Briefs Mount to Have FOMB Decisions Overturned

Opponents to Federal Board Seek Declaration that ‘Junta’s’ Decisions are Unconstitutional

Editor’s note: The following was first published in print, in the Aug. 29, 2019, issue of Caribbean Business.

Opponents of the Financial Oversight & Management Board (FOMB) have filed briefs with the U.S. Supreme Court arguing that all of the board’s decisions should be overturned and seeking a declaration that the FOMB is unconstitutional.

Aurelius Investment and Assured Guaranty, which have challenged the board’s appointments, argued last week that the U.S. First Circuit Court of Appeals was wrong to let the board’s decisions stand based on the “de facto officer’s doctrine,” which allows the decisions of people who appear to act on behalf of the government to remain effective.

“The Appointments Clause is meant to be a vibrant structural safeguard with enduring relevance for the selection of those who lead our federal government, not just a paper tiger,” Aurelius and Assured argued.

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Judge halts Puerto Rico bankruptcy process for 3 months

The U.S. District Court for the District of Puerto Rico (CB file photo)

Over 60 organizations made request amid political crisis

SAN JUAN — Amid the recent corruption indictments and uncertainty about the changes in Puerto Rico government administration, combined with the challenge to the constitutionality of the island’s fiscal oversight board, leaders of more than 60 community organizations presented a letter Wednesday to U.S. District Judge Laura Taylor Swain, requesting that the ongoing bankruptcy proceedings over the island’s debt be paused until Puerto Rico stabilizes and a comprehensive audit of its debt has begun.

Judge Swain reportedly granted the petition and halted all adversary cases and claims against the government for 120 days.

“We are facing a historical situation that merits immediately stopping the bankruptcy process. Currently, Puerto Rico does not have enough representatives in this legal process, from a government that has lost all political legitimacy and is about to collapse, to a Fiscal Control Board whose constitutionality is being discussed in the United States Supreme Court. We demand that the bankruptcy case be stopped, as happened after the impact of Hurricane Maria,” the spokeswoman for the “Construyamos otro Acuerdo” (“Let’s Make Another Agreement”), Eva Prados, said in a statement.

The director of Community Campaigns of the Center For Popular Democracy and spokesperson for the Construyamos otro Acuerdo campaign, lawyer Julio López Varona, also emphasized the importance of halting the bankruptcy cases amid uncertainty about who will be the next governor and the representatives of the fiscal board.

“At a time when it is not clear who will be the next governor of the island and the Fiscal Control Board is in a process of being challenged in court, Judge Swain must paralyze bankruptcy proceedings until the country stabilizes. Not taking action would be extremely irresponsible, Puerto Rico deserves a legitimate representative in a bankruptcy process that will have repercussions on the economy and lives of Puerto Ricans for decades.”

The letter’s authors stress that negotiations and the debt adjustment plan should be put on hold and that a comprehensive audit of the public debt must be ordered

“To this leadership crisis, we add that every day we wake up to a new case of corruption and misuse of public funds. That is why we request, more than ever, that a comprehensive audit of the debt be ordered by the Court and that the citizenry and the press be guaranteed access to all documents related to public debt to guarantee the legitimacy of this bankruptcy process,” said Prados, who is also a spokesperson for the Citizen Front for the Audit of the debt.

Joining the release was Sonia Palacios, a retiree and spokesperson for the campaign, who said a central government debt adjustment plan process cannot be allowed “in the face of this clear political crisis.”

“We are talking about a bankruptcy process that will affect the entire country for the next decades and in particular will affect the lives of pensioners and their families. It is irresponsible to continue this legal process until it is known who will govern us in the coming months. We ask Judge Laura Taylor Swain to stop the entire bankruptcy process,” Palacios said.




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

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.




Puerto Rico Unsecured Creditors, fiscal board committees allowed to pursue claims

New York’s Alexander Hamilton U.S. Custom House, where Thursday’s hearing was held (CB photo)

Judge Swain says that since Trump has yet to renominate board, its ‘future status’ is in question, and arguments over UCC conflicts were unpersuasive

SAN JUAN – U.S. District Court Judge Laura Taylor Swain granted Thursday the Unsecured Creditors Committee (UCC) and the Puerto Rico fiscal oversight board’s Special Claims Committee (SCC) derivative standing to pursue claims on behalf of the commonwealth Employees Retirement System (ERS) and the Highways and Transportation Authority (HTA).

The judge made her ruling at the end of a hearing in which she also approved a stipulation agreed upon by the UCC, the fiscal board and its SCC regarding the allocations of litigation responsibilities to assert causes of action on behalf of HTA and ERS, both of which filed for bankruptcy under the Puerto Rico Oversight, Management and Economic Stability Act (Promesa) in 2017.

May 20 is the statute of limitations for the two entities, which filed for bankruptcy on that day two years ago, to file avoidance claims, which are generally brought against corporations or individuals that received payment from the debtor sometime before the filing of the bankruptcy or to avoid so-called fraudulent transfers.

