Federal Cases

Lex Claims Oral Argument April 4, 2017

On April 4, 2017, Judges Howard, Lynch and Barron heard oral arguments in the Lex Claims case, where Judge Besosa had decided the PROMESA stay did not apply to some of the claims, including the validity of COFINA and its alleged lien. 

As usual, right from the start of the Supervisory Board’s argument, the Judges started asking pointed questions. Judge Barron started asking technical questions that boiled down to whether the stay applied to a declaration that Governor Garcia Padilla’s executive order were invalid or preempted. Judge Howard asked if some or all of the causes of action arose after PROMESA was approved. The Board’s lawyers denied this but clearly the Judges are not convinced. Judge Lynch seemed concerned about other cases arising but was assured there are none.

 

Judge Howard asked about mediation and was assured it would start next week. When Senior COFINA lawyers started their argument, Judge Barron asked why the declaration of the Executive order was preempted. COFINA had to admit that such declaration is not an issue of control.

 

Ambac came next for appellants and likened the Lex complaint to a bank in state court attempting to determine where income should go for a bankruptcy debtor but this did not bar Judge Barron from asking the same question as to declaratory judgment. We can see a pattern there.

 

Once Lex Claims came to argue, it invoked section 303(3) of PROMESA claiming this was not precluded by the stay. Judge Lynch, who seems intent on preserving the stay, asked if there was explicit language that pointed that way. Lex conceded there was none but that the overall interpretation of PROMESA showed that. Lynch did not seem convinced. Lex continued arguing that they did not seek control, but Judge Barron challenged this view. Judge Lynch went to the offensive and asked if you filed your complaint, why should we relieve you of it in clear reference to the second amended complaint. Lex answered that it could amend the complaint.

 

From this we may surmise that as the Circuit Court’s stay order stated, the Judges will decide the stay will apply to all of the Lex Claims’ complaint, although Judge Barron could file a partly dissenting opinion or convince them it does not apply to the declaratory judgment sought by appellee. Since I assume the panel will be as swift as it was in the Peaje case, a decision could come down by next week or earlier. If it comes down by next Tuesday, April 11, there would only be 19 days left of the stay.

 

This brings us to another issue. Since it is clear negotiations will start later than April 10, the PROMESA stay which was enacted to afford PR an opportunity to attempt to restructure its debt consensually has been instead used by the Government and the Board to pick and choose winners among bondholders. This may have serious repercussions in the coming Title III as I will discuss in an upcoming posting.

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JUDGE BESOSA REFUSES TO STAY LEX CLAIMS COMPLAINT

 

 

On February 17, 2017, Judge Besosa decided important issues in the Lex Claims litigation. In this case, plaintiffs, a group of GO bondholders, seek an injunction against the use of the sales tax to pay COFINA bonds, claiming they have first lien on “available resources” as per the Puerto Rico Constitution.

 

Defendants included, inter alia, the Government of PR, COFINA and its Executive Director, who filed various motions to stay the litigation. In addition, Ambac, a monoline that insures COFINA senior bonds, COFINA Senior Bondholders, Puerto Rico based bondholders and Mayor COFINA Bondholders (subordinate COFINA bondholders) filed motions to intervene, as did the Board.

 

Judge Besosa reviewed all of defendants’ arguments for the stay in great detail and rejected all. Hence, the claims for injunction against the payment of COFINA bonds and violation of civil rights (42 U.S.C. § 1983) will go forward. In addition, Judge Besosa granted intervention to all that sought it, except for COFINA Senior Bondholders since their request was limited to claiming the stay was applicable.

 

What will happen now? It is clear Judge Besosa wants to resolve the GO/COFINA controversy, which makes it unlikely that he will send it to the PR Supreme Court. Moreover, the case is what we call paper litigation. The issues before the Court revolve around an interpretation of the PR Constitution, the Constitutional Convention, the 1961 Amendment to the Constitution and its legislative record, COFINA statutes, its legislative record and the bond documents. There is no need for a hearing since there would not be any testimony, expert or otherwise as happened in the previous litigation on the stay.

 

Can PR or other defendants “appeal” Judge Besosa’s decision? Not really. The Federal system is hostile to appeals where there is no final determination of the issues. For example, in the Peaje litigation that recently went to the First Circuit, there was a final order since once the decision favored the stay, “there was nothing left for the district court to do.” Here, however, there is much left to do. Of course, defendants may seek leave from the District Court to appeal and then seek appeal via 28 U.S.C. § 1292(b). The First Circuit, however, is very hostile to this type of appeal and rarely grants it. Hence, defendants will have to continue with this litigation.

 

How long can it take? I am sure plaintiffs are at this time preparing their motion for summary judgment to have the Court decide the issue quickly and I have no doubt he will do so. Remember that the First Circuit reminded Judge Besosa “In conducting such proceedings, the district court should be mindful of Congress’s explicit direction to ‘expedite’ its disposition of the matter ‘to the greatest possible extent.’” Section 106(d) of PROMESA.

