The Challenges of a Successful Title VI Negotiation
If the recent exchanges between the Oversight Board and Gov. Ricardo “Ricky” Rosselló Nevares’ administration have revealed anything, it is that the governor remains deeply committed to a consensual negotiation process with Puerto Rico’s creditors and, consistent with sections 206(a) and 405(n) of Promesa, the administration, not the Oversight Board, will assert its authority in leading these negotiations.
Rosselló Nevares’ commitment to follow through on his campaign’s key promise is good news for Puerto Rico’s most senior creditors and for the Commonwealth’s hopes for renewed access to the markets.
Promesa’s (the P.R. Oversight, Management & Economic Stability Act) Title VI, which governs the negotiation process, stipulates that either bondholders or the government can propose modification to given tranches of the debt and, if the Oversight Board approves the agreed modification, it will place the bondholders into pools based on constitutional and lawful priorities for the purpose of voting on the plan. If two-thirds of the voters in a given pool approve of the modification, the board will then sign off on it.
Simple as this may seem, however, the administration must overcome significant challenges if it is to follow through on settling most of its restructuring outside of bankruptcy court.
The fiscal plan
The first and most immediate challenge is the development of the government’s fiscal plan. Here, the governor must overcome the immense damage that the previous administration did to Puerto Rico’s government financing apparatus and to La Fortaleza’s credibility among creditors and the larger lender community.
For its part, the administration has already begun to fight to earn that credibility back. It has publicly rejected rumored short-term financing deals that might tempt it to forgo making difficult but impactful reforms. It has reiterated to the board that it “will reflect a fundamental willingness to pay” creditors. And, just last week, it set aside $146 million in “clawed-back” funds in a show of good faith to the general-obligation (GO) bondholders.
Still, all of this work will be undone if creditors do not feel the numbers produced in the government’s fiscal plan are credible, or they do not feel they have been appropriately consulted in the crafting of that plan. If the numbers are not seen as credible, or the board imposes its own numbers, then creditors will react badly and we are almost assuredly heading to a Title III restructuring. Painful as it may be for the governor, getting to a point where senior creditors are happy with the numbers may involve zeroing out much of the junior credits.
Not that Title III is a bad idea for certain instrumentalities such as Prepa (P.R. Electric Power Authority), the GDB (Government Development Bank) and Cofina (the Spanish acronym for Sales Tax Financing Corp.), but it would make no sense for most of the government. Another candidate for Title III would be the municipalities, which Ramón Ruiz Comas, the Oversight Board’s interim executive director, recently mentioned would be examined very soon. In Title III, the board can not only restructure these entities’ debt but also change its governance pursuant to 11 USC § 1129. This may include the selling of Prepa’s generation monopoly, and reducing any Cofina debt and the number of municipalities. This idea is advanced by Oversight Board member David A. Skeel Jr. in his article “Governance Reform & the Judicial Role in Municipal Bankruptcy.” Substitute Municipal Bankruptcy for Title III and you have a roadmap of what the board can do.
Moreover, the government must also work to instill further clarity in what creditors can expect to be available to them in the negotiations to come. The board has said it expects to have about $800 million available for debt service in FY 2018-19. The administration has not rejected this number outright, but greater clarity on numbers for 2017 and beyond will be required.
Title VI as a pathway to growth
The key long-term challenge to any Title VI agreement is that it must not only satisfy bondholders, but must also establish a pathway to sustained growth for the Commonwealth. For this, it is imperative that Puerto Rico settles on a credible vehicle for future financing and gains access to new money.
Both the GOs and at least some of the Cofina bondholders (which are less unified because of different interests between holders of senior vs. junior bonds) are rumored to have approached the government about future lending, but this is complicated by their ongoing dispute.
There have long been questions about the validity of Cofina’s structure in some circles, with many asserting it should be considered illegitimate because it was created as a tool to circumvent the constitutional debt limit of previous governments. But the ongoing litigation by the GOs against Cofina, which I have discussed elsewhere, raises further questions about the strength of Cofina’s claimed lien on sales & use tax (IVU by its Spanish acronym) revenue. In short, the GOs argue that Cofina holders do not have a lien on sales-tax revenue itself, but only on the “box” that the government has been depositing sales tax into, and this revenue is still subject to clawback for payment of higher-priority obligations.
Thus far, unwisely in my view, the board and the government have refused to comment on the dispute, and there is also debate about whether the government might ultimately decide to join the litigation. While these issues remain undecided; however, there remains a great deal of uncertainty regarding long-term financing, which is the key to growth.
As of yet, the board will not permit the government to factor in sustained federal Medicaid funding in its financial projections. José Carrión III is on record saying this will not change until there is legislation introduced in Congress to continue funding at least at current levels. If Congress fails to act, it will deal a serious blow to Puerto Rico’s projected revenues and will severely complicate the creation of a workable fiscal plan.
Still, it is difficult to envision Congress undermining its own months of hard work in passing Promesa by zeroing-out Medicaid funds. Doing the same for a state would be unthinkable, so I think it is illogical for the board to entertain this hard-line approach.
Overcoming the challenges to a successful Title VI negotiation and reaching a negotiated settlement with bondholders remains the bedrock of Gov. Rosselló Nevares’ financial vision. So far, he remains steadfastly committed to following through on that vision and, as long as he remains so, the markets should continue to be supportive of his leadership and eager to help in any way they can. We will see what comes.
John Mudd is an attorney & legal analyst in Puerto Rico with more than 30 years of experience. He is admitted in P.R., the U.S. District Court for P.R. and the First and Fourth Circuit Courts of Appeals. He has been analyzing the possibility of a control board for P.R. for more than three years. You can follow him in on Twitter @MUDDLAW and on his blog at www.johnmuddlaw.com.