May 1: Days Away
Obviously, the situation between bondholders and the government is very fluid, but below is a quick recap of where things stand at the time of this writing.
Reports are that on April 13, 2017, mediation began between P.R., the Supervisory Board, and GO and Cofina bondholders. It has been reported that bondholders will be offered 50%-60% of their holdings. On the other hand, these bondholders are reported to want at least $1.4 billion and up to $2.5 billion. Accusations have flown that the government’s representative to the Supervisory Board, Elías Sánchez, and the governor himself, violated the mediation terms. And now reports are emerging that the government, facing the prospects of a long war in the courtroom, which could undermine its political aspirations, is pushing forbearance agreements to stave off a May 1 Title III process.
First, we need to look at the numbers. The numbers desired by bondholders do not conform to what the amended Fiscal Plan (April 18, 2017) states on pages 26-28, where it deals with debt service and the amounts available for that service. If we look only to Cofina (the Sales Tax Financing Corp.) and the GOs (general-obligation bonds) debt service for the next 10 years, we can see that in seven of the 10 years, as illustrated below, 50% of these two payments would exceed the amounts available to service the totality of the debt. This means that not only would there not be enough money to pay these two bond groups, but there also would not be any money left over to pay ANY other creditor. Should the governor and the Supervisory Board wish to stave off a Title III process, and protect credits held by locals like Cofina, they will have to get serious about actually addressing these incongruities with the numbers.
Mediation is not negotiation
While the government said last week that it asked bondholders to submit offers during the mediations process, it is still important to remember that mediation was not what bondholders wanted or what Promesa legislated. Mediators must be neutral and Judge Gropper cannot be perceived as such. Bondholders wanted face-to-face negotiations as required in Promesa but apparently the board will not grant them.
Numbers do not lie and, if the rumors of the 50%-60% offers from the government and expectations are true, there will not be any agreements. Matt Fabian wrote a report for Municipal Market Analytics where he posits that local bondholders, who mostly hold Cofina subordinate, Public Finance Corp. (PFC) and Government Development Bank (GDB) bonds, will recover very little of their investment and could come in as little as single digits. Moreover, Richard J. Cooper and Luke A. Barefoot—both partners of Cleary Gottlieb who represented the García Padilla administration and were oddly retained by the Rosselló administration—argue in an article in Law360 that P.R.’s taxing power debt is too complicated to be restructured under Title VI, and a Title III filing is proper.
As for Judge Gropper, one has to consider whether he fully understood what he signed up for. It will take him time to understand everything. There are significant legal questions on the validity of the Cofina arrangement and its long-term debt schedule (estimated as high as $50 billion, which remains to be paid). Moreover, Judge Gropper is not an expert on P.R. law, which is vital to understand the Cofina/GO controversy. In addition, the board has been intent on postponing the decision on the issue by staying the Lex Claims litigation.
Lex decision is inevitable
The board and P.R. government have been trying everything to prevent Judge Besosa from deciding the issue of Cofina v. GO issues presented in the Lex Claims case. Since a decision on those issues would simplify any negotiations, the question is why? Could it be that almost $10 billion in Cofina subordinate bonds are locally held? Could it be that board member Carlos García issued a large amount of those bonds and would be embarrassed by a judicial decision that Cofina is invalid?
All this validates my position that the board, and seemingly the P.R. government, do not care for good-faith negotiations since they know bondholders will not agree to the deep cuts it has placed on the Fiscal Plans. It seems their original plan was to fake the negotiations and go straight to Title III, and that is exactly what they are doing. Since Section 304 of Promesa prohibits the court from dismissing the petition in the first 120 days of the filing of the petition, the board figures it has four more months to attempt to mediate the controversies before it has to file its bankruptcy plan. The government’s half-hearted efforts to get bondholders to execute forbearance agreements to forestall Title III make no mention of what the board may do, and do not preclude Judge Besosa from deciding the cases before him after May 1, 2017. The P.R. government needs to substantially increase payment to bondholders to convince them to forbearance and any Title VI restructuring.
Challenges with Title III
Moreover, if the board decides to pay Cofina and GOs but does not pay other bond claimants a penny, it makes approval of any bankruptcy plan very dicey. Section 312 of Promesa entrusts the board with the filing of the bankruptcy plan, which must divide creditors into classes. Those classes that are impaired get to vote for the approval of the plan and, if you are not getting any or substantially any money in your debt, you can be assured they will not approve it. If the classes do not approve the plan, the court may still approve it by a cramdown via Section 314(c) of Promesa.
The problem is that in the history of Chapter 9, from which Title III is modeled, there has never been a cramdown. In addition, at least one class has to approve the plan and must do so fairly and equitably with respect to the impaired classes. In addition, the plan must comply with Section 314(b) of Promesa, which includes the requirement that “the plan is feasible and in the best interest of creditors, which shall require the court to consider whether available remedies under the nonbankruptcy laws and Constitution of the territory would result in a greater recovery for the creditors than is provided by such plan; and the plan is consistent with the applicable Fiscal Plan certified by the Oversight Board under title II” [314(b)(6) and (7)]. Since it is probable that bondholders would receive more outside of Title III, this does not favor any bankruptcy plan. In addition, many bondholders have already questioned that the Fiscal Plan is not consistent with Promesa, which will bring more litigation despite the wild claims made by some parties that the plan is not subject to judicial review.
What happens if the bankruptcy plan presented by the board is not approved and the judge refuses a cramdown? Section 930 of the Bankruptcy Code, adopted in Promesa in Section 301, allows the judge to dismiss the petition. And then what? Federal Court litigation from bondholders seeking to get paid. Pure bedlam.
Finally, a cramdown of bondholders would simply not be tolerated by Congress. This was already made clear by Sens. Cotton and Tillis in a strongly worded letter to the Supervisory Board. It will not sit idle while the Supervisory Board steals money from U.S. American taxpayers and investors. I doubt the board has thought this whole thing over from a political perspective, especially since Promesa is an experiment to see if Congress approves a bankruptcy law for the States.
Any Hope Left for negotiated restructuring?
It is possible that the government could prolong its chances of achieving a Title VI solution by entering into a forbearance agreement with creditors. Doing this might be important for the governor—remember that he promised many times to reach a negotiated settlement. Sticking to that promise would go a long way toward dispelling the notion that his administration is acting like the previous one, or even like Argentina. Moreover, if the administration is not seen as having been serious about Title VI, that may not be warmly received by a judge during the Title III process.
However, to get there, bondholders will need to feel the government is demonstrating progress in addressing their concerns. That means the government will likely have to both acknowledge and actually take some action on the huge discrepancy between the numbers in the fiscal plan and what is due for debt service. There will also have to be some demonstrated willingness to negotiate, which would mean responding to any offers that might have been received from bondholders during the mediation process.
Let’s see what happens.
—John Mudd is an attorney & legal analyst in Puerto Rico with more than 30 years of experience. He is admitted to practice law in P.R., the U.S. District Court for P.R. and the First and Fourth Circuit Courts of Appeals. He has been analyzing the possibility of a control board for P.R. for more than three years. Follow him on Twitter @MUDDLAW and on his blog at www.johnmuddlaw.com.