The stipulation approved by the judge was designed to address the so-called “Aurelius risk” by appointing the SCC and the UCC as co-plaintiffs to assert causes of actions the fiscal board would assert on its own. The Aurelius risk refers to the possibility that the board’s actions may be challenged after the U.S. First Circuit court decided, in Aurelius v. Puerto Rico, that the board was unconstitutional because its members were not appointed with the consent of the U.S. Senate. The court pushed the stay on the board’s mandate from late May to July 15 to allow President Trump and Congress to correct the situation.

At an April 24 omnibus hearing, Judge Swain had approved a stipulation to bring causes of action on behalf of the commonwealth that was similar to the one designed for the HTA and the ERS.

“In summary, the court previously determined that it has the authority to approve a consensual grant of derivative standing. The court further determined that the Oversight Board’s decision to share its responsibility to pursue causes of action in light of the so-called Aurelius risk constitutes the necessary ‘refusal’ for purposes of Section 926A of the Bankruptcy Code. The court adopts and incorporates by reference its early reasoning regarding consensual derivative standing in Section 926 of the Code,” the judge said.

“Necessity” and “debtor benefit,” Judge Swain added, support the grant of authority to the UCC and members of the board’s SCC to pursue causes of actions for HTA and ERS, which are expected to be commenced in the next few days. She noted that Service Employees International Union, which forms part of the UCC, meets the “requisite creditor status” because its members also have claims against the ERS.

Although Trump has indicated that he intends to renominate the board’s current members to continue serving their terms, “he has not acted on his intention to do so,” the judge said, and the First Circuit’s stay of its mandate is set to expire July 15.

“Therefore, despite the arguments made by the objectors, the future status of the Oversight Board remains in question and the movants are still in a situation where the Oversight Board authority to prosecute the actions may expire or be interrupted after the May 20th deadline. In the face of such uncertainty, it would be imprudent for the court to deny the requested relief,” Judge Swain said.

The UCC is the proper party to be appointed as co-plaintiff and co-trustee in the cases, the judge further said, because it is the only committee that has been appointed in both the HTA and ERS cases. She added that arguments raised regarding conflicts within the committee were unpersuasive.

The stipulation pursues claims against third parties and not inter-debtor claims because those are the subject of a tolling stipulation agreement approved by the court May 2.

The judge dismissed claims that the UCC’s stance in the commonwealth’s case may impede it from acting properly on behalf of HTA and ERS creditors, as it would advocate that any money collected go to commonwealth creditors.

“The fact that a pending motion exists that challenges the authority of the UCC in the ERS case does not change this analysis,” she said.

During the hearing, UCC’s lawyer, Luc Despins, said the status of the board was uncertain because Trump had yet to renominate its members.

“That process will not be completed by Monday,” he said, referring to the May 20 expiration of the statute of limitations.

In response to claims that the UCC is conflicted because it has defended the position of the commonwealth and would be unable to defend the positions of ERS and HTA creditors, Despins said the UCC has a fiduciary duty to defend the interests of all creditors. He also said the committee does not have the authority to make decisions regarding funds recovered by the debtors.

Regarding the types of avoidance actions that will be brought on behalf of ERS and HTA, Despins said there will be preference actions to recover money paid fraudulently by the entities. There will also be actions to claw back payments made in bonds, which will be stayed pending the court’s decision on whether certain issuances were legal.

He also said there will be lien avoidance actions but that those involve ERS bonds. In March, the UCC filed an objection to all claims that may be asserted against the ERS based on $3 billion in bonds issued by the pension system in 2008, arguing it did not have the authority to borrow through public bonds.

A lawyer from the firm McConnell Valdés opposed the stipulation, noting the aftermath of by the avoidance claims brought by the fiscal board against hundreds of government suppliers, making them liable for millions of dollars.

“You would expect a high level of diligence, especially in dealing with a deadline they knew was approaching,” the lawyer said in reference to the May 20 deadline.




‘Aurelius risk’ cited as roadblock in Puerto Rico fiscal board effort to pursue claims

U.S. Court of Appeals for the First Circuit in Boston (Screen capture of www.ca1.uscourts.gov)

Judge Swain expected to evaluate the matter during Thursday’s hearing

SAN JUAN – The Unsecured Creditors Committee (UCC), the Puerto Rico financial oversight board and its Special Claims Committee (SCC) are citing what they call the Aurelius risk in their effort to seek standing to pursue claims against creditors of the island’s Highways and Transportation Authority (HTA) and Employees Retirement System (ERS).

The Financial Oversight and Management Board, the SCC and the UCC want U.S. District Court Judge Laura Taylor Swain to approve a stipulation that ensures causes of action are preserved for HTA and ERS as the statute of limitations on avoidance actions for the two agencies expires May 20. Avoidance actions are those brought by a debtor after filing for bankruptcy to recover money that may have been paid fraudulently.

