Special Update – January 22, 2019

Welcome to your weekly Title III update for January 22, 2019.  Due to the Martin Luther King holiday and developments below, I decided to do the update on Tuesday. This week Judge Swain presided over the COFINA confirmation hearing during January 16-17. There were surprises galore during the hearing.  

Before the drama of the COFINA hearing, on Monday January 14, the Board and the UCC filed an objection to three GO issuances of the PR Government. The issuances include two 2012 bonds and one 2014 bond. The objectors argue that the PBA bonds should be counted as part of the Article VI,section 2 of the PR Constitution, which would mean that these emissions exceeded the constitutional debt limit.  In the objection, they call for the nullification of the debt and for no debt payments to be made. They also claim the 2014 issuance is illegal even if the PBA bonds are not to be added to the calculation, since PR reserved $425 million to pay interests. The complaint avers this should have been added but it was not.  In addition, the UCC (the Board does not aver it but reserved the right to do so) claims that the 2014 issue was illegal since it violated the balanced budget requirement of Article VI, section 7 of the Puerto Rico Constitution.

This is a well-written complaint that depends on the facts of the PBA bonds and the debt service calculation. If one examines the complaint, however, one notices that this objection depends exclusively on the Court’s interpretation of the Commonwealth’s Constitution.

But I fail to see the federal issues in this challenge. Moreover, I disagree with the claim that PR would not have to pay a penny if the 2012 and 2014 were illegally issued. Article 1247 of the Puerto Rico Civil Code, sec. 3496, which I believe is applicable here, states the parties have to give back what they received in the transaction, but the debt would not be bond debt pursuant to Article VI, section 8 of the PR Constitution. Procedures for this objection will be discussed during the January 30, 2019 Omnibus hearing.  One final point, the motion says that this is a gating issue for the Commonwealth Plan of Adjustment. Ominous words indeed.

On the 16th, Judge Swain started the hearing by saying that she could reach “no decision that can reconcile the peoples’ concern.” First, the 9019 objections were discussed and the UAI argued against the approval, as did PROSOL-Utier. UAI exhorted the Judge to reject the plan, give the parties clear instructions on what type of deal to arrange and presto, it would be done. As if COFINA bondholders were willing to lose more money on what they consider a secure credit. After that, Judge Swain asked the persons selected at random from the public to speak. In general, they did a good job arguing overwhelmingly against the deal. Judge Swain then asked if there was an agreement as to PROSOL-Utier and others alleged lack of standing.

After lunch, when it was obvious that no agreement could be reached, Judge Swain decided PROSOL-Utier and the other unions were not COFINA creditors so they had no prudential standing to object the Plan of Adjustment. Nothing new on this, but Judge Swain also decided not to consider the declaration of Dr. Alameda, PROSOL-Utier’s expert, because it did not conclude that COFINA wouldn’t receive 5.5% of SUT, irrespective of the Commonwealth’s situation. For Swain, this did not match with the feasibility of the Plan. Hence, the unions were not allowed to cross-examine witnesses or present evidence. The Board, in a clever move, said it would not object to the unions arguing against the plan.

That left the GMS Group, Mr. Hein, Mr. Dvoras and Mr. Emmet to cross-examine the witnesses since the declarations would be considered as direct examination. After some negotiations, it was decided that no cross-examination would be done except for Mr. Rodrigue.

I will not bore you with the back and forth. Suffice it to say that the objectors, all subordinate COFINA holders, gave good reasons for not approving the deal but I doubt it will do them any good. Judge Swain did not ask them any questions, a bad sign in this case. Moreover, after the presentations were done and she started asking questions to the Board and the COFINA Ad Hoc group, none were about the numbers of the COFINA deal. Surprisingly, her questions were directed on the Supremacy Clause and her power to rewrite the PR Constitution.

In the Plan of Adjustment and the ensuing order, what the COFINA bondholders want from Judge Swain is for her to federalize several documents that in essence would mean that forever and ever, the SUT would not be “available resources” as per Article VI, section 8 of the Puerto Rico Constitution. Because Judge Swain reads everything, she realized that the COFINA deal requires her to make that determination, effectively rewriting the PR Constitution. I have no doubt that Congress has the power to rewrite the PR Constitution, but I see nowhere in PROMESA where it gives this authority to the Board or the Court. Not even section 108(a)(2) of PROMESA, that states that PR cannot “enact, implement, or enforce any statute, resolution, policy, or rule that would impair or defeat the purposes of this Act, as determined by the Oversight Board.” But here there is no such claim. On the contrary, both section 201(b)(1)(N) and 314(b)(6) and (7) seem to require compliance with PR law as to lawful priorities and lawful liens as may be applicable in the constitution or laws of the territory.