 

What should PR and the Fiscal Supervisory Board do? Both the Board and PR have said they will not take sides on the controversy but I think they should. GO’s and COFINA amount to half of PR’s bond debt ($18 billion in GO related and $17 billion in COFINA) and there is no chance on voluntarily restructuring GO’s unless the issue is resolved since they will claim, with certain reason, Constitutional priority. A quick decision on the issue would not only resolve the issue but if COFINA is illegal, it would lose any claim to a stream of income from the sales tax, it would not have a pledge and lien and in a Title III proceeding would be an unsecured creditor. The Court could then reduce its indebtedness close to zero. Let’s see what happens.

ORAL ARGUMENT ON PROMESA STAY

 

 

On January 4, 2017, the First Circuit Court heard oral arguments on the appeals by Peaje, Altair, Brigade, and the Supervisory Control Board. The panel was composed of Judges Thompson, Howard and Kayatta. Judge Howard was one of the Judges in the Franklin California v. Commonwealth case and Judges Thompson and Kayatta were involved in the Wal-Mart v. Commonwealth, the first case that interpreted PROMESA. Many of the arguments were very technical in nature, dealing with the takings clause of the Fifth Amendment as well as lifting of stay in bankruptcy (11 U.C.S. §362) I will concentrate here on the questions posed by the Judges which is the better gauge of what is on their mind.

 

At the start of the argument, Peaje claimed that the burden of proof was on defendants to show, once plaintiff proved it had a lien and that its lien was being depleted, that it had sufficient revenues that would prevent the collateral from being depleted or exhausted. Judge Kayatta asked if there was any evidence of this in the proceedings below and asked that he be told where specifically in the record they were alleged or claimed. Also, Judge Howard asked what flexibility the Court has with PROMESA. None of the answers were very clear. Subsequent filings on these subjects were requested by the Judges.

 

Altair came in and was asked by Judge Kayatta whether the reduction of the collateral was sufficient enough that the debt was in jeopardy. The attorney answered that PR had stated that said payments were not safe, although the island was not using them and had the funds in a discretionary account. She stated that if it was placed in an account that could not be used by the island, there would not be litigation. Judge Kayatta mentioned that the Moratorium Act did not prohibit the transfer of these funds but seems to suspend the obligation. Judge Kayatta again asked who had the burden of proof.

 

When the individual PR defendants took their turn, they mentioned in passing that Judge Besosa’s order was an interlocutory order and not appealable. No judge said a word of this, so probably it will not be an issue. Again Judge Kayatta asked about the depletion of collateral. He was told there was ample collateral but, even if it was exhausted, plaintiffs could sue for damages. Judge Kayatta countered that then they would not be secured but rather unsecured creditors (secured creditors get paid first to the extent of their security in bankruptcy). He also asked for any cases in bankruptcy that held that the depletion of collateral could be allowed if a cause of action for damages was available. No cases were mentioned by defendant and Judge Kayatta mentioned that that was tantamount to closing the barn door after the horse had escaped. He had great difficulty with the proposition that the Government could have 7 months to destroy collateral without the certainty of recovery. Judge Kayatta then asked how do we deal with sec. 405(k) of PROMESA (the section states that it does not affect or discharge an obligation). The answer was lacking in what I think the Judge was asking, to wit, can the Court allow the destruction of a collateral? At this point, Judge Howard asked if there shouldn’t have been a hearing, which of course defendants said no. Judge Thompson followed up and asked if there was evidence of a cushion for the collateral.

 

Defendants kept hammering that adequate protection, the standard used by Judge Besosa to decide on the lifting of the stay, was incorrect; that PROMESA did not adopt this standard in Title IV. They want a balancing of equities but, as plaintiffs stated in the rebuttal, under that standard, there never would be a lifting of the stay. The Employee Retirement Fund claimed that non-governmental contributions (municipalities) to the fund were enough to maintain the collateral.

 

The Financial Oversight Board claimed that it did not file an answer to the complaints because it did not want to state its position on the constitutional and statutory claims made by plaintiffs before they sat at the negotiating table. Again, the Board claims it has the statutory mission to conduct said negotiations.

 

In rebuttal, Peaje said the burn rate of the collateral was 100% and their experts would state there was a likelihood there would not be sufficient funds in the future to maintain the collateral. As to the ERS non-governmental contributions, Altair said defendants said they were uncertain in the Fiscal Plan.

 

What can we conclude from this? The Judges are disturbed by the lack of hearing. There is evidence that the issue of depletion of the collateral is vital to the determination and that would be done in an evidentiary hearing. In addition, sec. 405(e)(2) requires a hearing. Hence, I believe that the Judges will reverse the Peajes decision by Judge Besosa and require a hearing. This could be important since it is likely that the stay will be extended by the Board to May 1, 2017. As to the other issues, I did not get a feeling one way or the other of what is on the Judges minds. Let’s wait and see. Since PROMESA requires that the issues be treated in an expedited manner, we could expect a decision by the end of the month or sooner.