#muni

THE SENIOR COFINA BONDHOLDERS’ LETTER

On September 24, 2015, a group of senior bondholders of COFINA, which claim to hold 25% of the principal amount of the debt, sent the Government Development Bank (GDB) a letter objecting to the Puerto Rico Fiscal and Economic Growth Plan’s supposed comingling of COFINA and Commonwealth debt. COFINA bondholders’ position is that this debt is totally separate from Commonwealth debt and by lumping them together, PR Government is violating the Amended and Restated Sales Tax Revenue Bond Resolution. The letter states, inter alia,

Moreover, pages 6 and 65 of the Working Group Plan assume “the clawback of revenues supporting certain Commonwealth tax supported debt” may be available to “service all principal and interest on debt that has a constitutional priority.” While the only lawful interpretation of those passages is that they refer to those bonds that are expressly subject to “clawback,” such significant statements by the Commonwealth should not be left open to interpretation.

These are not minor errors or mere oversights. Rather, the Working Group Plan materially misrepresents the essential nature of COFINA’s indebtedness to the investing public, and materially harms COFINA and its bondholders. It misleads the public by lumping the Commonwealth’s own debt together with COFINA’s (and thus should be treated similar to other Commonwealth debt) when in fact the opposite is true. Specifically, in the Working Group Plan, the GDB and the Commonwealth attempt to consolidate assets and liabilities of COFINA with that of the Commonwealth. There is no doubt that this is intended as a signal to the investing public at large that the Commonwealth’s struggling fiscal health threatens the health of COFINA, ignoring the fact that insulation from the Commonwealth’s other liabilities prompted the creation of COFINA in the first place. Consolidation of COFINA’s debts with the Commonwealth’s obligations will raise future borrowing costs and limit the Commonwealth’s revitalization.

The Working Group Plan’s material misstatements could open up the Commonwealth and all those responsible for the statements to potential liability. . .

Consistent with section 704 of the Resolution, COFINA should promptly cure the misstatements and provide the necessary assurances of rights of bondholders under the Resolution. It is important that you promptly perform your ministerial duty to untangle the COFINA debt and revenue from that of the Commonwealth. Doing so is necessary to avoid a breach of the Resolution and potential liability, and to fulfill the clear legal commitments made by the Commonwealth.

The purpose of the letter is not clear at first glance and an explanation is needed. The PR Government, probably under the advice of Millco Advisors and Cleary Gottlieb, has been trying to create a conflict between COFINA bondholders and GO bondholders. The old idea of “divide and conquer”. Each time a COFINA bond issue was done, there were three legal opinions stating that the revenue from the sales tax would not be part of the available revenues for payment of GO’s as per the Constitution. In other words, COFINA funds could not be used to pay GO’s. Whether this is true, it is irrelevant at this stage, but COFINA bondholders do not want the Government hinting that it could happen as the Puerto Rico Fiscal and Economic Growth Plan hints.

In the letter, COFINA bondholders demand that PR make a clear statement that their funds cannot be used to pay GO’s (as the PR Department of Justice has said every time there is a bond issue). What if PR does not make this clear statement? Here is where the COFINA AMENDED AND RESTATED BOND RESOLUTION comes in.

The letter requires the GDB to comply with its ministerial duty, i.e., if you don’t comply, I am going to slap you with a mandamus, which is a special writ in equity or complaint to require the Government to do something which is part of its ministerial duties, this duty being, protecting bondholders’ position of NO CLAWBACK. Moreover, the COFINA Bondholders’ Resolution at page 79, states as follows:

In addition, the Trustee may, and upon the written request of the Owners of not less than twenty-five per centum (25%) in principal amount of the Outstanding Bonds, shall, proceed to protect and enforce its rights and the rights of the Bondowners by such of the following remedies, as the Trustee, being advised by counsel shall deem most effectual to protect and enforce such rights subject to the provisions of Sections 201, 803 and 1206:

. . .

(iv) by action or suit in equity, to enjoin any acts or things which may be unlawful or in violation of the rights of the Bondowners or the Beneficiaries.

The COFINA bondholders have a very solid legal point that they can sue in equity to force the GDB and COFINA to make such statement. If a suit ensues, it will be difficult for PR to claim that clawback is possible since the Secretary of Justice has said time and again it cannot occur. Question now is, will COFINA bondholders follow through on their threat, and if so, in which court?

