Gov’t, Bondholders File Lawsuit Over Fund Distributions

Editor’s note: The following originally appeared in the Dec. 20, 2018 – Jan. 2, 2019, issue of Caribbean Business.

The government and bondholders of the Puerto Rico Sales Tax Financing Corp. (Cofina) have asked the court for an emergency scheduling to resolve a dispute contained in Cofina’s debt-adjustment plan, which is slated to be evaluated in January by the U.S. District Court.

Resolving the dispute is essential for moving forward with the Cofina deal, a source said. Judge Laura Taylor Swain heard the request for time to resolve the dispute at the omnibus hearing which took place Wednesday, Dec. 19.

The dispute is related to Section 19.5 of the plan, which discusses delivery of distributions. The section states that distribution and deliveries to bondholders will be made to their respective addresses. However, the initial distributions of cash by the disbursing agents will be made to the Bank of New York Mellon (BNYM) as trustee of the existing securities, which will then distribute the funds.

The section says that the distribution shall not be stopped on account of lawsuits filed by Whitebox and Ambac, a provision that is at the core of the dispute. Whitebox sued BNYM in New York state court in April 2017 alleging the bank breached its duty as trustee for Cofina debt to protect senior bondholders. Whitebox said BNYM should have accelerated or frozen payouts on Cofina debt after technical defaults by Puerto Rico that began in 2015, including the government’s plan to restructure its debt. The lawsuit was stayed. A similar lawsuit was filed by Ambac Assurance Corp., which was also stayed.

The government wants the court to agree to a schedule to resolve the dispute. BNYM wants the court to determine if it should withhold any amounts of money that it had incurred to defend itself from the lawsuits.

“The Cofina plan provides for the court to determine whether BNYM is entitled to any security from Whitebox or Ambac, in the form of a distribution holdback or a bond being posted for the benefit of BNYM in connection with fees and expenses which may be incurred by BNYM in the defense of the lawsuits, and if such security is warranted,” the government said in court documents.

As a result of discussions with mediators, the Financial Oversight & Management Board as well as the lawyers for BNYM, Whitebox and Ambac, developed procedures regarding consideration of the dispute contemplated in Section 19.5 of the Cofina debt plan, to which all parties had agreed to in September 2018.

The schedule is the following: Jan. 2, 2019, will be the deadline by which BNYM must file any briefs or declarations supporting the amount the bank contends should either be withheld from distributions to Whitebox and Ambac or posted by Whitebox and Ambac pursuant to Section 19.5 of the Cofina plan. It is also the deadline on which Whitebox and Ambac must file any brief or declarations supporting their position that no amounts are required either to be withheld from their distributions.

On Jan. 9, 2019, BNYM must file any responsive papers to the Whitebox and Ambac declarations. Whitebox and Ambac must also file their responses. From Jan. 10 through Jan. 15, 2019, each party can take depositions. Then, on Jan. 16, there will be a hear-ing on the dispute. A confirmation hearing on the Cofina debt agreement is also slated for Jan. 16.




Swain’s World: Cofina Plan of Adjustment One Step Closer to Reality

Editor’s note: The following originally appeared in the Nov. 8-14, 2018, issue of Caribbean Business.

The controversy around the Cofina deal continues. On Nov. 20, Judge Laura Taylor Swain is slated to determine the adequacy of the information in the disclosure statement from the Puerto Rico Sales Tax Financing Corp., known as Cofina by its Spanish acronym. This preliminary step would lead to approval early next year of Cofina’s plan of adjustment and settlement of the Commonwealth-Cofina dispute over ownership of the revenues from the sales & use tax (known as IVU by its Spanish acronym).

However, numerous questions still remain unanswered. The restructuring of Cofina’s $17 billion debt comprises what appears to be two agreements. The first is one in which holders of commonwealth debt and Cofina bondholders will decide how they will distribute the 5.5 percent sales & use tax revenue, with Cofina taking 53.65 percent of the tax each year and the remaining 46.35 percent going to the commonwealth. The second question involves the restructuring of Cofina securities. Cofina senior and junior bondholders would exchange their current bonds for new bonds. In that deal, senior bondholders would get 93 percent of the value of their bonds while junior bondholders would get 56.4 percent. The IVU tax will continue to be collected over the next 40 years and all parties agree not to challenge the deal in court.

