PROMESA

The Oversight Board’s Chrysler Playbook

 

 

The second in a series on Puerto Rico’s pensions

 

On May 3, 2017, the Financial Oversight and Management Board filed the Commonwealth of Puerto Rico’s Title III petition. In the nearly four months since the filing, we have seen the Board develop a legal strategy that relies on elevating pensions over secured bondholders and invalidating contractual liens such as those held by pension obligation bondholders of ERS.   Each of these steps eerily echoes the legal strategy of used by the Obama Administration during the Chrysler Bankruptcy. But what does an automaker’s Chapter 11 bankruptcy have to do with Puerto Rico’s supposed insolvency you may ask? More than you would imagine, and it’s not confined simply to the court room, either, as we explore.

 

First, let’s discuss what happened in the Chrysler Bankruptcy.

 

The Chrysler Bankruptcy

 

By December of 2008, Chrysler, after years of decline, was in dire straits. It was bloated, inefficient and burdened by labor contracts and pension costs. The timing – during the midst of the Global Financial Crisis – could not have been worse. This confluence led Chrysler, along with General Motors, to then start pleading for greater federal financial assistance (i.e. – a bailout; sound familiar?), arguing that liquidation would mean the loss of thousands of good (meaning union) jobs.

 

In December of 2008, the U.S. House of Representatives voted to bailout Chrysler, but the U.S. Senate voted it down. Then-President Bush proceeded to extend credit but when the credit ran out, then-President Obama intervened, forcing out Chrysler CEO Robert Nardelli and announcing that the federal government would provide additional funds to support Chrysler contingent on the completion of a merger with Fiat within 30 days.

 

After examining the restructuring plans, the Obama administration decided they were insufficient, thereby forcing Chrysler to file for bankruptcy in April of 2009. Within two months, Chrysler emerged as “The Chrysler Group,” owned by the United Auto Workers (55%), Fiat (20%), the US Government (8%) and Canada (2%). See, The Auto Bailout and the Rule of Law, by Todd Zywicki.

In the years leading to its bankruptcy, Chrysler had been unable to obtain financing and resorted to issuing secured debt to finance its operations. At the time of the filing, Chrysler owed around $6.9 billion in secured debt, but also $10 billion to an unsecured pension plan.

 

In a bankruptcy, secured debt has the first priority of payment and unsecured creditors get the rest in a pro rata basis. This general principal applies to all Bankruptcy Chapters and hence to Title III. Also, in a Chapter 11, the debtor prepares a Bankruptcy plan pursuant to 11 U.S.C. § 1123 in which it classifies the claims in order of priority and the debtors whose claims are impaired, have a right to vote on the plan. This is the same procedure of a Chapter 9 and hence, of Title III in PROMESA.

 

In Chrysler, it was done differently. The U.S. Government created and funded a shell company that, through a § 363 sale, bought substantially all of Chrysler’s assets for $2 billion, giving the secured creditors a paltry return of 29 cents on the dollar. FIAT was brought in to manage the new firm and was given a slice of the new company’s stock. New Chrysler (formally: New CarCo Acquisition LLC) then assumed the old company’s debts to the retirees, most dealers, and trade creditors. The unsecured claims of the retirees’ benefits plan were replaced with a new $4.6 billion note as well as 55% of the new company’s stock. Assessing the Chrysler Bankruptcy, by Mark J. Roe and David Skeel at page 5.

 

How the Board is using the Chrysler Playbook in Puerto Rico

 

In Puerto Rico, the Board has told the Court that COFINA, Peaje (HTA), and Altair (ERS) do not have a lien – essentially ripping up binding contracts. The Board has also told GO bondholders that they do not have a priority in payment structure, evidenced by the elevation of pensions over their constitutional-backed debt.

 

At the same time, the Board has allowed the Commonwealth to pay 100% of pensions, which will total $2.5 billion a year, as well as pay all suppliers and tax refunds. The Board will ensure a modest haircut of 10% on these pensions at some point in the future, although the details are vague and applies to only certain pensioners. Even this move by the Board has met resistance from the Rosselló administration, who has rejected any claims that say they will not pay pensions in full.

 

As we can see, the Board is trying to deprive secured creditors of their security so their claims can be deeply cut while at the same time, favoring non-secured pensions to be paid. Exactly like Chrysler.

 

Not wanting to waste time while the Title III proceedings unfold, the Board and the Rosselló administration are getting a jump start through legislative actions.

Together, these seemingly ‘opposing entities’ have jointly pushed through legislation in the Puerto Rico House of Representatives and Senate that codifies pensions as a higher priority payment than constitutionally-prioritized debt, and worse, crystallizes entitlements from the date enactment, instead of upon retirement, which essentially attempts to lock in pensions at current rates and not subject them to a restructuring on a pro-rata basis in Title III without creating claims, a flexibility that the Commonwealth might otherwise have enjoyed. At the same time, they do a farcical face-off about a 10% cut in pensions to give the impression there will be some pain.