Advertisements

Investors Beware: Bonds and Amending the Constitution

Today, three PPD (Manuel Natal, Luis Vega & Luis Torres) members of the Puerto Rico House of Representatives announced that tomorrow, they will be filing a Joint Resolution to consult the People of the Island whether to amend the Constitution “to permit the renegotiation of the Government’s debt and of the public corporations recognizing the importance that it does not impair or subordinate to it other socioeconomic development priorities of our people. Among these priorities are: the financing of cheaper energy; cheaper drinking water, strategic investment in infrastructure that encourages private investment and job creation; schools with teachers and materials that students need; special education programs; and better and more far reaching health services for the whole island.”

Natal Alvelo reminded us that PC 2003, which he wrote, seeks a 4-year moratorium on debt service, extendable for 3 additional years. In addition, PC 2314, also of Natal Alvelo’s authorship, calls for the creation of a Special Independent Commission to review all debt issues to determine which are legal and which are illegal. The illegal debt would be rejected. Witch hunt anyone?

At this time, we do not know how much support this Constitutional Amendment or the abovementioned measures have. Suffice it to say that if approved, they are tantamount to Puerto Rico rejecting its General Obligation debt, at least temporarily. Fortunately, Article VII of the Puerto Rico Constitution requires that the Joint Resolution be approved by 2/3’s of the legislative assembly in order for it to be put to popular vote, which would need to be held with the general election, unless ¾ of the legislature so approved it, which then could be at any time. Since the PPD has only a 3-vote majority in the House, it is unlikely it will be approved.

Even if this amendment was approved by the electorate, it would be subject to challenge in federal court for impairment of contractual obligations, see, United Auto., Aerospace, Agr. Implement Workers of America Intern. Union v. Fortuño, 633 F.3d 37 (1st Cir. 2011), and Romer v. Evans, 517 U.S. 620 (1996) (state constitution is not free from federal scrutiny).

As to PC 2003 and PC 2314, they were filed in 2014 and have not been moved in the House. This does not mean, as we saw with the Recovery Act, that they could not be approved, if need be, in one day. Investors need to monitor the situation closely.

My Thoughts Regarding Mr. Leonard Weiser-Varon and Mr. William Kannel of Mintz Levin’s Blog Post

On March 17, 2014, Mr. Leonard Weiser-Varon and Mr. William Kannel of Mintz Levin published an entry in his blog titled “Legislative Balloon for Puerto Rico Public Corporation Insolvency Attracts Bondholder Attention”.   Although I agree with much of what is said there, a few issues need clarification.

Puerto Rico defaulting on its bond obligations is not an if, but rather a when. The island’s economy has not grown since 2006, with the exception of one quarter of .1% in 2012, clearly a case of depression rather than recession.  The idea of Puerto Rico’s default has been discussed all over the bond and business media and there seems to be a general agreement that it will happen in the next three years. Hence, a orderly process for the reorganization of Puerto Rico’s public corporations and even municipalities is a must.

Felix Salmon recently stated that “[t]he default will be messy, however, since there is no chapter of the US bankruptcy code that encompasses Puerto Rico. A lot of different court cases will be held in a passel of different jurisdictions, and a lot of lawyers will get rich. In the end, everybody is going to have to take a nasty hit—including the island’s retirees, whose pension funds are woefully underfunded.” (footnote omitted).  Given this scenario, it is in bondholders interest to have the administration of this impending default in the hands of one court with a clear statute to guide it. Moreover, Puerto Rico’s public corporations owe over $25 billion and municipalities, not yet included in the statute, owe $3.88 billion more. See, GBD presentation to investors of October 15, 2013, at page 56.   It must also be remembered that the Puerto Rico Electric Power Authority, according to its financial statements of 2013, has $791,385,000 more in liabilities than in assets. See page 8.  See also my blog entry.

The entry mentions Governor Garcia Padilla’s opposition to the proposed measure but this must be taken with boulders of salt. As it is very common, he speaks with one side of his mouth to the voters in Puerto Rico and from another to investors. His only comments in the local press were that he had not participated in its writing and that no specific plans for restructuring of corporations had been adopted. In addition, given that the next administration, coming in on January 2, 2017, will have to assume the bulk of payment of the new $3.5 billion bond emission, the measure could very well garner minority vote to override any veto by the Governor.

