Bonds

PREPA-WHAT NEXT?

                                                                        May you live in interesting times. Chinese proverb

At 12:02 am of September 17, 2022, with Tropical Storm Fiona about to strike Puerto Rico, the Financial Oversight and Management Board (the Board) filed a motion informing the Title III Court that it believed that the path forward for PREPA was to litigate the bondholders alleged security interests, the allowability of their claims pursuant to section 927 of the Bankruptcy Code and the alleged seniority of the fuel line claims.

I confess I was surprised by the Board’s motion. I was inclined to believe a settlement was in the works. Obviously I was wrong.  This means, irrespective of the manner in which it evolves, there will be years of litigation in the PREPA Title III and beyond. I will attempt to provide a background to this mess.

Around July 1, 2014, PREPA drew $41 million from its debt service reserve and immediately creditors and analysts pondered whether this was a technical default.  https://www.bondbuyer.com/news/prepa-draw-is-a-danger-sign-analysts Subsequently, negotiations between PREPA and its creditors began, and in September of 2014, Liza Donahue was appointed restructuring Officer at PREPA https://www.bondbuyer.com/news/prepa-appoints-turnaround-vet-lisa-donahue-as-chief-restructuring-officer This move was dictated by bondholders. Ms. Donahue continued negotiations with bondholders in September 2015 https://energia.pr.gov/wp-content/uploads/sites/7/2016/07/Ad-Hoc-Group-Press-Release.pdf with a 15% haircut. By this time, however, Congress had already introduced PROMESA and on June 30, 2016, it was signed into law by President Obama. PREPA missed its July 1, 2016 payment pursuant to section 405 of PROMESA. Subsequently, then Disgraced Governor Rosselló renegotiated the deal by April of 2016 https://www.bondbuyer.com/news/puerto-rico-reaches-new-prepa-deal The Board, in a 4-3 vote, however, decided to ignore section 104(i)(3) of PROMESA and filed for Title III protection on July 2, 2016 https://www.nytimes.com/2017/07/02/business/puerto-ricos-electric-power-authority-effectively-files-for-bankruptcy.html

During the Title III proceedings, the bondholders asked Judge Swain to lift the stay for the appointment of a receiver for PREPA. Judge Swain denied the relief, partly claiming section 305 of PROMESA precluded her from doing so. Bondholders appealed and in FOMB v. Ad Hoc Group of PREPA Bondholders, 899 F.3d 13 (1st Cir. 2018) reversed Judge Swain, explaining that she could lift the stay in order to have a different judge determine whether a receiver was to be appointed. The First Circuit also emphasized that the lifting of the stay required a showing that movant had a lien that needed adequate protection and that the Title III Court could also determine the powers of the receiver. This decision will have great importance as we will soon see.

With this reversal, the Board quickly engaged bondholders in negotiations and by May of 2019 had reached a Restructuring Support Agreement with them https://aeepr.com/es-pr/QuienesSomos/Ley17/RSA%20-%20Public%20(May%203rd%202019).pdf As different groups joined this agreement, parts of it were modified, etc. By October of 2019, the Board filed a Bankruptcy Rule 9019 motion for the approval of the RSA. The Board subsequently alleged that it was trying to obtain the Legislature’s approval of laws for the RSA and that this, coupled with earthquakes, the Covid-19 Pandemic, caused the postponements of the 9019 motion. I find it doubtful given the Board’s claims in the Commonwealth plan of adjustment controversies where it claimed it did not need it but that is what it claimed.  

Tellingly, the Unsecured Creditors Committee (UCC) filed several motions claiming that the RSA was dead, and the Board opposed them saying that its attention was in the restructuring of the Commonwealth and negotiating with the Legislature. Every time Judge Swain swept away the UCC’s objections.

Things were coasting along when PREPA bondholders filed a motion pursuant to PROMESA section 312 requesting that the Court appoint a mediation team on February 18, 2022. The Board opposed the motion on February 28, 2022, stating, inter alia, at page 3 of its motion “[h]igher oil prices are now causing higher electricity rates independent of the increased rates imposed by the RSA, and likely by any restructuring. That underscores the need for prudence and evaluation rather than a rush to reach and consummate a deal that serves only one constituency and could prove too costly for PREPA post-emergence.” AAFAF and other stakeholders opposed the motion.

On March 8, 2022, the Governor announced it would withdraw from the RSA and Judge Swain denied the PREPA bondholders’ motion. The Court, however, stated that it would entertain mediation that was economically feasible. It also stated that “[u]ntil recently, the Oversight Board and the government entities’ words and actions gave the Court reason to expect that a plan of adjustment would be forthcoming promptly and that no interruption of the oversight engagement efforts would hinder the process.”