 

 

 

 

This action underscores that neither the Board nor the government are just waiting for the courts to act, as was the case in the Chrysler bankruptcy, but rather enacting policies that will lay the groundwork for the outcome they want in court – to give themselves and pensioner’s protection and outright injuring the secured bondholders they owe.

 

The Link between Puerto Rico and Chrysler

 

Judge Arthur González is a member of the Board and without a doubt its intellectual leader. He is on the most important committees, attends Judge Taylor Swain’s hearings (an old colleague of his as they used to be bankruptcy judges in the Southern District of New York together) and most importantly, was the presiding Judge in the Chrysler bankruptcy. Moreover, Judge Gonzalez was president Obama’s choice for the Board – a telling sign.

 

Additionally, the information I have received is that Judge González was adamant on hiring the Board’s law firm of Proskauer Rose, whose principal restructuring lawyer is Martin Bienestock. According to the University of Michigan Law School bio on Mr. Bienestock, he “developed for General Motors the section 363 sale free and clear strategy that the United States Auto Task Force deployed for both Chrysler and General Motors.” As the saying goes, there is no such thing as a coincidence. It is all too true in the case of Puerto Rico.

 

One closing thought, what bewilders me is how the Board and government believe they can pursue a legal strategy that will simply invalidate liens and contracts, and elevate pensions above and beyond adequate funding as directed by Congress in direct contradiction with PROMESA and the Puerto Rico Constitution.

 

In the next installment I will discuss the critics of the Chrysler Bankruptcy in detail, including some that will surprise you.

 

 

 

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Monday Update – August 28, 2017

 

 

Welcome to the Monday Title III-PROMESA Update! So much happens every day in Puerto Rico’s bankruptcy, including the Friday night news dump that I came up with the idea of updating every Monday morning what transpired during the previous week. Each day I receive dozens of notifications regarding the five Title III cases that comprise the bankruptcy and through this update I will highlight the previous week’s developments and shed a little light on their implications both to the case, to bondholders and the general public.

During the week of August 20-27, many motions were filed but perhaps most importantly, on August 22, Magistrate-Judge Dein held a “discovery hearing” in two key issues of the Title III litigation. The first was the COFINA Senior Parties objection to the Board and AFAF’s responses to certain areas of discovery. The objections read:

“(i) the Oversight Board’s blanket refusal to designate any witness to testify in response to any of the topics in the subpoena; (ii) the Government Parties’ refusal to offer any testimony whatsoever concerning the Fiscal Plan’s treatment of the dedicated sales tax pledged to COFINA (the “DST”); and (iii) the Government Parties’ overly broad assertion of the deliberative process privilege.” (Page 2-3 of THE COFINA SENIOR PARTIES’ URGENT MOTION REGARDING DISCOVERY DISPUTES AND FOR A PRETRIAL HEARING PURSUANT TO FED. R. BANKR. P. 7016 of August 11, 2017)

The COFINA Senior Parties wanted to depose a member of the Board as to COFINA and its position pertaining to that bond issuance. The Board flatly refused to designate any Board members pursuant to Federal Rule of Civil Procedure 32(b), made applicable to Title III as per the Federal Bankruptcy Rules of Procedure. The Board opposed said designation adamantly but Judge Dein made it clear that she believed the COFINA Senior Parties were entitled to either a Board statement on COFINA or a designation for deposition. Based on this, Judge Dein issued the following order:

“The COFINA Senior Parties (“Senior Parties”) and the Financial Oversight and Management Board (“Oversight Board”) will attempt to reach a stipulation of facts in order to eliminate the need for the Senior Parties to take the deposition of the Oversight Board. These parties shall notify the court by August 29, 2017 as to whether a stipulation has been reached. If no stipulation has been reached, the court will rule on the pending request that the Oversight Board designate a witness to be deposed, as detailed in the Motion.” (Page 2 of Judge Dein’s order of August 23, 2017)

From the statements of Judge Dein during the hearing, it is clear the Board must come up with something that will satisfy the COFINA Senior Parties or one of its members will be deposed. The stipulation must be reached by August 29, 2017 or Judge Dein will decide.

Interestingly, once Judge Dein made her point, counsel for the COFINA Senior Parties seemed to lose interest in the rest of their claims and accepted that most of the discovery was subject to the deliberative process privilege and the procedures would be taken on a case-by-case basis.

The second key issue that came up was the Unsecured Creditors Committee request to do discovery on the GDB, Banco Popular, Inc., Banco Popular, Popular Securities, Banco Santander, Santander Asset Management and Santander Securities pursuant to Rule 2004 of the Federal Rules of Bankruptcy Procedure. But first, a little background is needed.

Last year, the Puerto Rican left and Democrats, broadly, were screaming for an audit of the debt so part of it could be declared illegal and hence not paid. Aside from the fact that illegal debt would still have to be paid (see here), Governor Rosselló said he would not do it and Mr. Carrión has said it’s a waste of time. Then, after the Board filed for Puerto Rico’s Title III and Unsecured Creditors Committee (UCC) was formed, it requested leave to do the aforementioned discovery, mentioning the possible conflict of interest of a member of the Board. All of a sudden, the Board discovered PROMESA allowed the Board to do so and said, no UCC cannot do it, only the Board can do it. Obviously, GDB, Banco Popular, Inc., Banco Popular, Popular Securities, Banco Santander, Santander Asset Management and Santander Securities all said they agreed for the Board to do it but objected that the UCC conduct said discovery. During the hearing, the Board’s attorney, Martin Bienestock, said that the UCC did not have to stand down since it simply had not gotten up, ridiculing the discovery request. Even the Retirees Committee waded in support of the Board, no wonder since it has been allowed full payment of pensions.

