapter 9 bankruptcy by municipal debtors. Title III also contains creditor protections that apply at confirmation of a plan of adjustment, the means by which a debtor exits Title III. A plan of adjustment cannot be confirmed unless it complies with the applicable fiscal plan—which itself must respect lawful priorities and liens, as per Section 201.

This is clearly not what the Board has been doing. Congressman Bishop continued saying:

Testimony at hearings before the Committee in February 2016 reflected a need for Congress to make debt restructuring available for Puerto Rico only alongside a “long-term fiscal and economic authority” capable of addressing “comprehensively all of Puerto Rico’s issues.” The hearings further indicated that any authority created by federal legislation would need to be independent, free from island political influence, and empowered to oversee Puerto Rico’s fiscal and governmental activities, including the authority to enforce structural changes through budgets.

The legislation developed in response to these hearings was designed to instill fiscal discipline, restore legal order, uncover the fiscal data behind the island’s finances, return the island to the capital markets, and prohibit contagion effects into other municipal markets. The Committee agreed to provide Puerto Rico access to restructuring, conditioned by the inclusion of provisions to prioritize consensual negotiations, improve transparency on the island, preempt unilateral debt-related measures, and protect the best interests of creditors. If nonconsensual restructuring were to ultimately prove necessary, the legislation provided that it could occur only under clear federal mandates that would respect creditor interests and enable Puerto Rico’s future access to capital markets.

The theme of a Board free of Puerto Rico political influence and Title III as a last resort continues all through Congressman Bishop’s brief, which also stated:

However, the Committee rejected the notion that free access to bankruptcy would be helpful for the economic future of Puerto Rico. This rejection echoed a similar conclusion throughout Congress, as both the House and the Senate had ignored proposed legislation that would have simply allowed Puerto Rico access to bankruptcy protections under Chapter 9 of the Bankruptcy Code. . . As Mayor Anthony Williams recognized in his testimony before the Committee on April 13, 2016, nonconsensual “debt adjustment powers” were to be made available to the Oversight Board only “as a last resort.” Therefore, PROMESA mandated that bankruptcy proceedings under Title III be available only as a last resort if voluntary negotiations failed.

Again, the theme of bankruptcy as a last resort. Further on the brief:

Although the Oversight Board has steered debtors into Title III proceedings, Title III was created as a last resort, to be used in truly intractable cases after a lengthy negotiation period proved fruitless. To implement this, the Committee imposed several gating requirements on the Oversight Board to prohibit a rush into the Title III restructuring process and to ensure the Oversight Board would consistently and proactively engage with the creditor community. The Committee not only envisioned these gating requirements as substantial hurdles that would be overcome only by “truly unsustainable debt,” but also as mandated items that were intended to encourage dialogue between affected parties, promote transparency in financial data, and return Puerto Rico to the capital markets, before resort could be made to Title III.

Board members were appointed on August 30, 2016 but it was only in November 2016 that it stated that negotiations would start in December, which made no sense since a new government was coming in on January, 2017. Moreover, it was not until April of 2017 that bondholders met with the Board and representatives of the Commonwealth government. Also, not all creditors were included in these negotiations. Since the Commonwealth Title III was commenced in May of 2017, it is highly unlikely there were any good faith negotiations by the Board or the Governor. The brief continues by saying:

Another gating requirement under Section 206 focused on transparency. It mandated that the debtor entity have “adopted procedures necessary to deliver timely audited financial statements” and “made public draft financial statements and other information sufficient for any interested person to make an informed decision with respect to a possible restructuring.” The Committee required this gating mechanism to ensure the Oversight Board, and interested persons, including creditors, had access to enough financial information to “determine whether the entity actually needs restructuring.” The purpose of Section 206(a)(2) was to require the Oversight Board to implement transparency measures sufficient to support dialogue about the fate of an entity before beginning a Title III case.

To this day, the Puerto Rican government has not produced audited, GAAP compliant records of the Commonwealth’s financials, and the Board has taken a blind eye to this requirement that was mandated from Congress.  How then does a restructuring take place?  The Board is hoping everyone looks the other way.