Subsequently, PREPA, the Board, the UCC, Bondholders, Utier (the PREPA union) and the PREPA retirement fund, went to mediation. This mediation was extended several times, over the objection of the UCC, the Utier and PREPA’s retirement fund, who preferred to litigate different issues of bondholders’ rights.

When the decision by the Board was announced, Justin Peterson, a member of the Board, took to tweeter to express his disappointment on the Board’s decision. He also said that “rolling the dice on litigation instead of making a deal means that this will cost Puerto Rico even more.” In another tweet he said “To kick things off, consider this: now the pensions are on the table. Bondholders will come for everything.” Most interesting to me was this tweet: “The centerpiece of the FOMB proposed litigation schedule is alien challenge of bondholder claims. Everyone should understand this is a radical move by the Board and an attack on the entire system  of municipal finance in the United States.”

What can we expect from all this? Judge Swain, on Saturday July 17, 2022, a few hours after the Board’s motion, ordered the parties to file any oppositions by Monday September 19, replies by September 20 and be ready for argument during the Omnibus of Wednesday, September 21, 2022.

It is clear that the Bondholders will file a motion to dismiss the Title III bankruptcy. Section 930(a) of the Bankruptcy Code states that if a plan of adjustment cannot be filed, the case must be dismissed. In addition, Bondholders will request the lifting of the stay for the appointment of a receiver for PREPA. I do not think the Judge will dismiss the Title III but we must remember the case is over 5 years old. The longest Chapter 9 case I can remember is San Bernardino, which lasted 6 years. Even if the Court were to adopt the Board’s schedule, a hearing of the summary judgment motions would be held around April of 2023. Giving the Court time to evaluate the motions, she would decide the issues by fall of 2023 and the losing party would immediately appeal. This could take between six months to a year, meaning summer or fall of 2024 for the dust to settle and determine whether a plan of adjustment could be filed. Yes, could. Even with the issues decided, there is no guarantee a confirmable plan of adjustment could be achieved.

In addition, the problem with litigation is that you may win, or you may lose. Even if the Board wins, this does not mean PREPA will not have to pay bondholders but could mean that their claims could be substantially impaired as unsecured creditors. It could also mean that more money could go to Utier and the PREPA Retirement Fund. On the other hand, if bondholders win, it will mean that they would have to be paid in full. Have no doubt that after not being paid for several years, bondholders will want their pound of flesh. In addition, it is likely that after such a victory, Bondholders will gain a receiver to increase the PREPA rates in order to pay them. This would mean substantial increase of the rates. Moreover, even if the Board wins, it would mean an increase in the rates to a lessor degree.

If the Court were to dismiss the Title III, many things will happen. Not having the protection of the automatic stay, PREPA would have a receiver appointed. Moreover, this would not mean the end of the challenge to the bonds but would shift it from Judge Swain to some other Court, most likely Federal Court in Puerto Rico. Several years of litigation would ensue before the issue of the liens would be decided.

In any of the two scenarios, with or without Title III, LUMA, the administrator of PREPA’s distribution system, could decide to let the contract expire by November 30, 2022. This would put in jeopardy the reconstruction of the electric grid, require AAFAF to get another company to handle the system and substantially increase the future cost to PREPA. Governor Pierluisi recently stated that instead of the $115 million LUMA charges, it would be charging between $180-200 million for its services during the transition.

From what the Board wrote in February 2022, it seems the RSA ceased being a good idea due to the increase of the fuel costs due to the war in Ukraine. Although this may be true, an increase in fuel costs was foreseeable at some point in time. Hence, contrary to what the Board said for a long time, the RSA was not a good idea. Its actions, however, are risking a substantial increase in rates as I explain supra, something we won’t know until later. It is my belief, however, that this stance is nothing more than a ploy to extract more concessions form bondholders. That is why the Board hedged its bet by also requesting  that the mediation team be standby. The question is whether it will be available. Now we must wait and see what Judge Swain decides.

LA AGENDA MAS IMPORTANTE DE LA GOBERNADORA

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La Gobernadora tiene mucho taller ante sí. Pero sobre los dos asuntos más apremiantes, la Junta y la corrupción, nada ha dicho. Ambos asuntos son de lapidaria importancia, como diría mi apreciado profesor, Don Herminio Brau (QEPD).

 

El asunto de la Junta es multi-temática. ¿Continuará la Gobernadora la actitud de conflicto y desafío continuo a la Junta o tratará de ser más conciliatoria? ¿Que va a hacer sobre las pensiones, los bonos y la venta de la AEE? Definitivamente la Gobernadora no puede continuar con la política de confrontación abierta con la Junta de la Administración de Rosselló. Muchos de los cambios que propone la Junta son necesarios pero anatema a la clase política, como la reducción de pensiones y los bonos de navidad. Pero la confrontación a nada lleva ya que con excepción de la victoria sobre Zamot, la administración ha perdido todas las demás batallas.

