The Puerto Rico Oversight Board said its plan of adjustment for Puerto Rico’s debt was unaffected by the Supreme Court’s recognition that pension bondholders’ had a lien on the pension system’s revenues.
There are about $3.2 billion of Employees Retirement System bonds outstanding. The current board-proposed plan of adjustment says that the ERS bondholders would get a recovery of 13 cents on the dollar.
“The treatment of the Employees Retirement System bonds under the recently filed plan of adjustment for the Commonwealth of Puerto Rico is not affected by today’s Supreme Court decision,” the board said in a written statement late Monday. “The way the ERS bonds are treated under the plan has not been contingent on the outcome of this case. In addition, there is other litigation involving the validity of the ERS bonds, as well as the scope of the security interest under the bonds, that is still ongoing.”
Earlier on Monday the U.S. Supreme Court let stand a lower court ruling that in 2015 bondholders perfected a lien on Puerto Rico government revenue contributed to Puerto Rico’s primary pension system, ERS. The decision raised hopes among bondholder that they could claim as much as 100 cents on the dollar.
However, after the lower court ruling both ERS and the board, on one side, and the bondholders, on the other side, requested that federal District Judge Laura Taylor Swain rule on whether the lien entitled the bondholders to be paid from money the ERS received after it was put into Title III bankruptcy on May 21, 2017.
On June 27 Swain ruled that the bankruptcy ended the lien and that the bondholders weren’t entitled to money entering the system after the start of bankruptcy.
Since then the bondholders, or more specifically a group of hedge and investment funds that hold ERS bonds, appealed Swain’s decision to the First Circuit Court of Appeals. Briefs have been submitted for this appeal and the last submission was on Sept. 16. The next step is expected to be the court’s ruling on the appeal.
In her opinion, Swain said that the Puerto Rico Oversight, Management, and Economic Stability act included Section 552 of the U.S. bankruptcy code. Section 552(a) says, “Except as provided in subsection (b) of the section, property acquired by the estate or by the debtor after the commencement of the case is not subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case.”
She quoted subsection b, which said that if the creditor had a lien on property that existed before the bankruptcy than that lien continues after the bankruptcy.
Swain said that the creditors were trying to extend their lien to proceeds of property acquired after the petition date. The government contributions to the system were made after the bankruptcy and thus aren’t covered by the bondholders’ lien, she said.
While the bondholders argued that the employer contributions to the ERS were “special revenues” as defined in section 928 of the bankruptcy code, Swain rejected this. The section defines them as being revenues “primarily to provide transportation, utility, or other services.” This issue is important because section 928 specifies these revenues continue to be paid in bankruptcy.
Swain said that “other services” in this context should be considered to be referring to physical systems that provide services, since those would be like transportation and utilities. She said that the ERS is not a physical system and thus contributions to it shouldn’t be considered special revenues.
Even if Swain’s opinion holds bondholders might be entitled to the $400 million that ERS held on the bankruptcy date.
Since Swain released her opinion, and the bondholders appeal of it, the board, the Retirees Committee, and the bondholders group has submitted briefs in the appeal.
In their brief to the court, the bondholders said, “The board [in its brief] concedes that ERS had a prepetition property interest in ‘amounts owed to it on the basis of pre-petition work performed by employees for which a contribution had not been paid,’ and that ‘any post-petition collections’ of those amounts ‘are proceeds of ERS’s pre-petition property and therefore subject to the bondholders’ security interest under section 552(b).’”
The bondholders are referring to the roughly $30 billion that the Puerto Rico’s government owed the ERS prior to the bankruptcy.
The bondholders continued, “That conclusion alone gives up this case, because all post-petition employer contributions are payments of amounts owed to ERS to fund benefits to employees on account of their prepetition work.”
The bondholders also argued that legal precedent support the persistence of their lien on the property after the bankruptcy.
In addition to the appeals court case on the continued validity of the lien, there are other cases regarding the ERS bonds.
There are two adversary proceedings in the Title III bankruptcy on the issue of the bondholders’ lien. There are more than a half dozen adversary complaints where the board, Official Retirees Committee, and/or the Unsecured Creditors Committee have challenged the validity of the ERS bonds.
Swain stayed all of these cases in late July as part of her wider stay on cases whose disputes were being put into mediation. She said the mediators were to address the issues in mediation, which is being conducted confidentially.
The case that the Supreme Court declined to pick up and the case First Circuit is considering had been appealed beyond the district court level before Swain issued a stay.
