By LEN WEISER-VARON and BILL KANNEL

 

A draft of the U.S. Treasury’s proposed debt restructuring legislation began circulating earlier today.  The draft legislation would give Puerto Rico, as well as other U.S. territories, and their municipalities access to U.S. bankruptcy court under a new chapter of the U.S. Bankruptcy Code (so-called “Super Chapter 9”) as well as making Puerto Rico’s instrumentalities (but not Puerto Rico itself) potentially eligible to file for bankruptcy under existing Chapter 9. The prospects for bipartisan cooperation on some form of such legislation appear somewhat more promising than those for the confirmation of a new Supreme Court justice, but whether this trial balloon will fly remains uncertain.

Some initial observations:

  • The legislation would provide access to bankruptcy to Puerto Rico and other U.S. territories (Guam, American Samoa, Northern Mariana Islands and U.S. Virgin Islands) and their municipalities.
  • The availability of bankruptcy to a territory and/or any “municipality” (i.e. political subdivision, public agency, instrumentality or public corporation of a territory) would be conditioned on the establishment of a Fiscal Reform Assistance Council (Council) at the request of the applicable territory’s Governor.  The Council would consist of 5 members appointed by the President of the United States and would have to approve any such bankruptcy filing.  The Council would have a variety of oversight powers including budget and debt issuance approval powers.
  • The legislation preserves the concept of “special revenue” bonds that benefit from more protective provisions under Chapter 9, such as the continued application of a lien on special revenues to such revenues arising after the filing of the bankruptcy petition, and the inapplicability of the bankruptcy stay to the application of special revenues to payment of debt service on special revenue bonds.  However, the definition of “special revenues” is narrower under the draft legislation than it is under Chapter 9.  As under Chapter 9, “special revenues” include “receipts derived from the ownership, operation, or disposition of projects or systems of the debtor that are primarily used or intended to be used primarily to provide transportation, utility, or other services, including the proceeds of borrowings to finance the projects or systems.”  However, for Puerto Rico and other territories, the draft legislation would not include as “special revenues” “special excise taxes imposed on particular activities or transactions,”  “incremental tax receipts from the benefited area in the case of tax-increment financing,” “other revenues or receipts derived from particular functions of the debtor, whether or not the debtor has other functions” or “taxes specifically levied to finance one or more projects or systems, excluding receipts from general property, sales, or income taxes (other than tax-increment financing) levied to finance the general purposes of the debtor.”  Accordingly, debtors that under the legislation could file under either Chapter 9 or this new chapter would have an incentive to file under this new chapter if their revenues would constitute “special revenues” under Chapter 9 but not under the new chapter.
  • The legislation creates a one-year stay (from the date of establishment of a Council) on (i) the commencement or continuation of any action or proceeding that seeks to enforce a claim against the territory and (ii) the enforcement of a lien on “or arising out of” taxes or assessments owed the territory.  Note that the stay becomes effective without regard to whether a bankruptcy petition is filed.
  • A territory may be a debtor upon the establishment of a Council and approval of the filing by the Council.  A municipality of a territory must, in addition, be specifically authorized by territory law to be a debtor.
  • In contrast to Chapter 9, a debtor need not be insolvent in order to be eligible to file for bankruptcy under the proposed new chapter.
  • A territory and its municipalities may file bankruptcy petitions and plans of adjustment jointly.
  • If the debtor is a territory, the presiding judge in the bankruptcy is appointed by the Chief Justice of the U.S. Supreme Court.  If the debtor is a municipality filing separately from a territory, the presiding judge is appointed by the chief judge of the applicable federal circuit court of appeals (the 1st Circuit, in the case of Puerto Rico).
  • Among the various conditions for confirmation of a plan, noteworthy conditions include that “the plan does not unduly impair the claims of any class of pensioners.”  The draft legislation does not define what is meant by “unduly.”
  • The legislation provides a limited degree of protection for Puerto Rico’s general obligation bonds, including as a plan approval condition that “if feasible, the plan does not unduly impair” the claims of holders of the territory’s general obligation bonds that are “identified in applicable nonbankruptcy law as having a first claim on available territory resources.”   Notably, this protection is provided “if feasible” whereas there is no feasibility requirement on the protection of pensioner claims.  Again, the protection of general obligation bonds, “if feasible” is against being “unduly” impaired, without clarity as to what constitutes undue impairment.  Oddly, the implication is that general obligation bonds can be “unduly impaired” if it is not feasible to “duly” impair them.
  • The draft legislation makes many but not all of the general provisions of the Bankruptcy Code, many but not all of the provisions of Chapter 9, and some of the provisions of Chapter 11, particularly those relating to plan confirmation,  applicable to a bankruptcy involving a territory or a territorial municipality.