As part of the stipulation, the UCC, the SCC and the board are asking the court for derivative standing to pursue claims on behalf of the HTA and ERS, citing what they see as a threat created by the U.S. First Circuit’s decision in Aurelius v. Puerto Rico, which declared the board unconstitutionally appointed because its members were not confirmed by the U.S. Senate.

They say the Aurelius ruling created potential challenges to the board’s authority to bring causes of action.

“The HTA/ERS Stipulation is designed to address the Aurelius issue by appointing the members of the Special Claims Committee, on the one hand, and the (Unsecured Creditors) Committee, on the other hand, to assert causes of action before the expiration of the statutes of limitations, which causes of action the Oversight Board would otherwise assert on its own,” the document filed May 14 reads.

Judge Swain is expected to evaluate the stipulation at a hearing Thursday.

Parties objecting the board and the committees’ request argued that the Aurelius ruling is not a concern because the First Circuit Court extended the stay of its mandate to legalize the board through July 15.

They also say President Trump has announced his intention to reappoint the current members of the board for the remainder of their term. The objecting parties also say members of the SCC, on the one hand, and the UCC on the other hand, cannot be appointed as co-plaintiffs because they have not met certain legal criteria.

However, the board and the committees said the stay extension and the Trump’s announcement do not mitigate the “Aurelius risk.”

“The expiration of the stay of the mandate is not what animates the need to have the HTA/ERS Stipulation approved—rather, it is the risk that others will later challenge the Oversight Board’s authority to commence adversary proceedings, absent reversal of the Aurelius decision by the Supreme Court,” the committees and the board said.

The committees and the board oppose having the Retirees Committee be declared co-plaintiff in the cases brought by ERS because the latter is an official committee in the commonwealth bankruptcy case, not in the ERS case.

The UCC also dismissed arguments that it suffers disabling conflicts because it mostly comprises commonwealth creditors.




Judge rejects tolling statute of limitations to file avoidance claims in Puerto Rico bankruptcy

(CB file)

Rejects Unsecured Creditors’ petition to act as trustee to file claims for commonwealth

SAN JUAN – U.S. District Judge Laura Taylor Swain rejected the Puerto Rico Financial Oversight and Management Board’s petition to toll the statute of limitations to file avoidance claims on behalf of the commonwealth.

In Wednesday’s omnibus hearing, Judge Swain dismissed the claim without prejudice to adversary proceedings or other actions before the court, saying she had no jurisdiction on the matter at this time.

May 2 is the deadline to file avoidance actions for the commonwealth.

Under the Puerto Rico Oversight, Management and Economic Stability Act (Promesa) and the Bankruptcy Code, the board had two years to bring such actions, which can only be rolled under extraordinary circumstances.

Edward Weisfelner, an attorney for the Special Claims Committee of the fiscal board, said the task of identifying claims was huge. He said the panel narrowed down the claims it will seek for money paid by the government to amounts totaling $1 million and higher but that the number of claims is about 360,000.

“In the absence of tolling, we would be forced to file claims against thousands of individuals,” he said.

The judge asked whether there was precedent to the extension but Weisfelner said the island’s case was unique.

“Puerto Rico is sui generis,” he said.

Bruce Bennett, a lawyer for Employee Retirement System creditors, said the board had two years to bring the claims and that claiming it was distracted with other litigation was not sufficient justification.

“The idea that it gave priority to many other things is not an excuse,” he said.

Peter Hein, a retail bondholder, called for stopping the board and unsecured creditors from going after thousands of retail bondholders.

Weisfelner said he was not asking for an indefinite extension. In response to a question from Judge Swain, he said those affected by a claim would not be able to raise as a defense that the statute of limitations has been reached.

Among other things, Judge Swain rejected a request by the Unsecured Creditors Committee (UCC) to be appointed trustee to file avoidance actions on behalf of the commonwealth, and a motion seeking derivative action to investigate possible causes of action.

However, she approved a stipulation that will allow the UCC and the board to pursue avoidance actions decided by the fiscal panel. She postponed a decision on whether to appoint a receiver for the Puerto Rico Electric Power Authority (Prepa) and rejected a request filed by Hein calling for the appointment of a committee that would defend the interest of individual and small retail bondholders.

Earlier in the day, the group Construyamos Otro Acuerdo, which advocates for alternatives to the current debt restructuring; the Citizens’ Front for An Audit of the Debt; and the Feminist Collective protested in front of several banks on the island. The groups, which were promoting the so-called embargo of the banks and the cancellation of the debt, also brought their demonstration to the U.S. District Court.

Judge Swain reserved her opinion on a request from the Ad Hoc Group of General Obligation Bondholders, who seek to establish procedures to regulate objections involving claims asserted against Puerto Rico in connection with leases of the Puerto Rico Buildings Authority (PBA) and bonds it issued in 2010. The group opposes attempts to disallow $6 billion in general obligation (GO) and PBA bonds.