 

Tampoco puede unirse al esfuerzo de la Junta de destruir a los bonistas de obligación general. Aún si PR gana ese enfrentamiento, el mal sabor que esto dejará sobre los inversores retrasará cualquier regreso al mercado con intereses razonables, uno de los dos requisitos para la salida de la Junta. Hay que mirar al futuro y no a la próxima elección como fue la visión de Rosselló. Un acuerdo similar al de COFINA para los bonistas de obligación general ayudaría mucho a la imagen de la isla ante los inversores internacionales. Esto podría llevar a una confrontación con la Junta pero al fin y al cabo, PR es quien tiene que ejecutar el plan de ajuste y va a ser más difícil para la Juez Swain aprobar el mismo si el Gobierno lo objeta. No imposible, pero definitivamente más difícil.

 

Otro asunto atado a lo anterior es el costo de la representación legal del ELA. Peter Friedman y compañía ha hecho un muy buen trabajo PERO a $1,300 la hora. Es tiempo de examinar los costos de abogados y peritos y decidir si firmas locales no pueden hacer el mismo trabajo por una fracción del costo. Lo mismo se puede decir de los peritos de AAFAF. Esto nos lleva a otro asunto. ¿Quien será el director de AAFAF y cual será la actitud de la agencia hacia la deuda? ¿Quien será el representante ante la Junta y cual será su actitud hacia la Junta? Es tiempo de una revisión completa de ambas agencias y de que hacer. PR aumenta ingresos cada mes por encima de lo predicho por la Junta. PR tiene que comenzar a pagar su deuda, cosa que muchos políticos rehúyen hacer. Mientras más paguemos, mejor opinión tendrán de nosotros en los mercados de inversión, a los cuales tendremos que ir, más pronto de lo que muchos pensamos.

 

Por último, la corrupción. En escritos anteriores he señalado que el Depto. de Justicia bajo Wanda Vázquez se hizo de la vista larga sobre señalamientos de corrupción. Si de verdad la Gobernadora quiere demostrar que no es una politiquera, tiene que atajar la corrupción en el Gobierno y eso se hace con arrestos y convicciones. Obviamente se comienza con investigaciones pero la verdadera prueba de un compromiso  con combatir la corrupción es arrestando y consiguiendo convicciones de los que roban del erario público. Solo así se le puede demostrar al Pueblo y al Gobierno Federal, que no hacen falta monitores para velar por su dinero. La bola esta en la cancha de la Gobernadora.  Le deseo el mas sincero éxito en esta difícil labor.

BONDHOLDER NEGOTIATIONS AND THE ROAD TO NOWHERE

The Negotiation Farce

We are now in April and, come May 1, the PROMESA stay on litigation expires. Where are we on bondholder negotiations? What happens if there is no Title VI restructuring?

It looks like the answers to those questions might be “nowhere” and “we’re about to find out,” respectively.

Last year, the Oversight Board announced with great fanfare the start of bondholder’s negotiations set for December 19, 2016, but aside from a meet and greet session, nothing happened. And that has remained the case even after the board certified Governor Rossello’s second fiscal plan last month.

After certifying the plan, the board requested that the two senior-most bondholder groups, General Obligations and COFINAs, enter into private mediation to settle their ongoing dispute.

This request kicked off a flurry of letters from creditors, including joint letters authored by holders of some $13 billion of both GO and COFINA debt, which outlined numerous criticisms of the fiscal plan. The letters also asked the government to commence negotiations with bondholders immediately, arguing that the stay expires too soon to waste time negotiating a creditor dispute rather than negotiating with all bondholders.

Despite these overtures, however, the Puerto Rican Government and the Board have not moved onto negotiation, and have instead pushed forward with the mediation process, assigning Judge Allan Gropper to serve as mediator in talks reportedly starting tomorrow and lasting through the end of the week.

Why? To Sow Confusion

It appears that the Oversight Board and the Government are intentionally conflating mediation between two creditors in active litigation and actual negotiation with creditors.

It is impossible that a real solution to the GO/COFINA dispute will be brokered over a mere 48-72 hours, especially given the numerous, unaddressed problems that parties on each side have with the fiscal plan. Moreover, even if a settlement was reached, there will be only two weeks for real negotiation to occur after the mediation ends.

But the Board does not appear genuinely interested in a resolution to the dispute or conducting serious negotiation talks. Rather, I think the board is intentionally confusing the issue with the hope of stalling for Title III.

Once the stay runs out, the Board will most likely say that the mediation proceedings themselves actually qualify as a good faith effort toward reaching a consensual agreement under Title VI of PROMESA, and will use that to justify throwing the entire process into a Title III restructuring.

