Unsecured creditors challenge 2011 Puerto Rico bond issuance

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

Committee contests about $1 billion; says insurer Ambac supports suit

SAN JUAN — The Unsecured Creditors Committee (UCC) in Puerto Rico’s bankruptcy-like proceedings is challenging about $1 billion in general obligation bonds (GOs) issued in 2011 that remain outstanding, contending they were underwritten in violation of constitutional debt limits.

In its objection, filed May 21, the UCC said Ambac, which insures billions of dollars in Puerto Rico bonded debt, supports the challenge. The UCC has joined the island’s Financial Oversight and Management Board in challenging the legality of some of the commonwealth’s debt, including $6 billion in GOs issued in 2012 and 2014.

On March 17, 2011, the commonwealth issued $442 million in Public Improvement Refunding Bonds, considered GOs, to repay advances made to the commonwealth under a line of credit from the island’s Government Development Bank (GDB) and to pay interest on the bonds themselves. On July 12, 2011, the commonwealth then issued $304 million aggregate principal amount of Public Improvement Bonds of 2011.

On that same day, the commonwealth also issued $52 million in the aggregate principal amount of Public Improvement Refunding Bonds and $245.9 million in the aggregate principal amount of Public Improvement Refunding Bonds that were issued, among other reasons, to fund termination payments under certain interest rate swap agreements.

“For many years leading up to the Petition Date, the Commonwealth was running a structural deficit, i.e., recurring revenues were insufficient to cover recurring expenses. Rather than balance the budget by raising taxes and/or reducing spending, the Commonwealth borrowed money from GDB and bondholders to fund annual operating expenses and debt service,” the UCC said.

Of the 2011 GOs, about $412.5 million in net proceeds was used to refinance GDB credit lines to finance deficit spending by paying interest on GOs. Some $260 million in net proceeds was used to refund other bonds, “including Commonwealth GO bonds that indirectly financed deficit spending by refunding Commonwealth GO bonds the proceeds of which were used to pay debt service on other Commonwealth GO bonds and by paying a portion of $88 million in advances under a GDB line of credit.”

The commonwealth’s average internal revenue for the prior two fiscal years (2009 and 2010) was $7.32 billion.

“With the issuance of some of GO Bonds, the maximum debt service in any fiscal year (including PBA [Public Buildings Authority] Bond debt service) was $1.1092 billion in 2012, which is more than 15% or 15.2% to be precise of the Commonwealth’s average internal revenues for the prior two fiscal years,” the UCC said, referring to constitutional debt limits.

The UCC and the fiscal board separately claim the PBA is a “sham” structure to divert the Puerto Rico Constitution’s debt limits.




Puerto Rico fiscal board request for utility creditor info again denied

 (Screen capture of www.uscourts.gov)

Panel looking to argue against insurers who want a receiver for Prepa

SAN JUAN – U.S. Magistrate Judge Judith Dein denied Thursday the Puerto Rico Financial Oversight and Management Board’s request to reconsider a prior ruling denying its request to compel the production of information from certain insurers and bondholders of the Puerto Rico Electric Power Authority (Prepa) that want the utility to be put into receivership.

“As discussed herein, because no new evidence or appropriate claim of error has been identified for the Court, the Motion for Reconsideration is denied. The Court affirms its earlier ruling that the sought loss reserve information is not relevant,” Judge Dein said.

A group of bondholders and insurers are asking the judge overseeing Prepa’s bankruptcy-like proceedings to appoint a receiver to manage the dysfunctional public corporation. Their petition was filed in October.

The bondholders had previously requested the appointment of a receiver to raise electricity rates to pay bondholders, but the motion was rejected in 2017 by Judge Laura Taylor Swain. The renewed petition does not explicitly seek a rate hike nor demand that the creditors exert control over energy planning or budgets but to have a receiver implement sound management.

The fiscal board asked the court to compel National Public Finance Guarantee Corp., Assured Guaranty Corp., Assured Guaranty Municipal Corp., and Syncora Guarantee Inc. to “produce all documents relating directly or indirectly to Movants’ valuation and/or quantification of their security interest, if any, in PREPA’s revenues before, on, and after the Petition Date, including but not limited to all documents containing any loss reserve information concerning the PREPA bonds that has been furnished to insurance regulators.”

The insurers agreed that documents related to their valuation of their security interest would be produced but said the loss reserve information sought by the board was irrelevant. Judge Dein agreed.