Mark Stancil, a lawyer representing the Ad Hoc Group, accused the fiscal board of trying to target certain bonds to engineer a plan of adjustment. He rejected claims that the PBA is a sham or a mechanism of disguised financial transactions guaranteed by the commonwealth that have not been calculated toward the debt limit.

In a lawsuit filed Dec. 21, the board said the PBA leases provide for the payment of about $401.6 million in annual “rent,” with an excess of $600 million in unpaid “rent” having accrued since the debtors’ respective petition dates.

The board sought a court ruling that the leases are not “true leases,” but rather disguised financing transactions.

“As a result, the PBA has no right under Promesa or the Bankruptcy Code to receive post-petition rent payments from the debtors or administrative claims against the debtors,” the board said, adding that some of the leases do not give rise to administrative claims against the government because the lessees are nondebtor entities. The government is also trying to annul some $6 billion in GO bonds.

UCC lawyer Luc Despins, as well as Susheel Kirpalani, a lawyer for the Lawful Constitutional Debt Coalition, objected the request, contending it was not ripe because the Ad Hoc Group has not established it would suffer damages. Despins mentioned the Ad Hoc Group was trying to obtain discovery on matters that would be litigated in the future. Lawyers for Ambac Assurance and QTCN Noteholder Group also objected Ad Hoc’s request.

On the other hand, the judge dealt with a request from National Public Finance to seek a receiver for Prepa. Robert Barrison, a lawyer for National, urged Judge Swain to stop granting extensions on the decision on whether Prepa should have a receiver.

“All Prepa bondholders need questions answered,” he said, adding it was urgent to rid the public electric utility of “gross mismanagement.”

Fiscal board lawyers rejected the idea of a receiver, adding that a restructuring support agreement for Prepa could take no longer than a week to come into fruition. The extensions were granted because of the negotiations. Judge Swain gave a one-week extension.

Unsecured Creditors blocked

Judge Swain rejected requests from the Unsecured Creditors Committee to be appointed trustee to pursue avoidance claims on behalf of the commonwealth and a motion in which the UCC sought derivative actions to pursue possible causes of action to recover fraudulent or illegal payments but approve stipulations between the UCC, the Special Claims Committee or SCC and the board on the rules for pursuing avoidance actions and other claims.

The UCC wants to go after parties that negligently helped increase the debt. In motions, it has mentioned Banco Popular and officers and directors of the Puerto Rico Government Development Bank (GDB) involved in the commonwealth’s $3.5 billion bond issuance in 2014, including Proskauer Rose, the law firm that is currently advising the board in the bankruptcy-like proceedings.

The board replied that it intended to file claims against individuals involved in certain issuances for breach of fiduciary duties and other actions but not go after parties using “speculative reasons.”

Despins said his firm was going to hire the law firm Genovese, which worked on the Enron case and also on behalf of Doral Bank, which is one of the unsecured creditors, to pursue the claims, adding that the firm had agreed to work on a contingency basis.

He noted that he will be pursuing claims that the board refuses to pursue, which he said would be released May 2, when the statute of limitations is reached.

“The people we want to sue are third party,” he said, suggesting the board may be reluctant to go after third-party claims because two board members previously worked for the GDB and private banks.

Weisfelner said Section 305 of Promesa prevented the court from granting the UCC’s request because the board had not consented.

“I tell you, your Honor, that motion is a gross distortion of what SCC (Special Claims Committee) intends to do…. We are going to sue 27 underwriters, nine law firms and five accounting firms,” he said, adding that the lawsuits will charge them with breach of fiduciary duties and constructive fraudulent transfers.

He noted that the UCC wants to use deepening insolvency as a cause for action, which is not used in local jurisdiction.

The board also feels it will have a better chance of prevailing if it argues as basis for claims that the party engaged in constructive fraudulent transfers rather than actual fraudulent transfers because “undertaking a heavier burden for the same amount of damages does not make sense.”

Weisfelner also said UCC’s attempts to go after GDB officers is futile because they have immunity from lawsuits. He said any defense will have to be paid with commonwealth funds. He also said underwriters expressly disavowed fiduciary duties to the commonwealth in agreements made for issuances.

He added they were going to go after officials that authorized so-called scoop-and-toss strategies to move certain debts to the following year to recoup funds obtained.

Ambac Assurance Corp., Assured Guaranty and lawyers for Oppenheimer Funds all objected to the appointment of the UCC as trustee because the entity is not a creditor.

Assured Guaranty mentioned that members of the committee are not listed as claimants against the commonwealth. Despins said Doral Bank and Service Employees International Union are creditors.

A lawyer for National Public Finance said the UCC’s motion, as to the claims it intends to follow, is too broad and speculative.

A lawer for the Committee of Retirees did not have an objection to the UCC acting as trustee or having derivative standing but with parameters or limits.

On the other hand, Weisfelner said he would object to the UCC hiring Genovese on a contingent basis, adding it should be paid hourly, as are the other law firms.