Will Mediation Count as a Good Faith Effort at Negotiation?

Mediation is a type of alternate dispute resolution where a supposedly neutral person helps the parties involved to resolve their disputes. It is not the same thing as a negotiation, especially when some of the parties say they don’t want to participate in the process.

Section 206 of PROMESA requires the entity (PR) to make “good-faith efforts to reach a consensual restructuring with creditors” before the Board issues a certification for Title III. Good faith negotiations is part of Chapter 9 of the Bankruptcy Code, but the section that deals with it, 109(c), was not adopted by PROMESA. Nevertheless, it is a requirement and likely bankruptcy law precedents will be used by the Courts to determine if there have been any.

To be sure, bondholders will raise this point in court. While we often hear from Oversight Board members and Commonwealth leaders that this process is not subject to judicial review – and while that also seems to be the intellectual opinion of Judge Gonzalez and Marty Beinenstock – I don’t think any judge appointed to oversee the Title III process will just let such a crucial issue like this go unquestioned.

Thus it seems very unlikely that a judge will agree with the Board that its attempts to force bondholders into mediation will satisfy PROMESA’s requirement of a good faith effort at a consensual negotiations.

 

Has the Board or the Puerto Rican Government Provided Sufficient Information for Good Faith Negotiations to Commence?

In the Detroit litigation, the Court determined that the city had not negotiated in good faith for failing to provide sufficient information to make counterproposals and that there was not sufficient time to do so. In this case, negotiations started on June 14 and bankruptcy was filed on July 18. See In Re Detroit, 504 B.R. 97, 175 (E.D. Mich. 2013). As I said earlier, after the conclusion of mediation proceedings on April 14, there will be only 16 days until the end of the stay. Even in the unlikely event that mediation is allowed to constitute part of a negotiation process, there will still only be 18 days between April 13 and the end of the stay.

The issue of sufficient information is important with respect to Puerto Rico’s financial statements, since sec. 206(a)(2) requires PR to adopt   procedures necessary to deliver timely audited financial statements; and . . . made public draft financial statements and other information sufficient for any interested person to make an informed decision with respect to a possible restructuring.

Since the Board’s report by Ernst & Young, at pages 5, 9-10 and 16 states that the financial information it used (provided by the PR Government) is poor, it can hardly mean that it is sufficient for any interested person to make an informed decision with respect to a possible restructuring.

Hence, the way in which these negotiations are conducted and the information provided is of paramount importance for the Title III petition not to be dismissed by section 304 of PROMESA. As of yet, it does not appear that the government has submitted sufficient information for real negotiations to occur.

Does the Fiscal Plan Satisfy Requirements in PROMESA?

It is my belief the Court may review the fiscal plan to determine whether it complies with PROMESA in the intersection of sections 201(b)(1)(N) and section 314(b)(7). Section 201(b)(1)(N) requires that the Fiscal Plan “respect the relative lawful priorities or lawful liens, as may be applicable, in the constitution, other laws, or agreements of a covered territory or covered territorial instrumentality in effect prior to the date of enactment of” PROMESA.

The Fiscal Plan as approved, however, does not do this in any of it sections. In fact it states, at page 6 that it does not determine, inter alia, “the scope, timing or specific use of revenues to be frozen or redirected as ‘claw back’ revenue, the value, validity and/or perfection of pledges or whether any particular bond or debt issuance may have been improvidently issued” Since the Bankruptcy plan, pursuant to section 314(b)(7), must be “consistent with the applicable Fiscal Plan certified by the Oversight Board under title II” one can argue that any Bankruptcy Plan based on a deficient Fiscal Plan is invalid and hence the Court would have to make said review of the Fiscal Plan. Moreover, the Fiscal Plan cannot violate the US Constitution and bondholders seem poised to make that challenge.

What if the Court were to find that the Bankruptcy Plan is not consistent with what should be the Fiscal Plan? Pursuant to 11 U.S.C. § 930 (adopted in PROMESA by section 301), if the Court could determines that the Bankruptcy Plan could not be certified, it can dismiss the proceeding and PR would not have the protection of the automatic stay.

Or is the Strategy to File for Title III, then Negotiate?

Given all of these obvious shortcomings of an impending Title III petition, it’s worth asking why the Board would file for Title III and risk having it dismissed. The answer likely lies in Section 304(b) of POMESA, which does not allow the dismissal of a Title III petition during its first 120 days.

Therefore, the Board could use this window to negotiate AFTER filing Title III (including Court mandated mediation as in Detroit) and then claim that it negotiated in good faith. It could then aver that it would be a shame to dismiss the claim after all this time. Essentially, the board could file for Title III with full knowledge that its petition will most likely be rejected, if only to buy itself four more months.

Let’s see.