However, retail Cofina bondholders have pointed out certain irregularities. Seema Balwada, a Cofina junior bondholder, pointed to the fact that hedge funds have not only acquired senior bonds but are also holders of a significant portion of junior Cofina bonds, which influenced the negotiations to the detriment of those who only hold junior bonds.

Balwada pointed to court documents that show the Senior Cofina Bondholders’ Coalition, comprising investment advisers or managers of funds, held $2 billion in senior bonds and $616.4 million in junior bonds in August 2017. By August 2018, the Senior Cofina Bondholders Coalition held $2.6 billion in senior Cofina bonds and $1.7 billion in junior bonds. The agreement lists numerous hedge funds holding both senior and junior Cofina bonds. Many of them also hold general-obligation (GO) bonds, so it is a win-win situation for them.

Balwada, a financial analyst, told Caribbean Business via email that the agreement seems to cast away the property rights of retail-held junior Cofina bondholders, which were unrepresented in the mediation. “It is difficult for conflicts of interest not to arise when some mediating team members carry both senior and junior Cofina and GO bonds. When hedge funds that are part of the mediation dispute are also trading disputed bonds, it creates suspicions of manipulation. It raises questions whether the seemingly low-ball 56 percent recovery on junior Cofina bonds is an outcome of mediating team members’ profit motives,” he told Caribbean Business.

The agreement also appears to unfairly compensate mediating team members by providing them a $332 million distribution from the Cofina Bond Trustee-held funds and an additional $620 million to senior Cofina bonds, he said. Not only are junior Cofina bondholders being forced to accept a 44 percent haircut, but they are also left out of the Cofina Bond Trustee funds, he added.

Puerto Rican Independence Party Rep. Denis Márquez reiterated that the deal is a negative for Puerto Rico. The deal calls for Cofina legislation, which was recently approved, that would create a new Cofina corporation that will not be subject to constitutional debt limits. These Cofina funds are not considered part of the commonwealth’s available resources but are separate. Any savings in the sales & use tax will have to go to pay debt. “The sales & use tax is compromised for the next 40 years…. For us, there is a reality that the Financial Oversight & Management Board is pushing for this deal and they are here because of our colonial status,” he said.

Meanwhile, the Bank of New York Mellon (BNY Mellon), which is the Cofina trustee, expressed reservations about Cofina’s disclosure statement, which Judge Laura Taylor Swain must evaluate.

“The plan provides that certain institutional holders of beneficial interests in the existing securities, which participated in the mediation process and executed the plan’s support agreement, receive additional compensation over and above that provided to other holders in the same class. This payment is to be made from all holders’ shared collateral. The disclosure statement describes this payment, in the aggregate amount of about $332 million, as compensation for the costs of negotiation, confirmation and consummation of the term sheet and the plan,” the BNY Mellon says.

In its role as trustee for all existing securities, BNY Mellon said it seeks to ensure that holders who did not participate in the mediation process receive disclosure necessary for them to make an informed, intelligent decision with regard to the plan. “The disclosure statement does not explain the basis under Promesa [the P.R. Oversight, Management & Economic Stability Act] and applicable provisions of the Bankruptcy Code for making this payment from holders’ shared collateral to selected institutional holders generally and, more specifically, in the amount of $332 million,” the bank said.

Lehman Bros. also raised issues about the disclosure statement for various reasons, including the fact that the BNY Mellon is released from claims Lehman may have against it. Lehman also says the disclosure agreement fails to say what causes of action Cofina may have, including avoidance actions.