Peter Friedman, a lawyer for the Puerto Rico Fiscal Agency & Financial Advisory Authority (Aafaf), said it was unfair to blame GDB officials for the debt and noted that there was no precedent for Despins request because it calls for the UCC to replace the government in engaging in lawsuits.

Judge Swain rejected the UCC’s request on its entirety. She said Section 305 of Promesa supports her conclusion.

“If court grants the UCC request…it will be second-guessing the Oversight Board…. It is clear the Oversight Board opposes the motion and the court has no power to grant it,” she said.

Earlier in the hearing, Martin Bienenstock, a lawyer representing the board, provided a status report on the budget and fiscal plans. He said negotiations with unions toward a debt adjustment plan for the government are proceeding smoothly and that they are mediation with the Puerto Rico Judges Association regarding the treatment of its retirement system. He also said there was a lot of progress toward the restructuring of Prepa.

On the other hand, Judge Swain approved payments to law firms requested by the fee examiner but postponed until June the approval of certain standards law firms will have to follow to obtain payment.




Swain’s World: Viability of Cofina Deal Stirs Questions

Ambac Denies it is not Backing Cofina Bonds; Supports Repeal of $6 Billion in GOs

Editor’s note: The following was first published in the April 18-24, 2019, issue of Caribbean Business.

Ambac Assurance Corp. (AAC), which insures Puerto Rico Sales & Use Tax Financing Corp. (Cofina) bonds, has denied allegations made by certain Cofina bondholders that it is no longer backing the bonds as part of Cofina’s debt-adjustment plan.

The debt-adjustment plan, which went into effect in February, restructured about $16 billion in island debt.

Under the Cofina term sheet, holders of AAC insured senior Cofina bonds had two options. The first was to commute their rights with respect to the AAC insurance policy associated with the senior Cofina bonds, which would then be canceled, in exchange for new Cofina bonds, cash amounts to be paid by Cofina and other considerations by the ACC. The second option was to exchange their senior Cofina bonds for trust certificates issued by a custodial trust, which the trust would get distributions from Cofina under the new bonds plus payments under the existing AAC insurance policy to cover any shortfalls.

Sources close to Ambac said 75 percent of the Cofina junior bondholders took the first option and “tore up” the policy. The remaining took the second option and have their policy intact. Ambac, according to sources, is on the hook to pay what is owed on the policy if Cofina ever defaults. In the meantime, Ambac must pay any shortfalls if Cofina is unable to pay the entire value of the bonds. For instance, if a bondholder gets 93 percent of the value of the bonds in Cofina payments, the insurer will have to pay the 7 percent difference on the value of the bonds that the Cofina bondholder did not receive.

Ambac, meanwhile, filed a motion April 10 to support the bonds issued by the Public Buildings Authority from government attempts to prevent them from getting priority status payment, while supporting efforts from the commonwealth to repeal some $6 billion in general-obligation (GO) debt issued in 2012 and 2014. Financial Guaranty Insurance Co. and National Public Finance are also supporting the repeal of the $6 billion debt, even as thousands of bondholders have filed documents.

Meanwhile, certain banks, including the Bank of New York Mellon and Bank of America, are objecting to attempts to compel them to provide information on secured bondholders.

Trillions in claims

On April 15, the commonwealth and other debtors filed more than a dozen objections to thousands of monetary claims filed by creditors that were either duplicates or defective, where creditors could not provide evidence of a real claim.

In 2017, the commonwealth, Puerto Rico Electric Power Authority, Highways & Transportation Authority (HTA) and Employees Retirement Systems (ERS) filed for bankruptcy protection under the federal law Promesa, which creates a bankruptcy process for territories. Most of the objections were related to claims filed against the ERS, which filed for bankruptcy May 21, 2017.

On Jan. 16, 2018, the debtors filed their motion for order to establish deadlines and procedures for filing proofs of claim and the manner of the notice. That deadline was June 29, 2018.

“Of the proofs of claim filed, about 55,000…[were] in relation to the ERS. The ERS-related proofs of claim total about $10.1 trillion in asserted claims, in addition to unliquidated amounts asserted. As noted above, because the ERS is a special-purpose entity with only about $2.9 billion in funded indebtedness, it is clear that substantially all such claims are inappropriate,” one of the objections read.

To efficiently resolve as many of the unnecessary proofs of claim as possible, the debtors filed an order Oct. 16, 2018, seeking limited omnibus objection procedures and waiving certain requirements. The order was later revised.

“Each of the deficient claims purports to assert liabilities well in excess of $1 billion but fails to provide a basis for asserting a claim against the ERS, the commonwealth or another of the debtors. Of the deficient claims, one asserts liabilities in the amount of $32 billion, but states as a basis for the claim that claimant is a teacher who has provided services, without providing any information regarding salaries or benefits owed to the claimant by the ERS, the commonwealth or any other debtor,” one of the objections says.

