The First Frontier: Chapter One in Creditor Wars
SAN JUAN — When the Puerto Rico government announced it would be heading down the bankruptcy path, the sign was on the wall for a battle royale between creditors, the commonwealth and the island’s financial control board.
After a month and a half since the first Title III bankruptcy filing on May 3, hundreds of motions, a who’s who of law firms and over a dozen adversary proceedings have flooded court dockets and federal bankruptcy Judge Laura Taylor Swain’s desk.
Puerto Rico’s debt crisis pits creditor against creditor upon creditor against the government and the seven-member fiscal panel created by the federal Promesa law. With four Title III bankruptcy proceedings already underway—including the island’s two largest creditor constituencies—the shootout is on the level of conflicts waged above the stratosphere where the ultimate threat hinges on mutually assured destruction of the Star Wars ilk.
The latest episode in the island’s debt saga is more than just Sales Tax Financing Corp. (Cofina by its Spanish acronym) and general-obligation (GO) creditors locking horns—an intercreditor clash expected to continue for months to come. Other disputes and claims will also prove challenging, including actions taken by certain creditor groups that seek to lift the stay applicable under Title III, arguing they have to be paid as they have valid liens over “special revenues” that are being redirected, or “clawed back,” by the government.
Puerto Rico recently warned that it may need to “borrow” money as soon as November to meet spending levels set forth under its 10-year fiscal plan that the board certified in April. Specifically, it seeks to tap into Cofina’s pot of gold—over $730 million in sales tax money that secures annual debt service of these bonds.
Meanwhile, Judge Swain’s appointment of five federal judges to act as mediators in Puerto Rico’s bankruptcy cases marks the beginning of yet another effort to strike agreements that could pave the way for the restructuring of a large chunk of the island’s $73 billion debt and over $40 billion in unfunded pension liabilities.
The U.S. Trustee in charge of Puerto Rico’s bankruptcy cases also appointed this week committees for unsecured creditors and retirees that will be in charge of representing and negotiating in favor of these groups.
The all-important GO-Cofina battle
One question that could define the future of Puerto Rico’s bankruptcy is whether the commonwealth can tap into sales-tax revenues that secure payment of Cofina bonds. Cofina creditors argue these pledged funds are off-limits for the commonwealth, while GOs claim the money belongs to the commonwealth and is thus available to cover payments of their debt as well as government operations.
Judge Swain has already stated solving this conflict is a priority in the commonwealth’s Title III case. She scheduled deadlines for the filing of motions and deciding related matters, while ordering the Bank of New York Mellon—the trustee in charge of making payments to Cofina bondholders—to halt interest payments due on this debt for the time being.
Then there is the mediation committee, which in parallel with Title III proceedings, will seek to “facilitate confidential settlement negotiations of any and all issues and proceedings arising in these cases,” according to a June 14 order.
All told, Judge Swain seeks to solve the controversy by year’s end, with an Oct. 6 deadline for motions before deciding whether a trial is to be held.
“There is an October deadline by the court to make a decision on the Cofina and GO [matter], and payment priority. We are working in tandem with the board to establish a process in which we could go back to the table and negotiate in good faith,” Financial Advisory & Fiscal Agency Authority (FAFAA) Director Gerardo Portela recently told Caribbean Business.
The island’s fiscal agent was referring to the board’s June 10 motion, in which it asks the court to appoint independent agents for Cofina and the commonwealth, in consultation with representatives for the two creditor constituencies. It seeks to quickly address the dispute once agents are appointed, with a Nov. 1 deadline to solve the GO-Cofina conflict.
“If there is no settlement or final adjudication as to the commonwealth-Cofina dispute by Nov. 1, 2017, the commonwealth will likely need to borrow funds from Cofina to fund the commonwealth’s operating budget,” the board warns in its motion.
For attorney and political analyst John Mudd, the board wants “to do away with what the judge had ordered [in the Cofina-GO dispute]. It could probably be the first time you will see a clash between the board and Judge Swain.” He added that were the court to designate independent agents, as suggested by the board, the latter would be able to take a position on the matter.
“The board is thinking that [Cofina] revenues belong to the commonwealth,” said Mudd, who warned that the commonwealth would not necessarily use that money to pay GOs more.
Meanwhile, on June 7, a group of mutual funds holding Cofina bonds asked Judge Swain to turn to the Puerto Rico Supreme Court and have it decide the validity of the sales tax-backed structure and whether pledged monies are available for the commonwealth. However, the board has warned it will argue against this course of action.
According to the board’s June 10 motion, Cofina creditors and stakeholders comprise UBS, the Mutual Fund creditor group, Cofina senior bondholders and monolines Ambac and National. On the GO side, there is the Ad Hoc Group of GO bondholders and bond insurers Assured, FGIC and Syncora.
While the oversight board and the government state they have not taken a side in the conflict, the fiscal plan assumes Cofina revenues will be available cash for the commonwealth moving forward.
“Should the Cofina structure be determined to be valid, almost the entirety of the funds available for debt service may need to continue to flow to those creditors, leaving very little recovery to creditors of the commonwealth,” reads the board’s June 10 motion.
A possible settlement?
As the commonwealth grapples for funds come November, some sort of settlement could be struck between the government and any of the two major creditor constituencies, or a third party, as well, in exchange for a lien or pledge over some revenue stream, including sales-tax money.
Before Judge Swain’s appointment of the mediation team, two sources on Wall Street told Caribbean Business a settlement could very much be done by November, in which the government receives much-needed financing, particularly given the complexity of litigation and the time it could take to solve the GO-Cofina dispute.
