Saturday, June 15, 2019

Swain’s World: First Circuit Ruling Delays P.R.’s GO Debt-Adjustment Plan

By on February 28, 2019

Editor’s note: The following originally appeared in the Feb. 28 – March 6, 2019, issue of Caribbean Business.

What are the implications of the ruling by the First Circuit Court of Appeals on the Government of Puerto Rico’s Title III case? It will not only delay a debt-adjustment plan for the commonwealth’s $16 billion general-obligation (GO) debt but may also lead to a new and conservative Financial Oversight & Management Board that could even decide to file a dismissal of the island’s bankruptcy petition.

Those were just some of the scenarios presented by lawyers during the Third Promesa Forum that discussed the repercussions of the Boston court ruling that declared the Oversight Board was unconstitutional because its members were not appointed as established by the Appointments Clause of the U.S. Constitution, which empowers the president to nominate officials for appointment with the advice and consent of the Senate. The First Circuit Court of Appeals upheld the federal law Promesa, the Puerto Rico Oversight, Management & Economic Stability Act, and the bankruptcy cases but allowed for a period of 90 days to rectify the problems with the board’s appointments.

Oversight Board members were not appointed by former President Obama but were chosen from various lists produced by the majority and minority parties in Congress.

Zachary H. Smith, a partner & chair of bankruptcy and restructuring at Moore & Van Allen PLLC, said the Appeals Court first looked at the Territorial Clause, which gives Congress plenary powers over incorporated and unincorporated territories, and tried to square that authority with the Appointments Clause to conclude that the appointment of the Oversight Board members still requires the advice and consent of the Senate.

The court also looked at whether board members were federal or territorial officers. Although Promesa says the board is an entity within the territorial government, “the court looked past those labels” to conclude they were federal officers operating under a federal law. It also looked at the relationship between the commonwealth and the Oversight Board. “The commonwealth cannot overrule the board. It has the power to approve budgets…the power to put covered entities under Title III [of bankruptcy]. The court really did not have much difficulty concluding that members of the board were federal officers,” he said.

The court also evaluated who has the power to terminate board members and whether they are inferior or principal officers. “They answer directly to the President,” he said.

What happens now? John Mudd, a bankruptcy lawyer, said the Oversight Board has 90 days to ask the U.S. Supreme Court to revise the Appeals Court ruling. However, he noted that the Supreme Court only sees 80 out of 10,000 petitions. One of the options is for President Trump to appoint a new board so it can be confirmed by the Republican-dominated Senate. The new board will remain in place until 2022. “The board will probably not be very deferential to the commonwealth. It could be more conservative…. It could even go and say, ‘I don’t think we need Title III,’ and dismiss it for cause…. A new board may also decide to overturn any decision made by the previous board. It can say we should not pay pensions,” he said.

The 90 days given by the Appeals Court to validate the Oversight Board are slated to expire May 16, but in the meantime, it can continue to operate as it has done so far. The current board must approve a new commonwealth fiscal plan in April.

What happens after May 16 when the 90 days are up? “They can continue to act, but since they do not exist, they can’t do anything,” Mudd said.

If the District Court sees no movement in the case after some period, the judge may dismiss it.

How will the decision impact the commonwealth’s restructuring of its debt? Both Mudd and Smith said the ruling delays the debt adjustment plan. Smith noted there cannot be a debt-adjustment plan until there is a decision regarding a request from the board’s Special Claims Committee and the Unsecured Creditors Committee to repeal $6 billion in GO debt because it violates the Constitution’s balanced budget clause and the limitations on the level of the debt. “There is another pleading asking the court to set omnibus procedures to deal with this objection,” he said, noting that the request is slated to cause more delays.

The petition seeking the repeal of $6 billion in debt appears to have also had an impact on the mediation process because some creditors told Judge Laura Taylor Swain that the timing of the objection coincides with negotiations to settle the debt.

What can the board do in the 90 days it has left? Mudd said there may be new filings, including rumored bankruptcy petitions from the Puerto Rico Aqueduct & Sewer Authority and the University of Puerto Rico. UPR President Jorge Haddock said last week that UPR’s budget was balanced.

Where is all the rounding cash?

The settlement rounding cash, which was supposed to be used to iron out these shortfalls, was inexplicably distributed on a pro-rata basis from Depository Trust Co. to each nominee or custodian. “So, if a hedge fund received $1.2 billion in new Cofinas, out of the total settlement distribution of $12 billion, then they also received 10 percent (the same ratio as bonds received) of the rounding cash. This large cash transfer took place although it only requires $999, at most, to round up or down to $1,000. To allocate rounding cash on a pro-rata basis was ridiculous and should be clawed back from large holders, because this cash should have been allocated based on rounding needs, not ownership size,” said Glenn Ryhanych, CFP, CFA & president of BlueList Partners LLC.

“Who is responsible? Shame on all of the large-money funds and their advisers for pushing this scheme through. And, the Puerto Rico control board, commonwealth government and the Title III court are not blameless,” he said.

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