There were 165,466 proofs of claim filed against the debtors, which total $43.5 trillion. Some 2,336 claims were filed against the HTA, totaling $83.1 billion, which means most claims were duplicates. Of the proofs of claim, about 103,329 were against the commonwealth, which filed five omnibus objections to object to duplicates. It also filed several objections to claims that were deficient.

The commonwealth is currently trying to repeal about $6 billion in GO debt it claimed was illegally filed. The Unsecured Creditors Committee is trying to annul $3 billion in ERS bonds that were also issued in violation of the law in 2008.

Secured Creditors of the ERS, headed by Andalusian Global Designated Activity Co., on April 15 asked Magistrate Judge Judith Dein, one of two judges overseeing the bankruptcy process, to compel the commonwealth, the ERS and P.R. Fiscal Agency & Financial Advisory Authority to produce some 509 documents that they wrongly withheld, using as an excuse the attorney-client privilege. It is part of a process from creditors to seek a trustee for the ERS. Regarding Andalusian, the company is also seeking a protective order after the island’s Oversight Board sought to do depositions on more than 23 different topics that lawyers for Andalusian, Mason Capital Master Fund and Puerto Rico Fund say are burdensome and broad.

In addition, this week, Judge Laura Taylor Swain announced there will be an omnibus hearing in San Juan on April 24.




Swain’s World: GO Bondholders Want Level Field for Modest-Size Investors

We do not Want a Repeat of Cofina’s Debt Adjustment Plan, Investor who Requested Committee Says

Editor’s note: The following was first published in the April 11-17, 2019, issue of Caribbean Business.

A retail investor, who purchased a modest amount of general-obligation (GO) bonds in 2012, asked the U.S. District Court for special considerations for small investors, including the appointment of a Committee for Modest-Size Bondholders that would allow them to fight attempts by the Unsecured Creditors Committee (UCC) and Financial Oversight & Management Board to invalidate their debt.

In January, the UCC and Oversight Board filed a request to invalidate $6 billion in GO bonds sold in 2012 and 2014, contending the issuances violated debt limits. The UCC and Oversight Board are also seeking a declaration stating Public Buildings Authority (PBA) bonds are a “sham” used to issue debt that was not in the commonwealth’s name but payable through general revenues. The impact of this process would be that the PBA would have no right to receive post-petition rent payments. The UCC, meanwhile, is also seeking the invalidation of $3 billion in public pension bonds sold in 2008.

Peter Hein, whose request was previously rejected by Judge Laura Taylor Swain because he did not first direct it to the U.S. Trustee, attached a letter to his request sent by U.S. Trustee Daniel McDermott stating that his office did not comment on the appointment of official committees nor was it considering taking any action.

Hein, who is representing himself, requested that all pro se litigants like himself be allowed to file documents electronically themselves as is allowed in other courts or in the alternative to be able to serve papers by submission by email to Prime Clerk, the firm that is managing the Title III case. He also said they should be able to listen to proceedings over telephone.

“Many individual bondholders are affected by these proceedings, but most will not have a sufficient stake to make it economically feasible to retain counsel with access to the Puerto Rico District Court e-filing system,” he wrote.

Hein insisted upon the appointment of a creditor committee to represent individual bondholders with modest holdings of GO bonds because of what he called the “unfair asymmetry” among stakeholders as the Oversight Board and UCC “have unlimited resources and funds to pursue an effort to invalidate individual bonds.”

He noted the hundreds of pro se notices that have been filed to date to object to the invalidation of the GO debt. In addition, he said the proposed committee would be appropriate to avoid the conflicts that permeated the negotiations toward the debt adjustment of the Puerto Rico Sales Tax Financing Corp. (Cofina by its Spanish acronym), which recently restructured some $17 billion in debt through a deal in which, he said, some creditors got an advantage.

“In the course of confidential mediation and settlement proceedings, (i) certain creditors with major holdings sought and received added consideration not enjoyed by all holders, and (ii) Puerto Rico representatives successfully negotiated for added and different consideration for Puerto Rico residents (discriminating against United States citizens in the 50 states),” said Hein, who also suffered losses in the restructuring of Cofina’s debt.

These conflicts, he said, were in addition to the conflict between senior and subordinate Cofina bondholders, referencing the fact that junior Cofina bondholders had huge losses in the restructuring. As part of the deal, Cofina bondholders exchanged their bonds for new ones but senior Cofina bondholders recovered about 93 percent of the value of their bonds while junior holders got about 53 percent.

The Cofina plan documents and disclosure statement were turgid and difficult for individual Cofina bondholders to understand. It also failed to disclose the consequences of the plan to modest-size bondholders.

“All these problems were compounded by the fact that the notice to Cofina bondholders that provided a copy of the disclosure statement and proposed plan (on a flash drive) was mailed so as to be received prior to the Christmas-New Year’s holiday period with dates for objection and voting on Jan. 2 and 8,” he said of the Cofina plan that went into effect Feb. 12, 2019.

