Bondholders seek to take over Puerto Rico pension system

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Bondholders of Puerto Rico’s primary pension system filed a motion to seize control of the system.

About 30 investment funds filed the motion in the Title III bankruptcy for the Employees Retirement System. The motion was entered in the U.S. District Court for Puerto Rico on Wednesday.

The Employees Retirement System is the largest government pension system in Puerto Rico, covering central government employees outside the primary and secondary educational system, public corporation employees, and municipal government employees.

The bondholders move follows a ruling on Jan. 31 by judges in the First Circuit Court ruling that the bondholders had a perfected security interest in the system’s property. The ruling reversed a decision by Title III bankruptcy Judge Laura Taylor Swain, with whom the bondholders have filed the current motion.

The bondholders ask Swain to stop an effort by the Puerto Rico Oversight Board to dismantle the ERS and transfer all of its assets, including its revenues and rights to collect revenues, to Puerto Rico’s central government. Further, the bondholders are asking Swain to appoint them to be the system’s trustees. As an alternative, they ask Swain to appoint an independent trustee, which the bondholders would approve.

“This is strong stuff,” said Puerto Rico attorney John Mudd. “I doubt the judge will allow it but it is a direct result of the First Circuit's opinion on ERS.”

The bondholders "have an uphill battle, but they might win," said municipal bankruptcy expert James Spiotto.
If a trustee is approved, Spiotto said, the judge probably would make the appointment. She may consult the bondholders, but it is unlikely she will give them approval power.

The ERS owes $3.2 billion in bond debt. It has no significant savings for pension payments, which the central government is making on a pay-as-you-go basis from its General Fund.

The bonds were legally secured through ERS’ pledge of employer retirement system contributions. In mid-2016 Puerto Rico’s government suspended ERS’s obligation to use these for debt service.

While the bonds were paid through draws on a debt service reserve for several months, the bonds went into payment default in 2017.

In Thursday’s motion the bondholders wrote: “The Oversight Board has declined to pursue ERS’s claims against the commonwealth because it is suffering from an incurable conflict of interest given its simultaneous representation of both the commonwealth and ERS and its role in mandating the post-[Title III bankruptcy] petition legislation. The board’s inaction is deeply inequitable to both ERS and its creditors, to whom ERS owes a fiduciary duty.

“But this court can remedy the situation. By incorporating section 926 of the Bankruptcy Code, [the Puerto Rico Oversight, Management, and Economic Stability Act] authorizes a Title III court to appoint a trustee to prosecute certain types of avoidance actions the debtor has refused to pursue. … A trustee appointed by this court under section 926 would be able to avoid those transfers [of ERS and its property rights] and recover their value for ERS and its creditors.”

The bondholders have made a second motion that any responses or objections to their motion for a trustee must be received no later than 4:00 p.m. Atlantic Standard Time, Feb. 26. They also move for the hearing to take place on March 13.

The Oversight Board said it had no comment on the motion at this time. A spokesperson for Puerto Rico’s Fiscal Agency and Financial Advisory Authority didn’t respond to a request for a comment.

Puerto Rico also has a Teacher’s Retirement System and a Judiciary Retirement System. They would not be affected by the bondholders’ motion.

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PROMESA Puerto Rico Employees Retirement System Commonwealth of Puerto Rico Puerto Rico
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