Puerto Rico Title III bankruptcy Judge Laura Swain rejected the island government's request to lend $1 billion to the power authority, setting off efforts to craft a smaller loan to avert a shutdown as soon as Wednesday.

After the Thursday court hearing in New York, the Puerto Rico Electric Power Authority's chief financial officer, Todd Filsinger, said in a court declaration that the authority had started to “ramp down PREPA’s power production and shut down certain generating units in order to conserve its limited cash reserves.

PREPA's Costa Sur power plant in Guayanilla, Puerto Rico.
PREPA leaders say PREPA needs a cash infusion by Wednesday or they will take steps that will cut electricity to a wide array of customers.

"This exacerbate[s] the risk to an already fragile system, and leaves it vulnerable to outages and resulting in brownouts on the island,” he said.

The Title III process for the power authority, which has more than $8 billion of bond debt outstanding, was set in motion last year by the Puerto Rico Oversight Board, appointed under the 2016 Puerto Rico Oversight, Management and Economic Stability Act. Restoring power generation after last year's hurricanes is considered key to rebuilding the economy

Unless the authority receives a shot of money by Wednesday the authority will further reduce its electricity production and personnel and substantial parts of Puerto Rico getting service will no longer get service, the Oversight Board’s lawyers said.

At Thursday’s hearing Swain said she could consider Puerto Rico’s central government making a $300 million short-term “administrative expense superpriority” loan to PREPA. Whereas the proposed $1 billion loan to PREPA would have had a prime lien and superpriority, Swain’s suggested loan would only have the latter.

If one has a lien, one gets the first use of any money available, said municipal bankruptcy expert James Spiotto. Those with a superpriority claim but no prime lien get paid off after those with any lien.

If the court found that there is no valid plan of adjustment for PREPA, holders of a superpriority claim wouldn’t get paid, said Spiotto, managing director at Chapman Strategic Partners.

A loan for “administrative expenses” could be used for operating expenses since the start of PREPA’s Title III bankruptcy, Spiotto said.

In her oral ruling Swain said that while there is a cash flow crisis at PREPA and that the authority may be forced to turn off the electricity soon, there are difficult legal questions about Puerto Rico’s proposed loan. The commonwealth hasn’t established a need or even the legality of its loan, she said.

Swain said that she’d be willing to consider approving a larger Puerto Rico loan if both PREPA and the commonwealth showed a more robust effort to get a third party loan without a superpriority. Any proposed loan should consider the fairness to creditors as well as to PREPA.

Puerto Rico’s proposal for a $1 billion loan failed to show that the size was right for the authority’s needs, Swain said.

Swain said any short-term loan for PREPA should strike two provisions that the attorney for the Ad Hoc of General Obligation Bondholders Group had objected to. By striking the provisions the group will maintain their right to challenge any Puerto Rico central government loan to PREPA in their Title III hearings.

After the hearing broke, the Puerto Rico Oversight Board’s chief Title III attorney Martin Bienenstock said it might be possible to arrange the short-term loan in a few days. A few minutes later he said, “We will work out whatever we have to before [Wednesday.]” Bienenstock had overseen the petition to Swain for approval of the proposed $1 billion loan.

Following Swain’s decision Filsinger spoke with Puerto Rico Treasurer Raúl Maldonado Gautier, according to court documents. The interest rate for the new loan was raised to 5% a year, from as little as 0% in the the rejected proposal, following Maldonado Gautier’s direction.

Early Friday morning Bienenstock and his team at Proskauer Rose LLP, Hermann Bauer at O’Neill & Borges LLC and the Puerto Rico Fiscal Agency and Financial Advisory Authority, filed a group of papers in the PREPA Title III case proposing a $300 million loan along the lines that Swain suggested.

In the Bienenstock filing, the lawyers said, we “anticipate submitting a further request for approval of a larger financing within two to four weeks because the instant proposed financing is projected to be consumed before the end of March 2018.”

On Wednesday the Ad Hoc Group of PREPA bondholders had submitted a proposal for its members’ own loan to PREPA of $534 million. While not seeking a priming position, at least superficially the loan had much higher interest rates and fees than Puerto Rico’s loan had.

In the weeks leading to Thursday’s decision and at the day-long hearing on Thursday, lawyers for various Puerto Rico bondholder groups had generally expressed opposition to Puerto Rico’s proposed $1 billion loan. Lawyers for other creditors presented mixed opinions of the proposal.

At Thursday’s hearing the lawyer for the Ad Hoc Group of PREPA Bondholders, Thomas Mayer, made several arguments against Puerto Rico’s proposed loan. He said the loan was a “fake.” He noted that the loan’s proposed credit agreement would be suspended if there were projections for the commonwealth’s central bank account would go below $800 million for 60 days.

While the initial loan’s terms are for 0%, the credit agreement allows refinancings of the loan at higher rates, Mayer said. Mayer is a lawyer with Kramer Levin Naftalis & Frankel LLP.

Another section of the credit agreement allows the government in cooperation with PREPA to change the loans terms at any time, Mayer said. Even without any changes, the proposed loan wouldn’t provide the PREPA bondholders with adequate protection.

The Ad Hoc Group of General Obligation Bondholders’ lawyer Lawrence Robbins said in the proposed loan to PREPA, “The commonwealth is effectively giving away resources.” The terms are lopsided towards PREPA’s interests. Robbins is a partner at Robbins Russell.

After Swain’s decision and the hearing was breaking up, one attorney said, “First piece of good news regarding Puerto Rico in my [expletive] two years.”

On Friday morning at 11 a.m. lawyers for the Oversight Board and FAFAA, on one side, and lawyers for bondholders, on the other side, had a conference call, according to the board’s early Friday morning submission to the court.

On Friday afternoon lawyers for Puerto Rico and the Oversight Board submitted a proposed timetable for the court to handle approving the loan conditions. In it the non-Puerto Rico parties would have until 6 p.m. E.S.T. Saturday to file objections and all parties would have until 2 p.m. on Sunday to file replies to these objections. Puerto Rico wants the court to simply send out its order based on the filings but said if there is to be a hearing it should be held at 9:30 a.m. on Tuesday.

Attorney John Mudd said that he thought Swain was concerned with the failure for Puerto Rico’s loan to have been created through arm’s length negotiations. Rather, FAFAA guided both sides. Mudd is both an attorney in and observer of the Puerto Rico Title III bankruptcy process.

Lawyers for the involved parties and Swain will probably work through the weekend and Monday’s holiday, Spiotto said. However, it is unlikely, though not impossible, that there will be a hearing or order during that period. That would leave Tuesday for a possible hearing and order from Swain.

While PREPA is seeking a Community Disaster Loan from the U.S. Treasury, it now believes that its disbursement will not happen in time to avoid running out of cash.

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