The board later filed a motion for reconsideration in part based on financial information published by insurers, which it argued was new information relevant to the motion to compel. On March 25, the Unsecured Creditors Committee filed a motion supporting the board’s efforts. The reconsideration was denied by Judge Dein.

Judge denies Puerto Rico fiscal board request to compel certain bond insurer documents




U.S. pols urge Puerto Rico fiscal board to also go after banks, advisers in ‘illegal’ debt

Rep. Nydia Velázquez, D-N.Y., speaks during the House Natural Resources Committee hearing on Puerto Rico’s Electric Power Authority on July 26, 2018. (Screen capture of www.naturalresources.house.gov)

Base request on report that nearly $300 million in fees were paid out

SAN JUAN – Members of the U.S. Congress urged Puerto Rico’s Financial Oversight and Management Board to go after the banks and legal advisers that counseled island officials in relation to $6 billion in “illegal” debt.

The fiscal oversight board and the Unsecured Creditors Committee recently sued in court to annul some $6 billion owed from three bond issuances after 2012, arguing these violated constitutional debt limits.

The letter was led by Rep. Nydia Velázquez and signed by, among other lawmakers, Sens. Bernie Sanders, Charles Schumer, Elizabeth Warren, Edward Markley, Richard Blumenthal and Kristen Gillibrand.

The lawmakers said the three issuances earned banks and advisers hundreds of millions of dollars in the process, with some even managing to “double dip on these deals,” they said.

A report from the Public Accountability Initiative, a local government watchdog group, said underwriting and swap termination fees paid out for the three offerings totaled $293.8 million.

“While the initial step to invalidate a portion of the debt is a positive one, without any legal action against the banks and advisors that counseled the Puerto Rico government to create and market the underlying bonds, we feel Puerto Rico will not be made whole,” they said.

The letter noted that the Puerto Rico Oversight, Management and Economic Stability Act (Promesa) gave the fiscal board power to initiate claims that seek to return fraudulently transferred assets to Puerto Rico’s coffers.

Read the full text of the report by the Public Accountability Initiative here.

Unsecured Creditors seek invalidation of $3 billion in Puerto Rico retirement bonds

Fiscal board, Creditors Committee challenge $6 billion of Puerto Rico’s debt




Creditor group presses Puerto Rico fiscal board to reveal avoidance claims

Editor’s note: The following originally appeared in the March 28 – April 3, 2019, issue of Caribbean Business.

Court orders board to show cards by April 1

One group in Puerto Rico’s bankruptcy case that has been most vocal and has perhaps conducted a thorough oversight of the commonwealth’s expenditures is the Unsecured Creditors Committee (UCC). While the committee, represented by lawyer Luc Despins, is merely trying to increase the amount of money it can recover from the government, it has brought to light issues that may otherwise go unnoticed by court observers.

Federal Court Judge Laura Taylor Swain recently granted a request from the UCC that sought to set expedited deadlines for procedures for Puerto Rico to bring avoidance actions in its bankruptcy cases because of a looming May deadline.

Avoidance actions are any and all avoidance, recovery, subordination or other claims, actions or remedies that may be brought by or on behalf of the debtors or other authorized parties in the bankruptcy proceedings. They typically go against individuals or corporations that obtain payments from the debtor 90 days before the bankruptcy filing but can go further into the past. The debtor in these cases attempts to recoup money it has already paid.

The UCC said that despite repeated requests, the island’s fiscal oversight board has yet to submit a list of avoidance actions it intends to pursue.

As a matter of fact, since last year, the UCC has been trying to deal with avoidance claims. On Nov. 27, 2018, the committee filed a motion, which was granted Dec. 14, 2018, seeking discovery of Title III debtors, except for the Sales Tax Financing Corp. (Cofina by its Spanish acronym), to investigate whether they may have viable claims for avoidance actions against third parties. “The [UCC] believes it is critical to now move this investigation forward given the potential expiration of certain claims in May 2019. Specifically, the committee is seeking disclosure with respect to pre-petition transfers of property valued at $3 million or more in the two years immediately preceding the dates on which the debtors commenced the Title III cases,” they said.

Following the judge’s order earlier this week, the Oversight Board must provide a list by April 1 of the avoidance actions it will pursue. The UCC wants to be allowed to submit a motion seeking the appointment of a trustee to assert avoidance actions.

There are other matters the UCC has brought to light that in many ways have steered the commonwealth’s Title III case.