“These issues will take time. They are going to be litigated by everyone. They are going to look for evidence. The decision will be subject to appeal. This could go all the way up to the U.S. Supreme Court,” said one of the sources, who added that it is likely Judge Swain will move to influence a settlement.
FAFAA’s Portela said he could not comment on what may happen in November, as it is subject to a pending legal proceeding.
Another source said a settlement involving Cofina could see the latter being adequately protected by the commonwealth—most likely through interest payments—if the deal involves pledged sales-tax revenues.
As the GO-Cofina fight ensues, other creditors are seeking to establish they have a valid lien over special revenues that secure payments of their bonds.
The disputes mostly center on the question of whether a full-fledged statutory lien and pledge exist over these revenues, and if so, are these creditors being adequately protected by the commonwealth, as it claw backs these monies. If creditors are not adequately protected, the stay under Title III could be lifted for them and they could seek to enforce their liens.
FAFAA said it would not comment on matters related to special revenue bonds such as the Employees Retirement System (ERS) and Highways & Transportation Authority (HTA), since there are pending legal proceedings over such credits.
A group of ERS bondholders—which own roughly $2 billion in bonds and include Altair, Oaktree, Glendon and funds managed by UBS, among others—recently filed an action in which they seek the court to establish their lien and grant them relief from the stay for not being adequately protected.
The group alleges the government ceased to transfer money to pay interest, and will continue to do so, as it would withhold its contributions for its public employees’ retirement, thus wiping out its collateral. ERS bonds are backed by the government’s employer contributions.
Yet, one source believes ERS creditors “are mostly unsecured creditors” and have a weak case in establishing a lien that could give way to lifting the stay. Mudd believes otherwise, given the commonwealth’s previous statements made in court to the effect that ERS bondholders had a lien. Moreover, these creditors had previously reached a settlement with the government that allowed for the set aside of these revenues and future interest payments.
On the HTA side, there is Peaje Investments, which sued on May 31 seeking an injunction to stop the HTA from allegedly diverting pledged toll revenues, which secure payment of HTA bonds. Three municipal bond insurers also filed similar actions against the authority.
In a nutshells, they all want the commonwealth to stop “clawing back” these revenues, and assert they have a valid lien over these monies.
One source said some HTA bondholders may have a valid lien, specifically those secured by toll revenues, while others may find themselves without one.
Mudd recalled how during a June 5 hearing on the Peaje case, Martin Bienenstock, a lawyer for the board, seemed to suggest that if a creditor has a lien but no pledge, they would not get paid. Mudd also noted that while the government could claw back certain revenue streams that secure debt obligations, it would have to use that money to pay for GOs, under the Puerto Rico Constitution.
“They are not clawing back to pay GOs,” he stressed.
Challenging the fiscal plan
Some creditors have already challenged the validity of the commonwealth’s 10-year fiscal plan and actions taken based on it. After all, an overwhelming majority of creditors oppose the average $780 million a year in available cash to pay debt service during the next 10 years.
Roughly $10.5 billion would actually be needed over the three-year period of 2017-2019 to cover 100% of the current debt service for issuers under the fiscal plan. Thus, the average $780 million annual figure signals a large haircut for these creditors.
On June 15, the warned in a court filing that the certifications it makes as part of its management of the commonwealth government’s finances are not subject to review by a federal court because Promesa says so. It strongly believes challenges by creditor groups over the validity of the island’s certified fiscal plan are preempted by Promesa’s Section 106 (e).
“Most creditors believe the certified plan could cut more expenses. They will challenge whether the plan complies with Promesa and the [Puerto Rico] Constitution,” said one source on Wall Street. Yet, “at the heart of the dispute, is the available cash flow for paying debt.”
Take, for instance, Ambac, a bond insurer, with exposure to several commonwealth credits, including the Highways & Transportation Authority (HTA) and Cofina. On June 9, the monoline filed an action seeking to invalidate the fiscal plan, related legislation and former Gov. Alejandro García Padilla’s moratorium act and related executive orders that now have been extended by Gov. Ricardo Rosselló Nevares.
“Under the guise of fiscal discipline, the oversight board has certified a fiscal plan that escalates and entrenches as the foundation of Puerto Rico’s future the ongoing lawlessness [sic],” reads the bond insurer’s latest action against the commonwealth.
With challenges coming over the fiscal plan, the board would seek to have Judge Swain validate the 10-year blueprint, attorney Mudd told Caribbean Business.
“More importantly, it is to pay what the fiscal plan says should be paid, which is not only debt. For the board, it is more important to fund the government than paying debt,” he said.
On June 28, Judge Swain will hold a so-called “omnibus hearing” in San Juan over Puerto Rico’s Title III cases, including those of the ERS and HTA.
During the hearing, Judge Barbara Houser —who will preside the mediation team— will explain how the mediation process will be conducted.
Judge Swain will also address other procedural matters, motions filed prior to the hearing and some of the board’s latest requests, which include the application of the automatic stay to government officers, agents and representatives, as well as creditor lawsuits filed against the commonwealth before the Title III petition.
Also on agenda are arguments over Altair’s petition for stay relief and adequate protection related to ERS bonds. Also to be addressed that day is whether independent representatives for Cofina and the commonwealth will be appointed, as solicited by the board.
Meanwhile, on the HTA’s Peaje suit, sides are expected to engage during the next few weeks in a discovery process, leading to an Aug. 8 hearing on the dispute.
Mudd warned challenges to the board’s Title III filings could also be in the works, as some creditor groups have already signaled they would do so, once a 120-day term that impeded the filing of such actions, expires in September.
“There won’t be anything important being decided until December, at the earliest,” said Mudd, who believes a solution to the whole bankruptcy case could take years.