He also noted that major bondholders who received added consideration not available to all bondholders also impacted the voting to the detriment of retail or individual bondholders with modest Cofina subordinate bond holdings.

Major bondholders and Puerto Rico plan proponents, he said, had their fees paid through the negotiated Cofina plan either directly or in the form of consummation costs of $332 million. But modest-size Cofina bondholders did not receive any payment of their costs and expenses and were not represented in the negotiations, which he said ended up with a Cofina plan that was skewed in favor of the major bondholders.

In advocating for the creation of the committee of modest-size bondholders, Hein said there may be a commonality of interests between all GO bondholders in vigorously resisting efforts to invalidate their bonds.

If the court is unable to appoint the committee, Hein said that at least it should ensure there is adequate representation of bondholders with modest holdings in the negotiations toward a restructuring of the debt.




Swain’s World: Ambac no Longer Backing Cofina Bonds

Cofina Liquidating Trust Assets, Leaving Unsecured those who Chose not to Commute their Insurance for Pennies

Editor’s note: The following originally appeared in the April 4-10, 2019, issue of Caribbean Business.

Holders of Puerto Rico Sales Tax Financing Corp. (Cofina by its Spanish acronym) bonds got a recent surprise upon learning that Ambac Assurance Corp., a bond insurer, appeared to no longer be backing the bonds after the recent Cofina restructuring.

“Did anyone notice the latest Cofina robbery? Ambac just announced they are liquidating the trust assets securing those few insured who elected not to commute their insurance for pennies. Now, policyholders will get the liquidated value from the trust!” noted Elliot Asset Management, one of the investment firms that has questioned the adjustment plan for Cofina approved by the Title III court in February. The move leaves these Cofina bondholders up in the air.

The debt adjustment plan restructured about $16 billion in island debt.

Under the Cofina term sheet, which contained confusing wording, holders of AAC insured senior Cofina bonds had two options. The first was to commute their rights pertaining to the AAC insurance policy associated with the senior Cofina bonds, which would then be canceled, in exchange for new Cofina bonds, cash amounts to be paid by Cofina and other considerations by ACC. The second option was to exchange their senior Cofina bonds for trust certificates issued by a custodial trust, which would get distributions from Cofina under the new bonds, plus payments under the existing AAC insurance policy with respect to any shortfalls.

It appears Ambac, which participated in the negotiations for the Cofina deal, had tried to cut its losses all along. Claude LeBlanc, CEO for Ambac, in a recent conference call involving its fourth-quarter earnings said a key Ambac objective was achieved when the Cofina plan of adjustment went into effect Feb. 12. “Ambac was actively involved in crafting the terms of the consensual agreement, which became the basis for the Cofina plan of adjustment,” he said.

About 75 percent of Ambac’s insured Cofina bondholders elected to commute Ambac’s insurance policies in exchange for cash and new Cofina bonds. “We believe the Cofina Plan of Adjustment along with the associated commutations and collateralized trust structure is a tremendous achievement for Ambac in managing its overall risk exposure,” LeBlanc said.

Through the execution of the Cofina Plan of Adjustment, Ambac fully addressed and significantly reduced its largest single-risk exposures, which represented about 78 percent of Ambac’s total Puerto Rico exposure. After months of intense negotiations, Ambac and other senior Cofina creditors received a 93 percent notional recovery, he said.

Important protections clarifying that the share of sales used in tax earmarks for Cofina are not available resources for the commonwealth and dismissals of challenges to the Cofina structure were achieved. “As a result, Ambac’s insured Cofina exposure and our overall insured Puerto Rico debt-service exposure decreased by $5.5 billion. The 25 percent of holders, who elected not to commute their policies, received units issued by trust. This trust holds a ratable distribution of cash and new Cofina bonds, which will significantly off set Ambac’s remaining Cofina insurance liability,” LeBlanc said.

Through the Cofina transaction, which restructured more than $16 billion in debt, the government of Puerto Rico will receive, according to a P.R. Fiscal Agency & Financial Advisory Authority (Aafaf) press release, access to $425 million annually for the next 40 years.

The avoidance cliff

In addition, this week, U.S. District Judge Laura Taylor Swain granted a request from the Unsecured Creditors Committee (UCC) and ordered Puerto Rico’s Financial Oversight & Management Board to submit by April 5 a preliminary list of potential avoidance actions it intends to pursue.

Avoidance actions are typically those in which a trustee rejects or avoids actions taken by the debtor with respect to its property during a specific time before a bankruptcy filing. For instance, a trustee can seek the return of property sold by the debtor if it was sold fraudulently.

Earlier this month, the UCC filed a motion urging the court to require the fiscal board to start acting on the avoidance actions before a statute of limitations, scheduled for May, ran out.

After the board reveals its preliminary list of avoidance actions, it must then confer with the UCC about the anticipated allocation of litigation responsibilities, the judge said.