The committee litigated, on behalf of the commonwealth, the question of whether billions of dollars in sales & use taxes are the property of the commonwealth or Cofina, litigation resulted in a settlement that will allow the commonwealth to retain $28 billion in such taxes over the next 40 years. The UCC had serious concerns with respect to the restructuring of the Government Development Bank (GDB) because it purported to transfer the lion’s share of the GDB’s valuable assets away from the Title III debtors and to a newly formed entity for the benefit of certain consenting creditors. Moreover, the committee was concerned the GDB restructuring would result in Title III debtors losing valuable claims they may hold against this bank and current and former officers and directors of the GDB, before there has been an adequate investigation with respect to such claims. The committee filed a notice of its intent to object to the GDB’s Title VI qualifying modification and other pleadings, forcing the government to make changes to its restructuring terms.

They raised objections regarding the Kobre & Kim report on the debt. The informative motion points out, among other things, that the final report does not address the merits of any claims, including avoidance actions, whether Puerto Rico’s constitutional debt limit was exceeded or claims against private financial institutions.

The general approach of the final report is to exonerate potentially culpable parties, including by volunteering conclusions and presumptions that give the impression that there was no wrongdoing. Despite the final report’s efforts to exonerate, it still identifies highly troubling conduct by the GDB leadership, including swap transactions, GDB’s role as the government’s fiscal agent, the $3.5 billion general-obligation (GO) bond offering in March 2014 (though the report does not address potential claims of the debtors that could have arisen from the circumstances of the GO bond offering). Ultimately, they say the final report is of limited utility because it is impossible for any interested party to follow up on the investigator’s efforts.

The UCC was also behind efforts to stop the government from paying legal expenses to Bonistas del Patio, arguing that they were not part of any Title III case. The committee is also questioning the legality of the $6 billion in GO debt incurred after 2012, and the legality of Public Buildings Authority bonds.

The UCC joined the Oversight Board in seeking information from monoline bond insurers about their losses in their attempt to establish a receiver for the Puerto Rico Electric Power Authority.

In related news, the U.S. First Circuit Court upheld two lower court rulings, stating that certain GO bondholders do not have a lien on revenues and, in the second, that government is not obligated to pay pledged Highways & Transportation Authority revenue to bondholders.




Puerto Rico Debt Recycled?

Editor’s note: The following originally appeared in the Feb. 14 -20, 2019, issue of Caribbean Business.

Will the Financial Oversight & Management Board for Puerto Rico (FOMB) and the Unsecured Creditors Committee (UCC) successfully address a huge portion of the island’s debt by annulling about $6 billion in general-obligation (GO) bonds and $4 billion in Public Buildings Authority (PBA) bonds? There are no easy answers, but there is a precedent.

The process began late last year. On Dec. 21, the FOMB and UCC filed an adversary proceeding seeking to annul PBA leases because they were not rent payments, but rather financial transactions used to pay PBA bonds. The PBA is a government corporation that was created to issue bonds to finance the acquisition and construction of office space and other facilities used by government agencies. Currently, more than $4 billion in aggregate principal amount in PBA bonds remain outstanding.

Paying debt with rent

According to the adversary proceeding, the PBA entered into purported leases, pursuant to which it ostensibly leases PBA facilities to agencies. In reality, the FOMB and UCC say, the leases are not rental transactions designed to grant the government space, but rather are a vehicle for the commonwealth to repay the PBA bonds through the rent payments. Some 1,900 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 government filed for bankruptcy.

As a result of this changed focus, the Oversight Board and UCC are seeking a ruling, saying that because PBA leases are not true leases, but rather a disguised financial transaction, then PBA bondholders under Promesa and the Bankruptcy Code are not entitled to receive any rent payments from debtors. Such a relief is important for debtors to emerge from Title III bankruptcy.

Holders of PBA bonds have been alleging in court that the rent payments must be made because they are an administrative expense under the Bankruptcy Code. The holders of PBA bonds consist of a group of investment funds that include Fir Tree Partners, Candlewood Investment Group and IngleSea Capital LLC.

The attempt to annul the leases was followed by a Jan. 14 petition in which the FOMB, acting through its Special Claims Committee, and the UCC filed a request to invalidate $6 billion in GO bonds issued after March 2012 or, alternatively, to disallow the claims to the extent they include an unamortized original-issue discount. The FOMB and UCC are alleging the debt violated constitutional debt limits, which establish that debt service may not exceed 15 percent of average tax revenue over the past two years or the balanced budget clause of the Commonwealth Constitution.