Due to this, I believe, the GO bondholders informed Judge Swain that they did not believe that she had to reach 314(b)(6)(review if creditors could get better recovery outside PROMESA) in order to approve the COFINA deal. This issue will be very important in the Commonwealth Plan of Adjustment.

The issue of the Judge’s power over the PR Constitution is important for two reasons. Five years from now, the new PR government administration could go to court and claim that the settlement is illegal since constitutionally (Article VI, section 2) it could not surrender its power to tax by surrendering part of the SUT to COFINA. This argument was made by the UCC in the COFINA litigation, but there was no judgment on the issue. Also, if in the future GO’s bonds are issued by PR, they could claim that COFINA is available resources for payment of said bonds.

Judge Swain gave the COFINA Ad Hoc Group and the Board until Monday January 21 to revise the Findings of Fact and Law they had submitted. Before 4 pm on Monday, the Board filed said documents, with red-line of the changes. In the [Proposed] Findings Of Fact And Conclusions Of Law Regarding Confirmation Of The Third Amended Title Iii Plan Of Adjustment Of Puerto Rico Sales Tax Financing Corporation the changes are interesting. At page 63 of the red-line, it states:

As a separate debtor with its own Title III case, its own certified fiscal plan, and its own plan of adjustment, COFINA is a separate covered territorial instrumentality that is legally distinct from the Commonwealth. See 13 L.P.R.A.§ 11a(a) (“A public corporation and instrumentality of the Commonwealth of Puerto Rico, is hereby created, which constitutes a corporate and political entity independent and separate from the Commonwealth of Puerto Rico to be known as the Corporacion del Fondo de Interes Apremiante de Puerto Rico(‘COFINA’), Spanish acronym), whose name in English shall be Puerto Rico Sales Tax Financing Corporation.”); New Bond Legislation art. 2.1 (providing that Reorganized COFINA “shall be recognized for all purposes as an independent and separate legal entity from the Government of Puerto Rico and any other Government Entity.”). The Court has previously held, in connection with the Commonwealth-COFINA Dispute, that the nature of each debtor’s interest in the Pledged Sales Taxes, for purposes of PROMESA, is a mixed question of federal and Commonwealth law.The Plan, however, provides for an agreed upon allocation of the Pledged Sales Taxes premised upon this Court’s approval of the Settlement and confirmation of the Plan, and, upon such approval, the COFINA Revenues shall be the sole and exclusive property of COFINA, and shall not be property of the Commonwealth or available to the Commonwealth. The Settlement and the allocation of the Pledged Sales Taxes are necessary for the implementation of the Plan, and, pursuant to Bankruptcy Code section 1123(a)(5), made applicable to COFINA’s Title III Case pursuant to PROMESA section 301(a), are self-executing and preemptive notwithstanding otherwise applicable non bankruptcy law, including otherwise applicable Commonwealth law. See 11U.S.C. § 1123(a)(5) (“Notwithstanding any otherwise applicable non bankruptcy law, a plan shall . . . provide adequate means for the plan’s implementation,such as (A) retention by the debtor of all or any part of the property of the estate . . . .”); PROMESA § 301(c)(5) (“The term ‘property of the estate’, when used in a section of title 11, United States Code, made applicable in a case under this title by subsection (a), means property of the debtor.”); see also In re Irving Tanning Co., 496 B.R. 644, 664 (B.A.P. 1st Cir. 2013) (“[O]nly those means may preempt state law that are sufficient for the implementation of the plan: they must be sufficient to implement the plan, equal to what is required, but also not more than is required.”). Furthermore, pursuant to the Settlement Order and the Plan, and subject to the terms of the plan, claims of COFINA’s creditors are released as against the Commonwealth and the Commonwealth itself shall not be liable for the repayment of the COFINA Bonds,nor will the COFINA Bonds have any recourse to any property of the Commonwealth.See New Bond Legislation art. 3.1(c).

