Wed 03/22/2023 18:14 PM
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Judge Laura Taylor Swain issued her long-awaited decision today in the PREPA lien challenge litigation, through which the PROMESA oversight board challenges the security interest and recourse of bonds issued by the Puerto Rico Electric Power Authority. The opinion grants in part and denies in part each of the two sides’ cross-motions for summary judgment. Summary judgment was sought by, on the one hand, the oversight board and, on the other, the PREPA bondholders - the ad hoc PREPA bondholder group and monoline insurers Assured and Syncora - along with U.S. Bank as bond trustee. Approximately $8.5 billion in PREPA bonds are outstanding.

Regarding the secured portion of the PREPA bondholders’ claim, the court concludes that the PREPA bondholders have perfected liens only in the sinking fund established under the bonds (with a balance of only $16 million) and related accounts over which the bond trustee has established control, finding that the trust agreement expressly granted the bondholders’ security interests in the funds actually deposited into the funds. In contrast, the court holds that the bondholders have no security interest in the trust agreement’s “covenants and remedies.” The court also determines that the security interest in the capital improvement fund and construction fund may not be perfected. The court’s ruling is in sharp contrast to the bondholders’ asserted secured claim in the amount of $8.5 billion.

However, relying upon PREPA’s “payment and equitable relief covenants” in the trust agreement, Judge Swain rejects the oversight board’s argument that the sinking fund is the sole source of recovery and recourse for bondholders, concluding instead that the bondholders have an unsecured deficiency claim in the form of an unsecured net revenue claim. The court explains that the unsecured net revenue claim would be calculated by reference to the value of future net revenues that would have become collateral upon being deposited in the sinking funds and thus payable to the bondholders over the remaining life of the bonds. Whether these funds would have been deposited in the sinking fund and become collateral is determined by the trust agreement’s waterfall provision and applicable nonbankruptcy law, according to the opinion.

Judge Swain stresses that at this time, the court will not “predetermine the method of valuation or the appropriate time as of which valuation should be gauged,” adding that the ultimate value of the unsecured net revenue claim “must be determined consensually or through proceedings under section 502 of the Bankruptcy Code.”

PREPA’s exit from Title III hinges on Judge Swain’s decision, which largely dictates the recoveries of nearly all creditor constituencies under PREPA’s plan of adjustment, including PREPA’s largest class of creditors - the bondholders.

Judge Swain’s ruling comes after taking the matter under advisement at oral argument on Feb. 1. The judge grants in part and denies in part both cross-motions for summary judgment making determinations on four intertwined issues.


At the outset of the opinion, Judge Swain summarizes the dispute, stating that the oversight board moved for summary judgment with respect to the allowance or disallowance of the PREPA bond claim, which was asserted as a secured claim for approximately $8.5 billion. The oversight board requested that the court disallow the claim to the extent the proof of claim purports to be secured by PREPA property outside of the funds currently in the sinking fund. Further, the oversight board maintained that the sinking fund is the sole source bondholders can look to receive payment on their bonds and that their collateral is limited to those funds. Accordingly, the opinion states, the oversight board asserted the bondholders could not have an unsecured claim for any amounts owed beyond those on deposit in the sinking fund.

In contrast, Judge Swain writes that the bondholders “contend that they have a claim for the face amount of the bonds that is secured by all of PREPA’s current and future revenues, to which they can look for payment in perpetuity.”

The oversight board and the bondholders moved for summary judgment with respect to all seven counts of the first amended complaint and the two counts of the bondholders’ counterclaim complaint. Judge Swain grants summary judgment outright on counts IV through VI pertaining to bondholder security interests in covenants of the trust agreement, as the bondholders abandoned the arguments.