PBA bonds part of debt limit

The proposed annulment of GO bonds covers two issuances made under former Gov. Luis Fortuño: one for $2.3 billion and another for $450 million. It also covers $3.5 billion in GO bonds issued in 2014 under the administration of former Gov. Alejandro García Padilla. The FOMB says the first two bond issuances are invalid when the debt from PBA bonds is considered in the calculation and the 2014 bond issue is invalid regardless. Therefore, the dispute will include a debate over whether PBA bonds should have been calculated as part of the debt limit, which according to the FOMB and UCC, was guaranteed by full faith and credit and should have been part of the calculation.

“Courts throughout the country have seen such public building authority structures for what they really are—transparent shams designed to circumvent constitutional debt limits,” the document says.

If the commonwealth succeeds in annulling the debt, it would be cut by nearly half the $13 billion GO debt.

Tied to all these transactions are government attempts to object to claims made by dozens of bondholders because their assertions are defective in some form. There is a difference between a repudiation of a debt, which is made when it is invalid, and the objection of a debt, which is mostly because it is the wrong amount or the debtor has already paid it.

Audited debt

Nilda González Cordero, a bankruptcy lawyer from Guaynabo, said that in her practice she has seen business clients in bankruptcy processes object to claims but noted that “it is a complicated process…. It is a different matter to engage in a controversy over the amount of the debt or to have interests reduced than to say, ‘take this away from me.’”

She declined to say whether the government would be successful in its endeavor because she has not studied the constitutional aspects of the dispute but noted that “Puerto Rico has not audited its debt and an audit could tell you if a debt was illegal.”

Did government officials know, or should they have known, that the bond iss

uances were illegal? What went wrong? The Kobre & Kim investigation report into the causes of the debt, published last year, said the government followed a robust process to determine constitutional debt limits, a process that included the Treasury secretary, Government Development Bank (GDB), bond counsel, underwriters’ counsel and the secretary of Justice. The latter issued an opinion in 2014 stating that bonds are valid commonwealth obligations. The problem the debt report asserts is the Justice secretary did not check debt-limit calculations and deferred those matters to the GDB.

Part of the problem was that Puerto Rico officials have interpreted the constitutional debt limit to not include certain types of debt, such as swaps, a complex financial transaction into which certain issuers enter that transfers the risk of interest-rate fluctuations between the issuer and its counterparty.

PBA Funds

PBA Funds, a group which holds PBA bonds, objects to the attempts to annul its debt, contending the FOMB brought the litigation to mount pressure in anticipation of negotiations among various classes of creditors, with respect to a commonwealth adjustment plan. “They are not serious in seeking a judicial determination on the question of whether the PBA leases are true leases or a disguised financing,” PBA Funds said.

First, the group said, there is no allegation that any of the PBA leases contain the crucial term that is the hallmark of a financial transaction, which is the ability of the tenant to convert monthly payments into equity or an ownership interest in the leased premises, as would be the case in a mortgage. “The case law on this issue is clear that without such an ownership interest, the ‘lease-disguised-as-financing’ argument fails,” PBA Funds said.

Those leases, PBA Funds added, continue to enjoy the presumption that they are true leases.

PBA Funds also noted that the Oversight Board is attacking the portion of the rent payments designed to service debt, but not the portion designed to cover operating expenses, such as the salaries and benefits of PBA employees.

James Spiotto, in an article titled “Puerto Rico’s Repudiation of General-Obligation Bonds: A Real Risk or Just Kabuki Theater,” said repudiation of claims of the invalidity of previously issued GO bonds by states or even local governments historically have never been viewed by the market as an acceptable or respectable position for an issuer who had earlier represented, through its statements and its agents, that the bonds were valid and in compliance with the law. “Generally, constitutional debt limits or balanced budget requirements are guideposts for the governmental issuer, in conjunction with bond counsel prior to actual issuance, to determine whether such debt can and should be incurred. These provisions were not intended to create an artifice that clever government issuers could spring on unsuspecting good faith bond purchasers, who had no prior notice of any defect, and in fact were told at issuance there were no compliance problems with the Constitution and law of the government,” he said.