BNY Mellon objects to Cofina mediator compensation

SAN JUAN – The Bank of New York Mellon (BNYM), which serves as trustee of the Puerto Rico Sales Tax Financing Corp. (Cofina by its Spanish acronym), and Lehman Brothers objected Tuesday to Cofina’s disclosure statement that the U.S. District Court must evaluate the entity’s debt restructuring to move forward.

The bank objected to compensation that would be given to certain mediating parties.

“The Plan provides that certain institutional holders of beneficial interests in the Existing Securities, which participated in the mediation process and executed the Plan Support Agreement, receive additional compensation over and above that provided to other holders in the same class.

“This payment is to be made from all holders’ shared collateral. The Disclosure Statement describes this payment, in the aggregate amount of approximately $332 million, as compensation for the cost of negotiation, confirmation, and consummation of the Term Sheet and the Plan,” the bank said.

In its role as trustee for all of the existing securities, BNYM said it seeks to ensure that holder who did not participate in the mediation process receive disclosure necessary for them to make an “informed, intelligent decision” with regard to the plan.

“The Disclosure Statement does not explain the basis under Promesa [Puerto Rico Oversight, Management, and Economic Stability Act] and applicable provisions of the Bankruptcy Code for making this payment from holders’ shared collateral to selected institutional holders generally and, more specifically, in the amount of $332 million,” the bank said.

Lehman Brothers also raised concern with the disclosure statement for various reasons, including that BNYM is released from claims Lehman may have against it. The investment bank also said the disclosure agreement failed to say what causes of action Cofina may have to recuperate debt money or engage in avoidance actions.

Judge Laura Taylor Swain is slated to evaluate the disclosure statement next week.




Puerto Rico Sales Tax trustee asks court to intervene in Commonwealth-Cofina dispute

The Bank of New York Mellon, the trustee of the Puerto Rico Sales and Use Tax (SUT), asked the court to allow it to intervene in the negotiations for a settlement in the Commonwealth-Cofina dispute, to oppose certain aspects involving the distribution of the funds.

The Commonwealth-Cofina dispute centers on who is the owner of the sales and use tax, whose revenues are currently used to pay for government operations and to back Cofina bonds. A resolution to the dispute is needed as part of the Title III bankruptcy proceeding so the judge can determine how to distribute assets. Recently, representatives of the Commonwealth and of Cofina announced a preliminary settlement.

The Commonwealth representative in the dispute, which is the Official Committee of Unsecured Creditors, asked the court to issue an order establishing certain procedures to dispose of the SUT funds.

The Commonwealth Agent wants the Bank of New York Mellon, to put in separate accounts all 5.5% SUT revenues currently in the bank that were received prior to June 30 and all SUT revenues received after July 1, 2018.

Once a settlement is reached on the dispute, the Post-July 1, 2018 funds shall be allocated and released to the Commonwealth and Cofina in accordance with the percentage shares in the settlement agreement, that is 53.65% for Cofina, which would be the first dollars of the 5.5% SUT, and 46.35% for the Commonwealth.

In the event the Agents do not proceed with the settlement agreement by August 4, 2018 or the effective date of Cofina’s Title III plan of adjustment, all of the funds including the Pre-July 1, 2018 Funds and the Post-July 1, 2018 Funds will continue to be part of the litigation.

Will Puerto Rico Incentives Code help offset tax slide?

The bank says it takes no position on the full agreement-in-principle but objected to what would happen to the funds in the event both sides are unable to reach a settlement and the court later rules that the Commonwealth owns the sales and use tax.

“The Commonwealth Agent would like the Court to approve an agreement between the Agents now that, in such circumstances, the Court’s hypothetical future ruling would be retroactive to July 1, 2018. In effect, the deposit of Pledged Sales Tax with BNYM after July 1, 2018, could cease to be governed by the Resolution and applicable law,” the bank said that such a possibility would hinder the bank.

Changes to fee examiner’s authority

Judge Laura Taylor Swain has issued a ruling that broadens the Fee Examiner’s scope in the Title III process. The Fee Examiner, Brady Williamson, is in charge of investigating the legal fees charged to the government during the bankruptcy process.

