PROMESA LITIGATION

The Coming Public Pension Fight

The first in a series on Puerto Rico’s Pensions

 

Last week, the Supervisory Board held its 9th Public Meeting in Fajardo, Puerto Rico. A key item on the agenda, “Discussion of Pension Reform,” was over-shadowed by the pending fight over furloughs, but is perhaps one of the most important items discussed.

 

As many know, one of the critical issues before the Supervisory Board is how to address the future of Puerto Rico’s public pension system and a $49 billion actuarial deficit. In fact, this is one of the reasons Speaker Ryan and the Congressional Republicans insisted on having an expert like Andrew Biggs on the Board. His knowledge of pensions ostensibly would help reform Puerto Rico’s public pension system to become a model for cities and states across the country.

 

What PROMESA Says the Board Must Do

 

Section 211(a) of PROMESA requires the Board, if it determines pensions are underfunded, to conduct an analysis prepared by an independent actuary […] to assist the Oversight Board in evaluating the fiscal and economic impact of the pension cash flows.” The Board hired Pension Trustee Advisors, Inc., a Colorado corporation, for this endeavor in February. To date, we have yet to see any documents or plans generated by this company or produced by the Board.

 

Instead, the government with the support of the Board moved first. Since February, Puerto Rico passed a law to convert the government and its component units into a single employer and although the Board instructed that pensions had to be cut by 10% by fiscal year 2020 in the Fiscal Plan, the Board green-lighted the government to move over $2 billion from the General Fund to the public pension system. At the same time, neither Governor Rosselló nor the Board provided any monies for debt service in FY18. This had the effect of elevating payment of public pensions above secured creditors.

 

Then, on May 21, 2017, the Board filed a Title III bankruptcy petition for the Government Retirement and the Judiciary Retirement Fund. Further, the government passed a measure to transfer $390,480,000 from the Central Government, Judiciary and Teacher’s retirement funds to the General Fund for the payment of pensions, known as RC 188.

 

All of this was done with the Board’s approval, but not without opposition from other stakeholders. On July 27, 2017, Altair Global Credit Opportunities Fund (A), LLC and others filed an adversary proceeding to challenge this action by the Puerto Rican Government. Altair & company claim they have a lien over Government contributions to the retirement fund and that RC188 is null and void; that they hold a secured claim to the full extent of their allowed claim against the ERS; that they hold a secured claim to the full extent of their allowed claim against the Commonwealth and that their lien continues in any Pledged Property transferred to the Commonwealth from the ERS. They also claim that the transfer of the Pledged Property from the ERS to the Commonwealth pursuant to Joint Resolution 188, on its face, constitutes an unconstitutional taking of private property without just compensation within the meaning of the U.S. and P.R. Takings Clauses; and that RC 188 substantially interferes with their contract rights with the ERS in violation of the U.S. and P.R. Contracts Clauses. Finally, they also ask for damages and that PROMESA does not preclude such claim. Since it was filed only recently, we have no idea how Judge Swain will handle it, except that it will be done swiftly.

 

Echoes of the Chrysler-UAW Pension Bailout

 

This strategy by the Board – elevating pensioners over secured bondholders – evokes memories of the Chrysler bankruptcy, which saw the Obama Administration support unsecured UAW pensioners become secured creditors – literally jumping the line ahead of actual secured creditors. The judge in that case was none other than Judge Arthur Gonzalez, the key architect behind the Board’s legal strategy.

 

Neither the Constitution nor PROMESA explicitly do not allow for the payment of public pensions to be put ahead of bondholders, which was the ultimate outcome in the Chrysler case. Now, the PR Supreme Court granted pensioners rights in Bayron Toro v. Serra, 119 D.P.R. 605, 608 (1987), stating that, “Once an employee is retired, when he has complied with all the conditions for his retirement, his pension is not subject to changes or impairments.” However, this precedent is subject to Article VI, Section 8 of the PR Constitution that states:

 

“In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid, and other disbursements shall thereafter be made in accordance with the order of priorities established by law.”

 

While Section 201(b)(1)(C) of PROMESA states that the Fiscal Plan must provide adequate funding for public pension systems, Section 201(b)(1)(N) requires the Fiscal Plan to respect the relative lawful priorities or lawful liens, as may be applicable, in the constitution, other laws.”

 

Moreover, the Committee on Natural Resources Report on PROMESA states the following:

 

“The Committee acknowledges the concern as to the ambiguity of the language regarding the funding of public pension systems. To clarify, Section 201(b)(1)(C) tasks the Oversight Board with ensuring fiscal plans ‘provide adequate funding for public pension systems.’ This language should not be interpreted to reprioritize pension liabilities ahead of the lawful priorities or liens of bondholders as established under the territory’s constitution, laws, or other agreements. While this language seeks to provide an adequate level of funding for pension systems, it does not allow for pensions to be unduly favored over other indebtedness in a restructuring.

 

Realizing that creditors and Congress are onto them, the Board has attempted to mask their strategy.

 

In their latest document, Explanatory Memorandum on Pension Reform,” the Board claims, “expenditures are being reduced throughout the Commonwealth’s budget and holders of government bonds are not likely to be repaid in full. Retirement plan participants, like other unsecured creditors, will have a reduction in the amounts paid to them by the Commonwealth.” Board member Ana Matosantos went further, rejecting Christian Sobrino’s claim that Governor Rosselló will fund 100% of the public pensioner’s benefits, stating “honoring 100% of the obligations is not workable.”

 

The Board has shown its hand, and they will face a stiff test before Judge Swain. Congress was clear that funding pensions was important, but not equal to or above existing constitutional and lawful priorities. To date, the Board and Puerto Rico have decided unsecured pensioners have higher priority.

 

Why is the Board and the government putting payment of pensions before payment of public debt in direct contradiction of both PROMESA and the Puerto Rican Constitution? Why is the Board pursuing this legal strategy?

 

I will explore and hope to explain the reasons for this in my series on public pensions in Puerto Rico.

 

 

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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.