Pursuant to PROMESA, including 171. section 4 there of, as well as sections 944 and 1123 of the Bankruptcy Code, and in accordance with the Confirmation Order, the Settlement, the Plan,and Act 241, the Court determines that the COFINA Bonds are legal, valid, binding and enforceable obligations of Reorganized COFINA benefitting from the following protections, each of which are is legal, valid, binding, legal, and enforceable against Reorganized COFINA, the Commonwealth, and other persons and entities, as applicable, under Puerto Rico and federal law.

Later at pages 75-76:

Pursuant to Bankruptcy Code sections 1123(a), 1123(b), and 944(a) as well as genera principles of federal supremacy, the provisions of this Confirmation Order, and the Plan, and related documents or any amendments and modifications thereto shall apply and be enforceable notwithstanding any otherwise applicable non-bankruptcy law. The documents contained in the Amended Plan Supplement (as such documents may be further modified and filed with the Court prior to the Effective Date), including, without limitation, Reorganized COFINA By-Laws, the COFINA Bonds, the New Bond Indenture, the Instructions Agreement, the Ambac Trust Agreement, the National Trust Agreement, the Standard Terms to National Trust Agreement, the Remarketing Agreement, and the Continuing Disclosure Agreement provide adequate means for implementation of the Plan pursuant to Section 1123(a)(5) of the Bankruptcy Code, and, as of the occurrence of the Effective Date, shall constitute valid legal obligations of COFINA and the Commonwealth, as applicable, and valid provisions to pay or secure payment of the COFINA Bonds pursuant to section 944(b)(3) of the Bankruptcy Code, and be enforceable in accordance with their terms.

In addition, footnotes 4 and 5 were added. Footnote 4 states:

Adversary Proceeding. ECF No. 483, Decision and Order, dated May 24, 2018, at 5-6,Exhibit DX-TT (“the Court must decide what the relevant property rights are within the context of these Title III proceedings, under PROMESA and federal bankruptcy law provisions that Congress has incorporated into PROMESA . . . .[T]he Commonwealth-COFINA Dispute presents a mixed question of federal and Puerto Rico law”). See also Abboud v. Ground Round, Inc. (In re Ground Round,Inc.), 482 F.3d 15, 17 (1st Cir. 2007) (“The label … that state law affixes to a particular interest in certain contexts is not always dispositive.” (citingIn re Nejberger, 934 F.2d 1300, 1302 (3d Cir. 1991)).

Footnote 5 states:

Section944(b)(3) requires the Court, as a condition to providing a discharge, to determine the validity of obligations imposed under a plan of the debtor and of any provision made to pay or secure payment of such obligations. 11 U.S.C. §944(b)(3). See generally In re City of Stockton, 526 B.R. 35, (Bankr. E.D. Cal.2015) (“The structure of the federal-state relationship . . . regarding restructuring of municipal debt is dictated by the U.S. Constitution. . . .[T]he Supremacy Clause operates to cause federal bankruptcy law to trump state laws, including state constitutional provisions, that are inconsistent with the exercise by Congress of its exclusive power to enact uniform bankruptcy laws”(citing Ass’n of Retired Employees of the City of Stockton v. City of Stockton(In re City of Stockton, CA), 478 B.R. 8, 14–16 (Bankr. E.D. Cal. 2012); U.S.CONST. art. VI, cl. 2; Int’l Bhd. of Elec. Workers, Local 2376 v. City of Vallejo (In re City of Vallejo), 432 B.R. 262, 268–70 (E.D. Cal. 2010), aff’g403 B.R. 72, 76–77 (Bankr. E.D. Cal. 2009) (additional citations omitted)). As set forth in the leading bankruptcy treatise: “The requirement of a court determination of validity is extra assurance for those who might be skittish about the nature of the bonds being issued . . . . It has the added feature of removing any doubt concerning the matter, because the determination of the court on that issue should be binding in the future.” 6 COLLIER ON BANKRUPTCY §944.03[1][b] ((16th ed. 2013). See, e.g., Order Confirming Third Amended Plan for the Adjustment of Debts of the City of San Bernadino, California, as Modified by the Court, dated February 7, 2017, ¶ 22 (“In accordance with Section 944(a) and notwithstanding any otherwise applicable law, upon the occurrence of the Effective Date, the terms of the Plan and this Confirmation Order shall be binding upon . . .”); Order Confirming Eighth Amended Plan for the Adjustment of Debts of the City of Detroit, dated November 12, 2014, ¶ 86(“ in accordance with section 944(a) of the Bankruptcy Code and notwithstanding any otherwise applicable law, upon the occurrence of the Effective Date, the terms of the Plan and this Order shall be binding upon, and inure to the benefit of . . .”); Findings of Fact, Conclusions of Law, Order Confirming the Chapter 9 Plan of Adjustment for Jefferson County, Alabama, dated November 6,2013, ¶ 37, (“Pursuant to Bankruptcy Code sections 1123(a), 1123(b), and 944(a), as well as general principles of federal supremacy, the provisions of this Confirmation Order, the Plan, and related documents or any amendments or modifications thereto shall apply and be enforceable notwithstanding any otherwise applicable nonbankruptcy law”).