Chairman Bishop brief continues:

Despite the clear intent and design of the gating provisions, the Oversight Board filed Title III cases for four debtors within one month of the expiration of the stay under Section 405, 48 U.S.C. § 2194. The Committee did not intend for the expiration of the stay to prompt the initiation of Title III cases; rather, the automatic stay was included to allow the Oversight Board ample time to establish itself under the statutory framework of PROMESA, and to initiate voluntary negotiations under Title VI. The Board’s haste to begin what was meant as a last resort has sown confusion in the lower court’s interpretation of PROMESA. PROMESA should be read and interpreted with the understanding that the Oversight Board (and the fiscal plans) were intended to operate for an extended period of time prior to any Title III proceedings—if, indeed, such proceedings ever needed to be  filed. (emphasis added)

Congressman Bishop has been very clear, I don’t think I need to add anything. His brief further states:

The Committee envisioned fiscal plans as governing documents that would “require Puerto Rico to balance its budgets, incorporate pro-growth reforms, and ensure legislative acts advance Puerto Rico towards the goal of fiscal responsibility and regaining access to the capital markets.”

Once a fiscal plan is in place for the Commonwealth or a territorial instrumentality, the entity must comply with it in its official acts. Section 202, 48 U.S.C. § 2142, requires that territorial and instrumentality budgets be consistent with the fiscal plan. Section 204, 48 U.S.C. § 2144, requires that all contracts, rules, regulations, and orders conform to the fiscal plan, and gives the Oversight Board extensive powers to ensure compliance. . . In short, the fiscal plan sets policy for the covered territory or territorial instrumentality at a sufficient level to ensure fiscal responsibility and restore access to capital markets. . . Rather, the fiscal plan is a negotiated document with economic and governmental consequences to which all budgets, laws, contracts, rules, regulations, and executive orders must conform for the duration of the Oversight Board’s mandate—in Title III or outside of it.

This is clear rebuke of the Puerto Rico legislature that has resisted many of the needed reforms the Board has advanced. More on this later. Also, Bishop envisions the Fiscal Plan surviving Title III discharge as a way of ensuring that the bad practices from the past are not repeated. Difficult to achieve in Puerto Rico. In addition, Chairman Bishop’s brief sstates something of critical importance regarding the review of the Fiscal Plan:

Accordingly, Congress imposed requirements on the development of the plans in Section 201(b) of PROMESA to further these objectives. The requirements of Section 201(b) are not optional. A fiscal plan “shall” include each of the delineated items. If the Title III court finds the approved fiscal plan fails to comply with the requirements of Section 201(b), then the court should direct the Oversight Board to revise such plan accordingly.

I confess I did a double take when I read this. Section 106(e) of PROMESA states that “[t]here shall be no jurisdiction in any United States district court to review challenges to the Oversight Board’s certification determinations under this Act.” I have long advanced that the Court would review the Fiscal Plan at the Plan of Adjustment stage, as per PROMESA 314(b)(7) and Judge Swain has stated in the Peaje opinion that she would do so.

Here, however, Chairman Bishop is going further and stating that she may order that the Fiscal Plan be changed to conform it to section 201(b)(1). Strong stuff. The Brief continues with the Fiscal Plan and states:

Section 201(b) was modified during the legislative process to ensure the lawful priorities and liens held by creditors would be respected. The initial introduced version of PROMESA, HR 4900, was silent on the hierarchy of creditor rights in respect to fiscal plans. Responding to concerns expressed by Committee members and the creditor community, the Committee wrote in two new provisions in the reintroduced version of PROMESA, H.R. 5278, which required fiscal plans to: 1) prohibit the unlawful transfer of assets, funds, or resources between instrumentalities, and 2) “respect the relative lawful priorities or lawful liens, as may be applicable, in the constitution, other laws, or agreements of a covered territory or covered territorial instrumentality.” These provisions were included to “ensure fiscal plans keep intact the structural hierarchy of prioritized debt.” These additions to Section 201(b), which were included in the final legislation, prevent the Oversight Board from altering or impairing lawful liens and priorities held by creditors when developing fiscal plans. Congress intended for fiscal plans to govern the Commonwealth and its instrumentalities for an extended period of time, and to apply mostly outside of Title III proceedings, so these creditor protections and other Section 201(b) requirements are not limited to Title III cases. (emphasis added)

Altering or impairing lawful liens and priorities held by creditors is all the Board has done in this case in the 2 years since they took their oath. One could argue that their intent is to eliminate creditor rights so that there be no liens and no priorities so it can decide, like a feudal lord with its serfs, who gets what and when. Again, strong stuff and a clear rebuke of the Board’s actions to date.  Surely, creditors will use this brief at the right time.

