Judge Besosa

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.

 

 

PROMESA DECISIONS SHED LIGHT ON PARTIES CLAIMS

 

 

On November 2, 2016, Judge Besosa denied the lifting of the stay in the Peaje cases. We are still waiting for the decision in the Brigade cases but what many have not noticed is that Judge Besosa is establishing some clear views of the parties’ claims.

 

In Assured Guarantee, Corp. v. García Padilla, 16-1037, 16-1095- Judge Besosa issued an opinion deciding that the Moratorium law is not preempted by section 903 of the Bankruptcy Code, but it could be unconstitutional. What most reporters have missed in this opinion is that Judge Besosa quickly made clear at page 4 that [i]n cases of an unbalanced budget, the Commonwealth Constitution establishes a priority system detailing in what order appropriations will be paid. P.R. Const Art. VI § 8. First priority is assigned to ‘interest on the public debt and amortization thereof.’” The PR Government has maintained that due to its “police power”, the first priority of payment is essential services and not the debt. Clearly, this view is contrary to what Judge Besosa said.

 

On the most recent opinion, the Judge discussed Peaje bond claims and said:

 

Because of these provisions, and because PRHTA’S pledged revenues are constantly replenished by an ongoing stream of toll payments, Peaje Investments continues to hold a security interest in a stable, recurring source of income that will eventually provide funds for the repayment of the PRHTA bonds. Though it will not receive the pledged revenues during the stay period, this enduring security interest means that it faces only a delay in recouping such funds, not a permanent loss of them.

The Court believes that the existence of this continuing lien on a perpetual source of revenue satisfies the “flexible” standard applicable to determinations of adequate protection. (page 16 of the Opinion, underlining ours)

 

The Judge opined on the Altair bonds as follows:

 

Those plaintiffs, pursuant to the terms of the applicable bond resolution, hold a security interest and lien in certain pledged property, including all future employer contributions. This lien continues indefinitely until ERS’s outstanding debt obligations have been satisfied in full. As discussed above, nothing in the language of PROMESA or the Moratorium Act diminishes or destroys this lien against the ERS employer contributions, which, like the PRHTA toll revenues, are a perpetual revenue stream whose value is not decreased by the Commonwealth’s acts of temporary suspension. (page 17 of the Opinion, underlining ours)

 

Hence, Peajes and Altair bondholders in these cases have a pledge and lien on these streams of income and pursuant to Title III of PROMESA, are secured creditors, entitled to be paid in full. Moreover, pursuant to Section 201(b)(1)(N) of PROMESA, the Fiscal Plan must “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 this Act.” Also, Section 314(b)(7) of PROMESA requires that the Bankruptcy be consistent with the Fiscal Plan. Finally, the House Natural Resources Committee Report on PROMESA, at page 50, in discussing section 314, stated that “[b]y incorporating consistency with the Fiscal Plan into the requirements of confirmation of a plan of adjustment, the Committee has ensured lawful priorities and liens, as provided for by the territory’s constitution, laws, and agreements, will be respected in any debt restructuring that occurs.’’

 

On November 3 the Board filed a motion for reconsideration of the Judge’s order on not to grant the intervention on the grounds that his legal reasoning is mistaken. I am not a fan of motions for reconsideration since Judges rarely reconsider. In my view, it is better to just do what they want instead of telling them they are wrong, but the issue is under the consideration of the Judge. As I expected, today Judge Besosa denied the Board’s motion for reconsideration. Now the Board will have to comply with the Judge’s order to present its position on the merits or appeal the decision. The Board has 30-days to file a notice of appeal.

 

In addition, today the Court denied PR’s motion for reconsideration on his decision in the Lex Claims case where he decided that the stay in PROMESA did not apply to the claims. In addition, Judge Besosa granted Lex Claims request to amend the complaint to question COFINA. The Judge cautioned, with reason, that the merits of the claims would be decided later. Lex Claims filed the Second Amended Complaint today. Let’s see what happens.