The UCC, however, came out swinging, pointing out that Mr. Carrión had a conflict as part of the family that founded Banco Popular and an ongoing referral arrangement whereby he provides insurance for many clients of Banco Popular (isn’t this where the $1.8 billion is at?), and Mr. Carlos García was mentioned as the issuer of much of COFINA. The UCC also called the Banco Popular, Santander Securities and the GDB relationship a “revolving door” since many of its executives worked at different times in these places.

Judge Dein was not convinced by the Board’s approach. She asked when the entity that was to conduct the investigation on the debt and when it would commence. When Mr. Bienestock could not provide an answer, Judge Dein made clear that she was concerned about the cost of discovery, the extent but that the UCC and the Board had to coordinate its discovery and stated this in an order

  1. “The Rule 2004 Motion shall remain pending and the Court is not ruling on it herein;
  2. . . ; 
  3. Once the FOMB retains its investigator for the investigation it intends to undertake (the “FOMB Investigator”), the FOMB and the FOMB Investigator shall meet and confer with the Creditors’ Committee’s attorneys to determine whether they can agree that certain areas of investigation can either be allocated between them or coordinated among them on terms they agree on; 
  4. The FOMB, the FOMB Investigator, and the Creditors’ Committee shall take into account and undertake to avoid unreasonable interference with discovery in the pending adversary proceedings; 
  5. On or before September 12, 2017, the FOMB and the Creditors’ Committee shall file with the Court a joint status report advising the Court (a) whether an agreement has been or will likely be reached resolving all or parts of the Rule 2004 Motion, and a proposed deadline for any agreement likely to be reached, (b) of the terms of any agreement already reached, (c) a joint schedule or separate schedules proposing, to the extent currently known, individual topics and targets of investigation and timelines for commencing and completing each investigation, and (d) the remaining unresolved issues in the Rule 2004 Motion for which rulings are requested and proposed hearing dates for such unresolved issues”

With this order, Judge Dein essentially authorized the Rule 2004 discovery but in a coordinated form. Hence, if the Board drags its feet, the UCC can come to the Judge and complain.  Moreover, in a very elegant way, Judge Dein put a deadline on the Board appointing its investigator in such a way that it can coordinate the discovery by the time the report must be made by September 12 or she will rule on the UCC’s motion.

Clearly, the Board lost on two important issues that it adamantly opposed, deposition of its members and debt discovery. It remains to be seen what will be the implications of these “defeats.”

From what we can see of the Board’s actions in the Title III proceedings, it wants to claim that all bond debt is illegal for one reason or another so they are unsecured claims with no constitutional priority (see Article VI, section 8 of the PR Constitution). This way it will substantially reduce debt payment and justify the ridiculously low debt service in the Fiscal Plan.

But with the UCC’s intrusion it has the problem that some of it members and their protected allies may be sued for millions of dollars. The UCC made it clear that it believes COFINA was illegal, and the 2014 GO issuance, as surpassing the debt limit of Article VI, section 2 of the Puerto Rico Constitution. It is very telling that one of the documents requests of the UCC to the banks is “Documents or Communications concerning any director and officer liability policies.” The Board members are immune from liability for their work as members of the Board but not for actions performed BEFORE they were members.

The decisions by Judge Dein seem to have convinced National and other bondholders to request discovery pursuant to Rule 2004, this time on the Fiscal Plan, the Budget and other documents issued by Puerto Rico and the Board. Movants claim they have asked Puerto Rico and the Board for certain documents since before the filing of the Title III petitions and that they are important for the understanding of the future Plan of Adjustment which must be based on the Fiscal Plan. Expect the Board and AAFAF to claim they have been produced or that now is not the time. Judge Dein will have another opportunity to rule on discovery sometime in the next month.

On Friday, August 25, 2017, the Municipality of San Juan filed a Preliminary Injunction in a case it has previously filed against the Board, Puerto Rico and the GDB. The Injunction seeks to stop the GDB from soliciting votes and tabulating them on its RSA, which it said it would start once the Governor signed the statute that permits it. Since it was signed Friday, the Municipality sought the injunction. The Municipality claims the RSA violates section 601 of PROMESA, and it very likely does. The problem as I see it is the proof of irreparable harm required in these procedures, especially since section 601 requires Court approval of any RSA in a hearing in which any party may challenge whether the requirements of the section have been met. Judge Swain would likely postpone any ruling until the aforementioned hearing. In any event, I believe the Municipality’s claim, as well as those of the Municipality of Caguas in a separate lawsuit are very valid and require careful scrutiny.

I hope you found this new update helpful… till next Monday…!

 

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.