Puerto Rico debt deal reaches a turning point

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The more than three year process of negotiating a new Puerto Rico central government $35 billion debt deal has reached a turning point.

On Tuesday the Puerto Rico Oversight Board submitted a status report to the court overseeing the bankruptcy that said “only a brief respite is required” to determine if the board could reach a deal with creditor parties.

NYU Professor Troy McKenzie
New York University School of Law professor Troy McKenzie said those trying to fight a Puerto Rico debt deal through opposing its classification of voting groups may have a hard time.

It said it expected to know by Oct. 25 whether it had completed a new deal. It told bankruptcy Judge Laura Taylor Swain that it would report back to her by then.

Since the spread of the global COVID-19 pandemic, and the resulting shutdown of much of Puerto Rico's economy, the board has said it would need to renegotiate the debt deal reached in February. The board has indicated it will give creditors less money.

While the Puerto Rico Oversight, Management, and Economic Stability Act gives the board a great deal of power over adjustments of debt, it doesn’t allot the board unlimited power. The board is still required to have one class of creditors in the plan of adjustment vote to approve the deal.

There are three plan support agreements for the plan of adjustment: one for retirees, one for current government employees, and one for debt holders. The board is renegotiating only the debt holder agreement from the one it reached in February.

In February, the board said holders of 58% of the General Obligation and Public Building Authority claims supported the deal.

The debt deal also addresses payouts to Highways and Transportation Authority, Employees Retirements System, Infrastructure and Finance Authority Rum, Metropolitan Bus Authority, and Convention Center District Authority bonds. In the February deal these bonds, amounting to $16 billion in debt, were to be paid at an aggregate level of three cents on the dollar.

To get court approval of the new deal, at least one class of the bondholders will have to support it. The law says that “an entire class of claims is deemed to accept a plan if the plan is accepted by creditors that hold at least two-thirds in amount and more than one-half in number of the allowed claims in the class,” in the words of Chapter 11 bankruptcy, whose provisions on this point are incorporated into PROMESA.

The board is currently trying to get at least one class to vote in favor, said Puerto Rico attorney John Mudd. He said he believed the board currently doesn’t have even this level of support.

If it gets it, the board plans to “cram down” or force the deal on the non-consenting classes, with the approval of Judge Swain.

“Obviously creditors will fight tooth and nail to get everything they can because there’s less available than there was before,” said Shaun Burgess, portfolio manager for Cumberland Advisors.

The board may try to restructure the existing voting classes to create a class that would vote for the deal, Mudd said. Swain may ultimately challenge how the board is dividing the creditors into classes, he said.

The issue of how the voting classes will be drawn will be litigated when the board submits the Disclosure Statement for the Plan of Adjustment, said Puerto Rico observer Cate Long.

“Objections based on gerrymandering arguments are difficult to make,” said Troy McKenzie, a professor at New York University School of Law. The legal code doesn’t explicitly bar like claims from being split into different classes. However, judges have generally held there has to be a legitimate reason to split classes.

McKenzie said the board had a reasonable shot at convincing Swain that, for example, different vintage holders of general obligation bonds should be placed into different voting classes. The board indicated its interest in dividing classes by vintage of the bond held in the September 2019 and February 2020 bond deals.

Long said she believed the board’s currently worked-on central government debt deal will not be ultimately approved.

It is unclear what the board would do if it can’t develop a central government debt deal with the support of a creditor class. McKenzie said normally the board would have to develop a new deal that could entice at least one class to support.

“We can’t file a plan of adjustment without creditor support,” a board spokesman said.

Complicating the efforts to negotiate a deal is that membership in the board is changing; Puerto Rico will also be getting a new governor.

The oversight board lost two members at the start of September. It is set to lose its chairman by October 5th. Some believe that at least one more of the four remaining members will not continue on the board.

Long said she expected President Donald Trump to name a seven-member board for a new three-year term prior to Election Day on Nov. 3. There is a danger that if the existing five-member board approves a new debt deal prior to the new board being seated, the new board may undo the deal, she said. The new board may include some of the same members as it does now but at least three of them will be new.

Either of the likely winners of November's gubernatorial election would be a change, in personality if not in policy.

Pedro Pierluisi, who beat incumbent Wanda Vázquez Garced in August's New Progressive Party primary, once worked for the board and thus is unlikely to be a major opponent of it, Mudd said.

On the other hand, Popular Democratic Party candidate Charlie Delgado has said he opposes the deal with LUMA Energy to run the island’s electric power transmission and distribution system. Undoing this deal could affect the central government debt deal, Mudd said.

Meanwhile, the board and the local government face the unpleasant prospect of Puerto Rico having to pay a $100 million termination fee if either some of the signing creditors to the February debt deal or the board terminates that deal. The February plan support agreement said that the court was supposed to approve a Disclosure Statement for it by Aug. 31. That hasn’t happened and this gives the parties legal basis for terminating the deal.

Further complicating matters, bond insurer Ambac Assurance in July filed a motion with the court to strike the termination fee. Assured Guaranty has since submitted a motion to support this.

With the board having filed for Title III bankruptcy for the central government over three years ago, on May 3, 2017, it is possible that Swain will put a deadline on the board to reach an agreement to submit to the court, Long said. Swain could say if the deadline isn’t met she will dismiss the case, leaving Puerto Rico to pay the whole $35 billion.

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PROMESA Puerto Rico Commonwealth of Puerto Rico Puerto Rico Highway & Transportation Authority Puerto Rico Public Buildings Authority Puerto Rico Infrastructure Financial Authority Puerto Rico Electric Power Authority Bankruptcy