By LEN WEISER-VARON and BILL KANNEL

Last week, the Working Group for the Fiscal and Economic Recovery of Puerto Rico gave the broadest hint yet of the next tactic in Puerto Rico’s ongoing quest to deleverage itself.  Although the details have not yet been articulated, Puerto Rico apparently proposes to blend into a single pot several types of distinct taxes currently earmarked to pay or support different types of bonds issued by a number of its legally separate municipal bond issuers, with the hope that the resulting concoction will meet the tastes of a sufficient number of its differing bond creditors to induce them to voluntarily exchange their various types of bonds for a single type of new debt presumably supported by the new blended tax revenue stream.

According to the “Restructuring Process and Principles” slides released by the Working Group on September 24, “the Working Group is working with the Commonwealth’s advisors to structure a debt-relief transaction that will permit the Commonwealth’s available surplus to be used to make payments on its indebtedness while the initiatives and reforms undertaken as part of the Fiscal and Economic Growth Plan take hold.”  Per the release, “[t]he consensual negotiation and ultimate transaction will seek to involve not just creditors of one governmental entity, but instead the creditors of many entities, as part of a single, comprehensive exchange transaction. The  goal of this approach is to avoid a piecemeal strategy that may result in uncoordinated and inconsistent agreements with creditors, litigation among creditor groups, and a lower chance of success.”

As the saying goes, good luck with that.

The Working Group’s trial balloon is short on details as to which existing debt would be involved in the contemplated “single, comprehensive exchange transaction.”  Given the magnitude of the Working Group’s projected funding gap,  after other proposed corrective measures are undertaken, of $14 billion from FY 2016 to FY 2020, and given that direct and guaranteed general obligation bonds and COFINA sales tax bonds  constitute approximately $34 billion out of Puerto Rico’s approximately $71 billion in outstanding public sector bonds, it seems virtually certain that, at a minimum, the contemplated “super-exchange” would involve the g.o. bonds and the COFINA bonds.  Other types of bonds supported, directly or on a contingent basis, by Commonwealth tax revenues are of substantially lesser magnitude and, in many instances, also are payable from independent revenue streams. Some or, depending on the Working Group’s appetite for complexity, all of those other types of bonds also are likely to be targeted for the to-be-negotiated “super-exchange”; as listed in the Working Group‘s September 9 report, they include bonds issued by HTA, GDB, PBA, PFC, PRIFA, UPR, PRCCDA, PRIDCO, GSA and ERS.

In evaluating the feasibility of a negotiated exchange that stirs together this alphabet soup of issuers and creditors, we start from the following premises:

  •  Debt service on the g.o. debt has top priority, under the Puerto Rico constitution,  on the Commonwealth’s “available resources.”  Although enforcement of this legal priority would raise some thorny issues, and although much of the g.o. debt may now be held by holders with a basis well below par, there is no clear incentive for many g.o. bondholders to give up  any portion of their legal entitlement to full debt service payment from “available resources” for what the Working Group’s slides characterize as reduced payment from the Commonwealth’s “available surplus.”
  • Debt service on COFINA bonds is payable from a statutorily assigned portion of the sales tax or of any substitute tax such as the VAT.   The statutorily assigned taxes should be sufficient to pay full debt service on the COFINA bonds for the foreseeable future.  Puerto Rico case law as well as a series of Puerto Rico Attorney General opinions support the validity of such an assignment.  Much of the outstanding g.o. debt has been issued and/or purchased with full awareness by the g.o. bondholders that the relevant portion of the sales tax has been assigned to COFINA and its bondholders.  Similar assignments of specified tax revenues to independent bond-issuing authorities have been upheld in other jurisdictions.  The complaint allegedly ready on someone’s shelf seeking an adjudication that the COFINA structure is a legal sham or that the assigned sales tax revenues remain “available resources” for the payment of g.o. debt service may be filed some day, but from our perspective COFINA holders should like their chances in any such litigation.  Absent disproportionate fear of an adverse result in any such litigation, there is no clear incentive for many COFINA bondholders to give up  any portion of their legal entitlement to full debt service payment from the statutorily assigned and pledged sales tax revenues for reduced payment from any other source.
  • What, if anything, could be achieved by Puerto Rico in consensual debt reduction negotiations with holders of other types of debt with more tenuous claims on Commonwealth taxes (due to express clawback provisions, appropriation requirements, lack of a constitutional payment priority or security interest or other factors) is an interesting question, but may be moot in the event of substantial nonparticipation in a “super-exchange” by g.o. and COFINA bondholders, as Puerto Rico cannot achieve the debt service reductions it asserts it needs without substantial buy-in from the g.o. and/or COFINA bondholders.
  • Although the “Restructuring Process and Principles” slides state that “[t]he transaction will be structured to take into account the priorities of the debt that creditors hold”, it is difficult to derive much meaning from that statement.  Any restructuring that reduces debt service payable on the g.o. bonds in order to pay other Commonwealth expenses will disregard the constitutional priority of debt service in application of available resources.  Any restructuring that reduces debt service payable on COFINA bonds in order to apply some of the sales tax/VAT pledged as security to COFINA bonds to instead pay Commonwealth expenses will violate the statutory priority of COFINA bond debt service.  To the extent that the restructuring would be consensual, it may be tautological that there will be no dishonoring of any constitutional or statutory priority, as the participating bondholders will have agreed to any deviation from such priorities.  If one assumes that Puerto Rico intends to seek concessions from the g.o. bondholders and/or COFINA bondholders, the statement that priorities will be “taken into account” in the proposed “super-exchange” can best be read as a statement that other types of tax-supported debt to be included in the proposed “super-exchange” may be offered less favorable exchange ratios than the g.o.’s and/or COFINAs.
  • The difficulties and uncertain outcome of consensual debt reduction negotiations involving PREPA, a single credit payable solely from electricity revenues widely deemed insufficient to cover the associated revenue bonds, do not bode well for the outcome of consensual debt reduction negotiations involving homogenization of numerous separate credits, including some with strong legal claims for full payment of their debt.
  • Negotiated exchanges involving some degree of municipal debt reduction or bondholder concessions have succeeded in certain other contexts, but few that we are aware of in which the issuer did not have access to a bankruptcy option as an alternative. Successful exchanges involving issuers that did not have access to a bankruptcy process (e.g., certain tribal casino bonds) involved debt that did not benefit from strong legal claims on tax revenues of the type held by Puerto Rico’s g.o. and COFINA holders.

Puerto Rico’s announced strategy for dealing with its debt has evolved from ring-fencing its tax-supported debt and attempting to address its public corporation debt with a Puerto Rico bankruptcy statute to targeting its tax-supported debt in a consensual negotiation process.  The Working Group and its advisors may sincerely believe that a “debt lite” consommé can emerge from such pot-stirring, but may also believe that a failed process will provide additional ammunition for what Puerto Rico really wants to address its unwieldy debt structure: enactment of federal “super Chapter 9” legislation that would give it access to a federal bankruptcy process encompassing its g.o. bonds as well as its public corporation debt.

By Len Weiser-Varon and Bill Kannel

As Puerto Rico prepares to access the public markets with a new bond issue, the Wall Street Journal reports that the list of demands from some potential investors include, in addition to a high interest rate and as much security as the issuer can provide, the issuer’s consent to the adjudication in the New York courts of any future disputes involving the applicable bonds.

Hoping for the best but preparing for the worst, holders of existing bonds issued by Puerto Rico and its bond-issuing instrumentalities (such as COFINA) are likewise engaged in prospective forum-scouting.   The desired option to litigate any potential dispute outside Puerto Rico may be driven by the assumption that in times of financial crisis Puerto Rico’s courts are less likely to side with off-island investors than with Puerto Rico’s bond issuers, however meritorious the bondholders’ claims may be. Continue Reading Could Bondholders Bring Claims Against Puerto Rico Bond Issuers in Courts Outside Puerto Rico?

By LEN WEISER-VARON and BILL KANNEL

The Government Development Bank for Puerto Rico (GDB) hosted an unusual public conference call on October 31 to respond to legal questions raised by investors in bonds issued by the Puerto Rico Sales Tax Financing Corporation, better known by its Spanish acronym, COFINA.  During the one-hour call (which is available for replay on the GDB website), bond counsel and underwriters’ counsel made presentations explaining the rationales for legal opinions they delivered in connection with COFINA’s most recent bond issues, and responded to several written questions submitted by investors in advance of the call. Continue Reading Puerto Rico Supreme Court’s Deference to Legislature’s Determinations: A Double-Edged Sword for Puerto Rico Bondholders?