Monday, November 18, 2019

Judge Swain Warns Ruling is Only on Disclosure Statement

By on November 26, 2018

Editor’s note: The following originally appeared in the Nov. 22-28, 2018, issue of Caribbean Business.

U.S. District Court Judge Laura Taylor Swain has ruled that the 600-page disclosure statement for the debt adjustment plan of the Puerto Rico Sales Tax Financing Corp. (Cofina by its Spanish acronym) was adequate enough to permit bondholders to make an informed decision but emphasized her decision is not a ruling on the substance of the debt adjustment plan.

“This is not a ruling on the substance of the proposed plan…. That will be adjudicated on Jan. 16. Today’s hearing and my ruling only concern the statement,” she said.

The debt adjustment plan has been questioned by some bondholders and political sectors on the island who noted Puerto Rico will be tied to a tax for the next 40 years and will end up paying over $40 billion to settle the $17 billion Cofina debt. Judge Swain’s remarks appear to open the door for possible changes to the plan.

The disclosure statement contains the risk factors of the Cofina deal, a ballot and election instructions to allow bondholders to decide on the restructuring plan.

Brian Rosen, a lawyer representing Cofina and the government, said the disclosure statement was amended Nov. 16 to provide a question-and-answer section, among other things, to make the document clearer.

(Screen capture of www.bnymellon.com)

Three entities and two individual bondholders filed objections to the disclosure statement. Three of the entities, the Bank of New York Mellon (BNY Mellon), four credit unions and Lehman Brothers all dropped their objections to the disclosure statement but said they may still oppose the debt adjustment plan itself.

While the hearing was only about the adequacy of the disclosure statement, a Cofina junior bondholder raised some strong objections to the deal itself.

Lawrence Dvores, a Cofina junior bondholder, complained that junior bondholders were not given adequate representation in the negotiations and that while senior bondholders will get 93 percent of what they invested, junior bondholders will only get half of the value of their bonds. “We also learned that the agreement will allow senior bondholders to get the shared collateral. What happens to the junior bondholders?” he asked. Mediation parties who agreed to negotiate and sign the restructuring support agreement would receive consideration for their efforts based on their holdings as of Aug. 7. That consideration is 2 percent to be set aside in the form of bonds or cash.

Dvores noted that the situation with the deal is a problem with the bankruptcy itself. “What is needed today is an acknowledgment that this process was flawed since the beginning,” he said. At the time Cofina filed for bankruptcy, it was solvent and paying bondholders. In the past, the Financial Management & Oversight Board (FOMB) has said it put Cofina in bankruptcy because it represented 25 percent of the total debt.

Dvores questioned the reasons for the sales & use tax to be divided between commonwealth and Cofina bondholders when Cofina bondholders have a lien on the tax and blamed the whole mess on the court for not ruling on the legality of Cofina itself. The negotiation between general-obligation (GO) and Cofina bondholders “left junior bondholders in the cold.”

Dvores blasted the Oversight Board for not doing enough to force Puerto Rico to manage its finances. “Puerto Rico has the opportunity to become the diamond of the Caribbean if it has good management…. They do not need to pick on people who have invested in good faith,” he said.

A recent report by Caribbean Business noted that court documents show most of Cofina’s senior bondholders are also holders of junior bonds, which could have influenced the negotiation.

Rosen said in court that bondholders representing $10 billion in Cofina bonds are in agreement with the debt adjustment plan.

Regarding the status of Cofina, Rosen said there are 3,478 claims against Cofina. “We intend to file 11 omnibus objections to 3,100 claims,” he said.

Asked about aspects that may affect the plan, Rosen revealed that in the commonwealth fiscal plan certified Oct. 23, the Oversight Board discovered an error in the projected pension payments. “We will have, prior to Dec. 7, information on the magnitude of the pension forecast,” he said, adding that it was a commonwealth issue and not a Cofina issue.

However, the debt adjustment plan calls for the general fund to make payments that Cofina is unable to pay.

Nonetheless, some of the entities dropped their objections to the disclosure statement.

In court documents, Lehman Brothers Holdings Inc., as plan administrator for Lehman Brothers Special Financing Inc., had asserted that the statement failed to describe Lehman’s contract rights under a Debt Service Deposit Agreement (DSDA) among Cofina, Lehman, and the Bank of New York, dated July 1, 2008, and how the DSDA and claims resulting from it will be under the restructuring plan. Lehman also said the plan provides for third-party releases, including for the trustee, of all claims and causes of action but Lehman says it has certain claims against the Bank of New York.

Rosen said the disclosure statement notes that the DSDA remains an executory contract and will be deemed rejected. Consistent with the proof of claim filed by Lehman, the claim will be treated as unsecured.

In response to the other objection raised by Lehman Brothers, Rosen pointed out that the revised plan does not provide for third-party releases, including for the trustee. He did say the commonwealth will be released from claims resulting from the deal.

On the other hand, lawyers for BNY Mellon, as trustee for the existing Cofina securities, said the disclosure statement did not provide a legal basis for the payment of consummation costs to selected institutional investors only, from the holders’ shared collateral. The BNY Mellon was talking about a $332 million payment to be made to certain institutional holders of beneficial interests in the existing securities, which participated in the mediation process and executed the plan’s support agreement.

Rosen said the consummation costs were $135 million. Throughout the disclosure statement, Cofina has described the factual basis for the payment of the consummation costs, including settlement negotiations, entry into the Plan Support Agreement and its amendments, and elimination of multiparty, multifaceted litigation that would likely ensue for years if the plan were not confirmed. The costs also included lobbying of the Legislature for passage of the bill that changed Cofina’s charter law to enable the debt adjustment plan.

“Additionally, the BNY [Mellon] objection simply assumes the consummation costs are being paid from funds that constitute the bondholders’ ‘shared collateral,’ but this is inaccurate. For instance, the funds used to pay the consummation costs could be the Commonwealth’s property or the funds could be unencumbered property of Cofina in the event the bondholders’ purported security interest in such funds is determined to be unperfected and/or avoidable. Accordingly, there is no guarantee that the funds being used to pay the consummation costs would have been distributed to bondholders collectively in the absence of the consummation cost provision,” the government said.

Stephen T. Mangiaracina, a lawyer representing some Cofina retail holders, did not attend Tuesday’s hearing but he also had complained that Cofina junior bondholders were not given equal representation in negotiating the restructuring plan.

“Further, the court’s failure to rule on whether Cofina was validly formed pursuant to the Commonwealth Constitution denies retail bondholders due process,” he said.

Rosen said retail bondholders were represented throughout the process by Bonistas del Patio, a signatory to the amended preliminary support agreement. In doing so, Bonistas looked after the interests of bondholders and was successful negotiating for increased distributions for all “on island” bondholders, he said.

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