The board must then submit its final list of commonwealth avoidance actions, including designations to the committee by April 10. On April 12, the committee must submit a motion seeking the appointment of a trustee who can assert the avoidance actions. The board has until April 15 to file a motion opposing the trustee.

The board and committee will file by April 22 a joint status report related to avoidance actions for other debtors. “The Oversight Board shall file an informative motion disclosing the final list by May 6,” the judge said.




Bondholder group seeks disallowance of Puerto Rico Public Buildings Authority, certain GO bonds

Ad Hoc Group says fiscal board, unsecured creditors are choosing ‘to squander what little is left of Puerto Rico’s credibility with investors’

SAN JUAN – The Ad Hoc Group of General Obligation Bondholders has filed a conditional claims objection in Puerto Rico’s bankruptcy case related to the request by the island’s Financial Oversight and Management Board and the Unsecured Creditors Committee (UCC) to invalidate $6 billion in debt issued after 2012.

The fiscal board and the UCC filed a suit in January seeking the invalidation of $6 billion in general obligation (GO) bonds from three issuances in 2012 and 2014, contending these violated constitutional debt limits. The committee argued the issuances violated balanced budget provisions as well.

The board and the UCC have also filed a complaint against the Public Buildings Authority to have lease agreements between the PBA and agencies declared not true leases but financing mechanisms to allow the commonwealth to make improvements to leased properties.

Seen as financing mechanisms by the UCC and the board, they contend the rent is not subject to a priority payment under the Puerto Rico Oversight, Management, and Economic Stability Act (Promesa) because the PBA was created to issue bonds to improve office space for the agencies. Therefore, obtaining the declaration that they are not true leases would leave some $600 million as not entitled to full payment but merely a potential unsecured claim.

In a petition filed earlier this week, the Ad Hoc Group said that although the board and the UCC claim the PBA is a “sham” intended to evade the constitutional borrowing limit, it seeks to invalidate not the PBA bonds but instead the $6 billion in GO bonds.

The group claims the board and UCC’s calculations of the debt limit are wrong and said they are choosing “to squander what little is left of Puerto Rico’s credibility with investors and to launch a multi-year feeding frenzy for the lawyers at Proskauer Rose LLP, Brown Rudnick LLP, and Paul Hastings LLP.”

“The amounts billed by the Board’s and the UCC’s professionals as a result of this reckless litigation strategy, as well as billions of dollars of other professional expenses previously incurred or projected, will be paid by Puerto Rico,” the Ad Hoc Group said in a statement Thursday.

The group contends in its suit that the only remedy should be to invalidate all claims related to the PBA bonds and leases, “or, failing that, to invalidate all PBA Bonds and GO Bonds that fall within the Selective Claim Objection’s ‘logic’,” adding that the “sole remedy should not be to invalidate” only the $6 billion in GO bonds.\

“If the Board’s and UCC’s Objection is otherwise right, its own logic dictates that the onus should fall on the claims targeted by the Ad Hoc Group’s Objection,” the group said.

Boston ruling raises muni market concern

In related news, a recent U.S. First Circuit Court of Appeals ruling on an appeal brought by Assured Guaranty Corp. and three other insurers has raised concern in the municipal bond markets.

The board filed for Title III bankruptcy on behalf of the Highways and Transportation Authority (HTA) on June 3, 2017, and shortly thereafter, Assured Guaranty Corp., Assured Guaranty Municipal Corp., Financial Guaranty Insurance Co. and National Public Finance Guarantee Corp. sued, contending that HTA’s failure to make payments violated certain bankruptcy code statutes and seeking relief from the court.

After analyzing the law, Judge Laura Taylor Swain concluded that “Promesa Section 305’s prohibitions on interference with debtor property interests, revenues and use and enjoyment of income-producing property” deprive her court from interfering with the debtors’ dealings.

On March 26, the U.S.First Circuit Court of Appeals affirmed a U.S. District Court ruling that dismissed the amended complaint from the insurers that special revenues pledged to bondholders are only exempt from Promesa’s stay on litigation if the government or entity voluntarily agrees to continue to pay bondholders. The court said timely payments were not mandatory.

The First Circuit ruling is contrary to case law precedent that special revenues must continue to be paid, raising the concerns of bondholders and municipal market publications.

MuniNet Guide stressed the potential adverse effect to the municipal market if there were any stay in the timely payment to the bondholders of pledged special revenues collected postpetition.

“These adverse effects include the impairment of needed access at a reasonable borrowing cost to revenue bond financing for essential infrastructure improvements and other services. The First Circuit response was unmoved by the dire consequences to the municipal market resulting from its ruling by stating, ‘Our duty is to interpret the law not to re-write it,’” the publication wrote.

The publication said the court ignored past rulings and practices by Chapter 9 bankruptcy courts.

“This is the expectation of the municipal market and commentary, both legally and by credit analysts, that timely payment of special revenues postpetition is essential to access to the market and lower borrowing costs that revenue bond have up to now enjoyed,” it said.