In essence, the COFINA bondholders and the Board are legalizing the COFINA bond issues, the COFINA ownership of part of the SUT and changing the Constitution by making this portion not available resources pursuant to Article VI, section 8 of the PR Constitution. Judge Swain saw this and as a former bankruptcy judge, is well aware of the case law cited by them.Moreover, the problem I see with this attempt is that there has been no actual adjudication of a case or controversy as to COFINA. Rather, it is all done via settlement. Furthermore, the U.S. Supreme Court in Raleigh v. Illinois Dept of Revenue, 530 U.S. 15, 20 (2000), held that “[t]he basic ‘federal rule’ in bankruptcy is that state law governs the substance of claims, Congress having ‘generally left the determination of the property rights in the assets of bankrupts estate to state law.’” Will Judge Swain refuse to sign the agreement because she cannot change PR’s Constitution or will just shrug and do it? If she does not sign it,what will the Board and COFINA Ad Hoc bondholder do? Judge Swain cannot change the Plan of Adjustment but she does not have to approve it either. The alternative is dismissal via 11 U.S.C. § 930. I have no idea what Judge Swain will do but this is something to ponder.

Also of interest is proposed Order And Judgment Confirming The Third Amended Title Iii Plan Of Adjustment Of Puerto Rico Sales Tax Financing Corporation, which states at pages 27-28:

Releases by COFINA  and Reorganized COFINA. Except as otherwise expressly provided in the Plan, this Order, or the Settlement Agreement, on the Effective Date, and for good and valuable consideration, each of COFINA and Reorganized COFINA, the Disbursing Agent and each of COFINA’s and Reorganized COFINA’s Related Persons (other than any former elected or appointed officials, directors, or officers of any of the Government Parties and the Commonwealth, in each case acting in his or her capacity as such prior to January 1, 2017)3 shall be deemed to have and hereby does irrevocably and unconditionally, fully, finally and forever waive, release, acquit, and discharge the Released Parties from any and all Claims or Causes of Action that COFINA, Reorganized COFINA, and the Disbursing Agent, or any of them, or anyone claiming through them, on their behalf or for their benefit, have or may have or claim to have, now or in the future, against any Released Party (other than any former elected or appointed officials, directors, or officers of any of the Government Parties and the Commonwealth, in each case acting in his or her capacity as such prior to January 1, 2017) that are Released Claims or otherwise are based upon, relate to, or arise out of or in connection with, in whole or in part, any act, omission, transaction, event or other circumstance relating to COFINA taking place or existing on or prior to the Effective Date, and/or any Claim, act, fact, transaction, occurrence,statement, or omission in connection with or alleged or that could have been alleged in the Actions, the Related Actions, including, without limitation, any such Claim, demand, right, liability, or cause of action for indemnification,contribution, or any other basis in law or equity for damages, costs or fees; provided, however, that, notwithstanding anything contained in the Plan to the contrary, “Related Persons” shall not include any financial advisors, investment bankers, underwriters, attorneys, accountants, agents and professionals of the Commonwealth and COFINA, solely to the extent of services provided in connection with the issuance of the Existing Securities; and,provided, further, that the plaintiffs in that certain adversary proceeding before the Title III Court, captioned Cooperativa de Ahorro y Credito AbrahamRosa, et al. v. Commonwealth of Puerto Rico, et al., Adv. Proc. No. 18-00028,shall be entitled to continue pursuit of such litigation against all parties other than COFINA and Reorganized COFINA, subject to all available rights and defenses with respect to claims and causes of action asserted therein.

This is interesting because Judge Swain questioned during the hearing why she had to give officials a waiver. The Board and AAFAF changed it and they are now NOT immune. Interesting. Also, the Cooperativas mentioned above had objected to the COFINA deal because it affected their case. Now, it will not affect it, especially since the Board has already filed a motion to dismiss. Let’s see what happens. 

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.