Next comes a rebuke on the Court’s opinions:

PROMESA incorporates 11 U.S.C. §§ 922 and 928, the “special revenue” provisions from Chapter 9 of the Bankruptcy Code. Because government entities typically cannot mortgage their assets to creditors, they instead offer revenue bonds—liens on ongoing streams of revenues like taxes, tolls, or fees. Several territorial instrumentalities in Puerto Rico, including the Highway & Transportation Authority (HTA) and the Puerto Rico Electric Power Authority (PREPA) have significant outstanding revenue bond debt. This debt is “non-recourse,” meaning that creditors cannot collect from any source other than the pledged revenues. Taken together, the special revenue provisions ensure that creditors’ liens on special revenues streams are not interrupted by the filing of a Title III case, exempting their claims from the automatic stay.

This is a clear rebuke to Judge Swain’s decision that sections 922 and 928 allowed a municipality to pay its bonds if it wanted but did not force it to pay. The muni community was appalled at the decision and some groups filed their own amicus briefs. Personally I believe the Court will reverse Judge Swain’s decision for further evidentiary hearings but this brief could change said decision.

The brief continues stating:

Once a Title III case proceeds to plan confirmation, PROMESA provides additional protections not found in Chapter 9 of the Bankruptcy Code. Upon the introduction of the first draft of PROMESA, the Committee heard testimony that Chapter 9 proceedings throughout the country had failed to respect creditor rights despite Chapter 9’s intent—a failure that had been recognized by at least one member of the Oversight Board. . . Second, Section 314(b)(6) requires that any plan be “in the best interests of creditors,” in light of the recovery creditors could reach through “available remedies under the non-bankruptcy laws and constitution of the territory.” Together these provisions ensure that the Title III process protects creditors’ rights and definitively precludes the confirmation of a plan that would result in an adverse result for creditors and hinder Puerto Rico’s return to the capital markets.

Clearly, the Brief is worried with the Board’s actions against bondholders, the Puerto Rico legislature’s flaunting of the Fiscal Plans and Judge Swain’s decisions. Judge Swain is protected by the Constitution from influence by the political branches, but not the Board or the Puerto Rico Legislature. The timing is clearly meant to influence the First Circuit – although its about 2 years late – so even if the First Circuit does not allow the amicus brief or simply ignores it, Congressman Bishop is the Chairman of the House Natural Resources Committee with jurisdiction over Puerto Rico.  Put another way, the Brief is quite simple, and if denied by the First Circuit, the Chairman could move to codify these points into law by amending PROMESA.

At the local level, the Puerto Rico Legislature ignored the Board’s newly certified Fiscal Plan, which is the Fiscal Plan it certified in April and approved a non-compliant budget.  This will force the Board to certify its own Fiscal Plan. Senate President Thomas Rivera Schatz has vowed to take this challenge to the Courts.

What will happen will depend on the different possible scenarios. Pursuant to section 202(e) of PROMESA, if the Legislature and governor do not provide a compliant budget, the Board may certify its own and send it to the governor. It will then become the Commonwealth’s budget as if it had been approved by the Legislature and signed by the governor. The latter, however, is the one called upon by the Constitution to execute the budget and this leaves Governor Rosselló with a political conundrum. Will he side with the Board and execute their budget, losing face with the Legislature? Will he side with the Legislature and enter into a fight he knows he cannot win? If the governor sides with the Board, will the Legislature go to Court as it has announced to enforce its budget? The first question would be if the Legislature has standing? I think it does based on Arizona State Legislature v. Arizona Independent Redistricting Commission, 576 U.S. __ (2015) if its argument is that the Board’s actions are interfering with its constitutional duties. This only means they can sue, since as I have stated before, section 106(e) of PROMESA deprives the Court of jurisdiction to review the Fiscal Plan. It could, however, argue that the Board’s actions are repugnant to the Federal Constitution, which arguments Judge Swain has rightly decided she can hear. I can’t think of any arguments that would hold water but we will see some effort. When, I do not know and will depend on the Governor’s actions.

Oh, and not to be lost on anyone, the Board claims that failure to enact Law 80 will now result in $25 billion less for bondholders.  Theoretically, that should then negatively affect the Board’s support for the Commonwealth-Cofina Agent’s agreement, if the forecast is actually accurate.

Stay tuned.

Not much happened in the cases but AAFAF requested that Adversary Proceeding 18-0059, Assured Guarantee, Corp. v. Commonwealth, be stayed pending the Ambac appeal. Let’s see what the Court decides.

June 29 was the last date for the Proofs of Claims to be filed and in the afternoon, the Prime Clerk website collapsed. Judge Swain was promptly informed but her answer was to tell filers that they could file in ECF. Problem is that those Prime Clerk users where individuals who could not or did not want to hire an attorney to do the filing. I assume the Board will allow some leeway since many of those who wanted to file, employees and retirees, did not have to file.

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.