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Puerto Rico: Commonwealth-COFINA Dispute Nearing Possible Resolution

As we reported last year, on August 10, 2017, Judge Swain entered an order establishing procedures to govern resolution of the Commonwealth-COFINA dispute (the “Resolution Stipulation”).  In recognition of the fact that the Oversight Board acts for both the Commonwealth and COFINA, the Resolution Stipulation provided for appointment of agents to act independently for each of them:  (i) the Creditors’ Committee, to serve as the Commonwealth’s representative (the “Commonwealth Agent”) and (ii) Bettina Whyte, an experienced restructuring professional with Alvarez & Marsal, LLC,  to serve as the COFINA’s representative (the “COFINA Agent,” and, with the Commonwealth Agent, the “Agents”).

Since the appointment of the two Agents, complaints and counterclaims were filed; the scope of the dispute was limited to the central question of whether the Commonwealth or COFINA owns the portion of the Commonwealth’s general sales and use tax that was transferred to COFINA and pledged to secure the COFINA bonds; nine parties were authorized to intervene in the litigation; the Court considered and rejected a request to certify certain questions to the Supreme Court of Puerto Rico; six independent cross motions for summary judgment were filed; and the parties participated in an ongoing mediation.

Finally, on June 7, 2018, the Agents announced an “Agreement in Principle” to resolve the Commonwealth-COFINA dispute.  The settlement would grant COFINA an ownership interest in 53.65% of the pledged sales-and-use tax, which will be used to fund debt service payments on new COFINA bonds.  The Commonwealth would receive a junior interest in the residual sales-and-use taxes.  Special provisions to account for COFINA bonds that benefit from monoline insurance are also included in the deal. 

After several more months of negotiation, on October 19, 2018, the Oversight Board filed the (a) Commonwealth of Puerto Rico’s Motion Pursuant to Bankruptcy Rule 9019 for Order Approving Settlement Between Commonwealth of Puerto Rico and Puerto Rico Sales Tax Financing Corporation (“9019 Motion”), (b) Title III Plan of Adjustment of the Debts of Puerto Rico Sales Tax Financing Corporation (“COFINA Plan”), and (c) the Disclosure Statement for the Title III Plan of Adjustment of the Debts of Puerto Rico Sales Tax Financing Corporation (“COFINA Disclosure Statement”).

Most significantly, even though the settlement in principle was reached between the COFINA Agent and the Committee in its capacity as Commonwealth Agent, the actual settlement submitted to the Court with the 9019 Motion is between the COFINA Agent and the Oversight Board acting for the Commonwealth.  The Committee, in its capacity as Commonwealth Agent, is not a party.  The Oversight Board has taken the position that it can seek approval of this settlement notwithstanding the delegation of authority to the Committee to act as Commonwealth Agent for purposes of the Commonwealth-COFINA dispute.  

Initially, the Committee disputed the Oversight Board’s authority to seek approval of the settlement and stated its intention to file a “Motion to Enforce” the Resolution Stipulation, i.e., asking the Court to rule that the Oversight Board filed the 9019 Motion in violation of the Resolution Stipulation.   In its request for a briefing schedule on a possible motion to enforce, the Committee explained:

As the Commonwealth Agent repeatedly advised the Court and parties-in-interest over the last few months, the Agreement in Principle was approved by the Commonwealth Agent in reliance upon the May 30, 2018 certified fiscal plan. The Oversight Board revised the May 30 fiscal plan’s long-term projections materially downward in connection with its certification of the June 29, 2018 fiscal plan, thus rendering, in the opinion of the Commonwealth Agent, a settlement along the lines of the Agreement in Principle neither feasible nor desirable.  Indeed, after taking into account the COFINA debt service under the COFINA Settlement, the projected cash flows under the June 29, 2018 certified fiscal plan would reflect an approximate $28 billion (in nominal dollars) deficit for the Commonwealth and that deficit amount assumes that no Commonwealth creditor would receive a plan distribution.

Before filing a motion, however, the Committee and the Oversight Board struck a deal.  The Committee has agreed not to file a motion to enforce the Resolution Stipulation.  Instead, the Committee has agreed, based on modifications to the June fiscal plan reflected in the October fiscal plan (most significantly, an increase in the 40-year cash flow projections) that it will not oppose the Oversight Board's entry into the COFINA settlement.  And, with one caveat discussed below, the Committee has further agreed that it will "(a) not object to approval of the 9019 Motion, approval of the COFINA Disclosure Statement, or confirmation of the COFINA Plan, and (b) take no action to otherwise inhibit (i) approval of the COFINA Disclosure Statement, (ii) 9019 Motion and consummation of the Settlement Agreement, or (iii) confirmation and consummation of the COFINA Plan." 

The Committee’s agreement not to oppose the 9019 Motion or COFINA Plan is contingent upon there being no "Material Adverse Change," which is defined in the stipulation as either a "material reduction of the 40-year cash flow projections (Fiscal Year 2019 to Fiscal Year 2058) from those contained in the October Fiscal Plan" or an amendment, modification, or supplement to the Settlement Agreement or COFINA Plan that "provides a material negative economic impact to the rights and interests of the Commonwealth."

Assuming Judge Swain approves the proposed stipulation, and assuming there is no Material Adverse Change, the Committee’s agreement not to oppose the Commonwealth-COFINA settlement clears a potentially significant hurdle to approval of the deal.

The deadline to file objections to the COFINA Disclosure Statement is November 13, 2018 at 5:00 p.m.  A hearing to consider approval of the COFINA Disclosure Statement is scheduled for November 20, 2018.  The deadline to file objections to the 9019 Motion is November 16, 2018 at 5:00 p.m.  Any reply must be filed by December 7, 2018 at 5:00 p.m.  The deadline to file objections to the COFINA Plan is January 2, 2019.  A hearing to consider approval of the 9019 Motion and the COFINA Plan is scheduled for January 19, 2019.  All of these dates are tentative and remain subject to change.