Monday, June 24, 2019

Swain’s World: Puerto Rico Fiscal Board Files $392M in Claims Against ERS Bondholders

By on May 23, 2019

Sues Gov’t Suppliers, for $119M, that HTA Presumably Paid Without a Contract

Editor’s note: A version of the following was first published in the May 23 -29, 2019, issue of Caribbean Business.

The Financial Oversight & Management Board (FOMB) recently filed a slew of claims against bondholders of the Employees Retirement System (ERS) to recover some $392 million in aggregate payments and also sued government suppliers to the ERS and Highways & Transportation Authority (HTA) to recover $119 million presumably because there was no contract.

The Financial Oversight & Management Board (FOMB) recently filed a slew of claims against bondholders of the Employees Retirement System (ERS) to recover some $392 million in aggregate payments and also sued government suppliers to the ERS and Highways & Transportation Authority (HTA) to recover $119 million presumably because there was no contract.

The FOMB had to file the claims by May 20, which marked the end of a two-year statute of limitations to file avoidance claims by the ERS and HTA.

One vendor the FOMB sued was Transcore Atlantic, which was accused of receiving an allegedly illegal transfer of $119 million in funds because the entity had no written contract registered with the Commonwealth Comptroller’s Office.

However, the contract is not only registered with the Comptroller’s Office but there also is a civil action in federal court involving the company that discusses at length the contract signed in 2003. The contract was for the operation and implementation of a toll collection center and management of a customer service center. In 2015, the company had a dispute with the HTA over ownership of the customer service center.

The FOMB also sued GILA LLC for $31 million, contending there was no contract. However, GILA was involved in a very public dispute in 2018 with the HTA and was pondering cancelling its contract signed in 2015 over deficiencies in the collection of fines involving AutoExpreso.

The actions filed by the FOMB intend to recover interest and principal from bondholders who own at least $2.5 million worth of bonds that the FOMB said the ERS was “never authorized” to issue to the public in 2008 because the issuance was not submitted to the Legislature. The panel said in a statement it does not intend to pursue litigation until the court determines the bonds are invalid.

The fiscal board’s executive director, Natalie Jaresko; member Ana Matosantos; and Chairman José Carrión (CB file)

“The people of Puerto Rico should not have to pay for bonds that were issued illegally,” said David Skeel, a member of the FOMB’s Special Claims Committee. “Nevertheless, no holders of smaller amounts of bonds will have to pay back any principal or interest.”

The complaints against the vendors would allow the FOMB “to ensure about $190 million in payments to vendors were made appropriately” but the board will try to settle disputes out of court. The identified vendors received payments of more than $2.5 million “without a valid contract, or the payments [did not] match the respective contract” during the four years before May 2017, when the board filed for bankruptcy on behalf of the commonwealth, the HTA and the ERS.

Critics of the lawsuits have said lawyers get paid thousands of dollars to precisely ascertain the existence of a contract to avoid putting people in the position of having to defend themselves in court. The costs of the bankruptcy cases are very much an issue with the fee examiner.

Fee examiners recently raised the alarm about a petition filed in U.S. District Court by the FOMB that seeks to extend the 90-day term to serve more than 1,200 defendants sued in relation to up to $6 billion in commonwealth general-obligation (GO) bonds whose legality have been challenged.

The petition is “duplicative,” and its cost would be “significant,” said a motion signed by Eyck O. Lugo Rivera, a lawyer for fee examiner Brady Williamson.

The FOMB’s Special Claims Committee, as well as the Unsecured Creditors Committee, earlier this month filed hundreds of adversary proceedings to challenge the issuance of the $6 billion in GO bonds or to seek to recover money illegally paid to government suppliers.

Cate Long, a former reporter now investigating debt, challenged the FOMB to claw back the more than $7 billion given in incentives to companies. She published a contract granted to Lufthansa in which the Puerto Rico Industrial Development Co. awarded the company up to $40 million in construction incentives to build hangers. The P.R. Industrial Development Co. also provided $11 million in incentives to General Electric from an Economic Development Fund to build a Center for Excellence. “Shouldn’t this be clawed back if P.R. were truly insolvent?” she asked via Twitter.

The Bankruptcy Code, however, does not list tax incentives as a type of “illegal” transfer that could be clawed back.

Was PayGo established to circumvent ERS debt?

In an unusual development, the FOMB is attempting to stop lawyers representing bondholders of the ERS from bringing into evidence the contents of a 2016 meeting with Jim Millstein—a former adviser to the commonwealth under former Gov. Alejandro García Padilla—who said the change from the current system to PayGo was done to circumvent ERS obligations to bondholders.

The bondholders, mostly hedge funds, are seeking adequate protection to stop the commonwealth from reducing their collateral in a case that goes back to 2017 and in which the First Circuit gave them the go-ahead to pursue their claim.

Two lawyers, Bruce Bennett, of Jones Day, and John K. Cunningham, of White & Case LLP, which are representing the bondholders, have submitted sworn declarations stating that Millstein informed them that the commonwealth could begin taking steps to establish a new means to make pension payments to circumvent ERS obligations to holders of bonds issued by the ERS in 2008 and he referred to the new system as a “pay as you go” system. The transformation of the ERS into a PayGo system was eventually approved by the Legislature.

The government contends the request of ERS bondholders is irrelevant for adequate protection and would do more damage. They also say the collateral no longer exists.

“Missing from the record of this case—and, thus far, from the overall dispute about adequate protection—is competent evidence explaining one of the great mysteries of this bankruptcy, namely, how did billions of dollars of present value and billions more of future payments somehow disappear from the ERS in what appears to have been a legerdemain [sleight of hand] to deprive ERS bondholders of their constitutionally guaranteed property rights in this very property? And, similarly, how did it happen that when the dust cleared, a new, nearly identical pension system—called “PayGo”—spontaneously appeared and received the same stream of contributions from the same employers as had the old ERS, paying benefits to the same population of public employees as the ERS did, seems to have used the same formulas to calculate the amount of employer contributions as the ERS did, and used the same actuarial and other methods to determine the benefits due to retirees?” the bondholders said in a response.

“How is it that the current owners of ERS property can escape perfected liens that follow transferred collateral under Puerto Rico law? These are not idle questions: The debtors now claim there has been no diminution in the value of the bondholders’ collateral because, thanks to the two legislative enactments that created PayGo, the bondholders simply no longer have any collateral at all and, therefore, a fortiori, there is nothing of value to be diminished in the first place. Putting to one side the cynicism of this argument, it raises more questions than it answers. Who, for example, thought up this idea, and when did they do it?” they asked.

Ironically, the commonwealth and Unsecured Creditors Committee contend the ERS bond issuance from 2008 is illegal because it was not approved by the Legislature and the ERS did not have the authority to issue debt.

New Progressive Party Rep. Lourdes Ramos said there is no need for the FOMB to spend money trying to prove that the $3 billion bond issue is illegal because she investigated the matter and put the contents of her probe at the FOMB’s disposal.

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