The judge granted a Motion that allows the Fee Examiner and his counsel to undertake the review of fees for services provided outside of the Title III cases and that extends the Fee Examiner’s assignment extends to all fee requests within the Title III cases whether or not the services provided were directly related to the Title III bankruptcy cases. The judge ordered the Fee Examiner, in consultation with counsel for the Financial Oversight and Management Board, FAFAA, and the official committees, to develop and present a proposal to the Court to resolve the concerns the Fee Examiner raised on the fee applications of certain professionals.




Puerto Rico GOs denied intervention in Cofina dispute

SAN JUAN — Federal Judge Laura Taylor Swain denied Thursday intervention to a group of Puerto Rico’s general obligation (GO) creditors in the interpleader action filed by Bank of New York Mellon (BNYM)—trustee of the Sales Tax Financing Corp. (Cofina)—with respect to pledged sales tax funds that guarantee payment of Cofina bonds.

On May 16, BNYM filed action that seeks to have the court determine how the trustee should proceed with sales tax funds under its possession amid conflicting instructions over said monies.

Meanwhile, a group of GO bondholders sought to intervene in the action, arguing that pledged sales tax funds belong to the commonwealth and thus should be used to cover GO debt obligations pursuant to the island’s Constitution.

“The members of the GO group are not Cofina creditors, and have no direct claim to the Interpleaded Funds,” the court order reads, as Judge Swain found that the GO group lacked standing to assert its claims under BNYM’s action.

The court had already ordered BNYM to hold the funds in escrow until the interpleader was resolved.

“This is a setback not only for GOs, but also for the commonwealth and its legal strategy,” one source said, in reference to the government’s plan to tap into Cofina funds and redirect them to the island’s coffers.

The court recognizes that the intent of both the government and the board is to pool Cofina funds into available resources for an eventual debt-restructuring plan, and that the board seeks to solve the dispute with respect to Cofina.

“The claim that the commonwealth is entitled or required to apply the Cofina trust funds to payment of the commonwealth’s obligations to GO bondholders is one of which the commonwealth, as a debtor in a related Promesa Title III proceeding, has control. The commonwealth is not a party to the instant adversary proceeding,” the order adds.

The document also establishes that “the GO group’s asserted interest in the interpleaded funds would exist only if the commonwealth’s yet-unasserted claim on those funds were successful.”

In March, the Ricardo Rosselló administration and the GO bondholder group issued a joint statement in which they announced that the government—even if it was not taking a “definitive position” on the matter—would seek “prompt and expeditious resolution of the claims asserted by the GO bondholders regarding the constitutionality of Cofina,” under the Lex Claims case filed by GO creditors. In a nutshell, Lex Claims intends to have a court declare Cofina funds belong to the commonwealth.

On May 5, Puerto Rico’s financial control board filed for bankruptcy protection under Title III of Promesa on behalf of Cofina, as it did with the commonwealth. A mediation process has been set to address, among other issues, the commonwealth’s dispute with Cofina bondholders.

Discovery rules set

After holding a hearing in Boston on July 5, U.S. Magistrate Judge Judith Dein—who was appointed to assist Judge Swain with Puerto Rico’s Title III cases—set the rules for discovery on the commonwealth government over the Cofina dispute.

The commonwealth had opposed the Cofina creditors’ discovery petition, as it believed it was too broad and would not help solve the merits of the controversy.

By July 7, government officials and Cofina senior creditors will have to agree on search terms “aimed at identifying documents in the possession of [the government] that concern proposed changes to the use of the dedicated sales tax revenues,” Judge Dein’s order reads.

If disputes over the discovery process remain by July 12, parties will notify the court so it can promptly solve these issues.

As for the discovery time period, it will span from Feb. 15 to present. Documents to be produced include “public statements to third parties,” as well as electronically stored information in computers and cellphones.

If the commonwealth government refuses to produce documents citing such privileges as deliberative process and attorney-client, it must explain the court why it is withholding them.