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.