Spiotto said the U.S. Supreme Court and many federal courts consistently supported bondholder rights in cases, such as the one in Puerto Rico, especially if the debt was issued in good faith. However, it has been invalidated in different circumstances, such as the 1880 case Buchanan v. City of Litchfield, because there was a failure to have any recitals or representations about full compliance with constitutional provisions relating to debt limits and a failure to have any assessment valuation for the relevant year permitted in the question of invalidity.

“Puerto Rico, in connection with the issuance of the asserted invalid [GO] bonds not only stated specifically that the bonds were in full compliance with the Constitution and laws of Puerto Rico but also, in the Official Statement, detailed the calculation and determination by Puerto Rico that the GO debt limit was not violated. It is illogical and unrealistic to require or expect the bona fide bond purchaser to be better able to perform the calculation than the government issuer, [which] is the one tasked to make the determination before issuance of the bonds,” he wrote.

However, what do the bond documents say? The disclosure statement for the 2014 bond issue identified as a risk factor that the government might reach the debt cap in the future and the constitutional guarantee does not cover any debt incurred over the cap. It also states that there is some debt issued by certain instrumentalities that is guaranteed by the full faith and credit in what appears to be a reference to the PBA debt. While bondholders often do not pay attention to bond documents, the warning was there.

“According to opinions provided by the secretary of Justice of the Commonwealth, bonds and notes of certain instrumentalities that are guaranteed by the good faith, credit and taxing power of the Commonwealth (Guaranteed Obligations) are considered public debt and enjoy the same priority of payment protection that is afforded to bonds and notes issued by the Commonwealth for which its good faith, credit and taxing power has been pledged (Direct Obligations). As of Dec. 31, 2013, there were outstanding $5.6 billion in Guaranteed Obligations and $10.2 billion in Direct Obligations. After the issuance of the bonds and the refunding of the refunded bonds, the amount of Direct Obligations outstanding will increase to $13.3 billion. The Commonwealth may continue to pledge its good faith, credit and taxing power to guarantee additional bonds and notes issued by certain of its instrumentalities,” the bond document says.

A lawyer consulted by Caribbean Business, who declined to use his name because he is close to the case but not authorized to speak about it, said Puerto Rico should not be penalized for trying to enforce, after the fact, the debt limits or balanced budget clauses because it will force officials and executives working on these transactions in the future to be more careful in order to protect debtors from




Unsecured Puerto Rico creditors disclose claims

SAN JUAN — On Wednesday, the committee that represents Puerto Rico’s unsecured creditors in the commonwealth’s bankruptcy cases under Title III of Promesa disclosed its claims against the government and its instrumentalities.

The members of the committee hold unsecured claims against the commonwealth arising from a variety of relationships, including contracting, labor and tax-related claims, among others. None of them hold bonds.

One of the committee members is the creditors’ trustee of now-defunct Doral Financial Bank, Drivetrain LLC, which has filed a claim against the government for about $300 million in tax overpayments. The defunct bank shut down its operations in 2015 over a bitter tax dispute with the commonwealth government.

Drivetrain—which was appointed Doral’s trustee in October to prosecute claims and causes of action—seeks payment under a closing agreement dated Dec. 30, 2013 with Puerto Rico under which the bank was allegedly entitled to a credit for overpayment of taxes in the amount of $34,097,526. Other claims related to Doral include certain 2006, 2007 and 2009 closing agreements, under which the financial institution was allegedly entitled to accrue an aggregate deduction of $296.5 million, according to the document.

Retirees, unsecured creditor committees named in Puerto Rico’s bankruptcy cases

Genesis Security Services Inc., meanwhile, said it holds $31 million in claims against the commonwealth and its instrumentalities under agreements for the provision of security services to a host of entities, including $10 million owed by the Education Department and $7 million owed by the Health Department.

Puerto Rico Hospital Supply Inc. holds $3 million in claims against the government under agreements for the purchase of hospital supplies, inventory and related services.

Other members of the unsecured creditors committee include Total Petroleum Puerto Rico Corp., which holds $14.5 million in claims arising from motor fuel purchases and supply contracts; and Unitech Engineering Group S.E., which has $11 million in claims, including $2 million against the Public Buildings Authority under certain construction contracts.

At least two unions—the American Federation of Teachers (AFT) and the Service Employees International Union (SEIU)—hold labor-related claims against the commonwealth, including breach of collective bargain agreements. SEIU represents the local Puerto Rican Workers Union, while AFT is the authorized agent of the Puerto Rico Teachers Association.

The unsecured creditor committee is represented by law firm Paul Hastings LLP.