The entry continues with a general questioning of Puerto Rico’s power to enact a liquidation or reorganization law. Although the power to enact bankruptcy laws was delegated to Congress via the U.S. Constitution, it is nevertheless a fact that for a large part of our history it was not used. The first bankruptcy law was enacted by Congress in 1800 to 1803 when it was repealed. Later it was enacted twice and repealed twice but in 1898 it was here to stay, with several amendments and a complete overhaul in 1978. In the interim, several state laws were enacted to fill the void.

In this framework and considering that Puerto Rico’s public corporations and municipalities are explicitly excluded from Chapter 9 of the Bankruptcy Code, 11 U.S.C. § 101 (52), Puerto Rico can legislate since there is no preemption. With a doubt, however, any filing of a Puerto Rico public corporation or municipality pursuant to this law would trigger litigation but it would not take several years to resolve. Let us imagine that PREPA filed for protection of this new reorganization law. What would be the bondholder’s reaction? Rush to Federal Court to question the laws constitutionality? Very likely, but then they would be faced with several abstention doctrines, to wit, Railroad Commission v. Pullman Co., 312 U.S. 496 (1941); Burford v. Sun Oil Co., 319 U.S. 315 (1943) or Louisiana Power & Light Co. v. City of Thibodaux, 360 U.S. 25 (1959). Pullman requires the federal court to abstain when there are federal and state constitutional questions and send the case back to state court to litigate them. Unless plaintiff makes a specific reservation of federal rights via England v. Louisiana State Board of Medical Examiners, 375 U.S. 411 (1964), all claims will be litigated in state court and will be res judicata in federal court, see, Duty Free Shop Inc. v. Administración de Terrenos, 889 F.2d 1181 (1st Cir.1989). If there is such a reservation via Pullman, the plaintiff may return to federal court. Burford and Thibodaux are a bit more complicated for they involve undecided questions of state law of great public policy import. Case law is not clear if an England type reservation of rights would be possible pursuant to these abstention doctrines, see, Front Royal and Warren County Industrial Park Corporation v. Town of Front Royal, Virginia, 135 F.3d 275 (4th Cir. 1998) and Fields v. Sarasota Manatee Airport Auth., 953 F.2d 1299 (11th Cir.1992). Hence, the cases would be sent back to Puerto Rico’s courts.

Moreover, even if bondholders made a reservation of rights, the issues would be quickly decided. The Puerto Rico Supreme Court has very actively exercised its discretion to certify issues in the Courts of First Instance for quick decision. This was done in Trinidad v. ELA, 2013 TSPR 73 and Domínguez Castro et al. v. E.L.A. I, 178 D.P.R. 1 (2010), cert denied, Domínguez Castro v. Puerto Rico, 131 S. Ct. 152  (2010) Both Trinidad and Domínguez Castro were decided in a year or less on issues of the constitutionality of altering contractual obligations.

This brings us to the issue of the alteration of contractual obligations pursuant to the U.S., rather than Puerto Rico’s constitution. Federal courts, however, have been accommodating of a government’s efforts to alter its obligations. It is allowed as long as evidence of crisis and failure of other efforts is discussed in the legislation. This was affirmed by the First Circuit in the firing of over 12,000 employees due to the 2009 financial crisis, see, United Auto., Aerospace, Agr. Implement Workers of America Intern. Union v. Fortuño, 633 F.3d 37 (1st Cir. 2011). As evidenced by the dates in these cases, these controversies were decided in less than two years at the state Supreme Court level and the Circuit Court of Appeals level. Given the strictures of the U.S. Supreme Court’s certiorari practice, it is unlikely it would be granted. Also, irrespective of which court decides the case or when, the fact remains that once the reorganization filing occurs, bondholders will cease to be paid.

The entry also points out, quite correctly, that the law as it is now, does not provide for a cram down of a plan. However, the Senators who wrote the act knew that it was incomplete and were expecting input from several sources, including my own.   Mr. Weiser-Varon and Mr. Kannel’s insight will undoubtedly be examined and adopted by the Puerto Rico legislature.