Before turning to the merits of the lien and recourse arguments, Judge Swain first addresses the bondholders' contentions that the dispute is not ripe for decision and that the court lacks subject-matter jurisdiction to decide the summary judgment motions, concluding that the bondholders’ arguments are “not persuasive,” for several reasons. Ultimately, the court concludes the “present posture of the case … is an appropriate way for the Court to address and resolve the issues raised by the summary judgment motions.” Further, the opinion emphasizes that the resolution of bondholders’ claims “is of utmost importance to PREPA’s prospects of emerging from Title III and to Puerto Rico’s financial stability.”

After finding that the bondholders failed to establish that the motions for summary judgment are not ripe for adjudication, the court then turns to its substantive discussion regarding the scope of the bondholders’ security interests and liens and the bondholders’ unsecured net revenue claim based on PREPA’s payment and equitable relief covenants in the trust agreement.

Scope of Bondholders’ Security Interests and Liens

Turning to the merits of the decision, Judge Swain walks through the relevant provisions on which the bondholders rely, finding the bondholders’ “expansive view of their lien rights inconsistent with the clear and unambiguous terms of the Trust Agreement.” The court disagrees with the bondholders’ position that the trust agreement provides them with security interests “in all present and future revenues of the Authority” and that the preamble creates and defines the scope of the security interests, “notwithstanding the existence of more specific operative terms within the remainder of the document.”

Judge Swain states that reading the trust agreement as a whole, it “unambiguously embodies a pledge (i.e., a promise) to pay the amounts owing on the Bonds from Net Revenues, that is partially secured by a lien on the moneys received by PREPA attaching at the time they are ultimately deposited into the Sinking Fund, as well as liens on moneys the provisions of the Trust Agreement make ‘available’ for transfer to supplement the Sinking Fund in the event of a shortfall that attach at the time they are deposited into the ‘Specified Funds.’”

The opinion considers the meaning of “pledge of revenues of the system.” It states that the term “pledge” as used in the preamble does not grant the bondholders any security interests, as it does not reference any grant of lien or charge. Judge Swain refers to the court’s decision in revenue bond litigation for the Puerto Rico Highways and Transportation Authority, in which she found that “a pledge that lacks ‘references to a lien or charge or other language indicating’ that it is meant to expand the scope of specific lien grants results in a mere ‘unsecured promise[] to deposit Revenues in the manner required by the’ agreement.” Further, if the operative language granting a security interest had been in the preamble, the preamble language would have rendered the specific limited lien grants in the agreement superfluous, a result that Judge Swain says would “not only be illogical, it would contravene [] basic principle[s]” of contracts.

According to the opinion, section 701 of the PREPA trust agreement “speaks most directly to the contours of the pledge of ‘revenues of the System.’” Section 701 embodies a covenant to pay interest and principal “‘solely from the Revenues and said Revenues are hereby pledged to the payment thereof in the manner and to the extent hereinabove particularly specified.’” Judge Swain finds that this provision narrows the meaning of “revenue” to a defined term that means “only ‘moneys received’ from System operations or financing.” These revenues are then subject to the payment terms contained in the preceding sections of the body of the trust agreement, or the payment waterfall, the opinion says.

The opinion describes the payment waterfall, beginning with PREPA’s general fund, where “‘all Revenues, other than income from investments’ are first deposited.” The revenues in the general fund are “‘used first for the payment of the Current Expenses of the System[.]’” Next, the opinion says, after payment of current expenses, “but holding back a reserve for Current Expenses as they come due, the moneys are transferred to the ‘Revenue Fund.’” Judge Swain explains that “Excess Revenues remaining after payment of Current Expenses are ‘Net Revenues’ … These are the moneys - all of which consist of Revenues - that are required to be transferred to the Revenue Fund and then finally rendered collateral upon transfer to the liened Sinking Fund and Specified Funds.”

Moreover, Judge Swain looks to the provisions regarding opinion of counsel as the best summary of the trust agreement’s general pledge: “‘this Agreement creates a legally valid and effective pledge of the Net Revenues, subject only to the lien of the 1947 Indenture, and of the moneys, securities and funds held or set aside under this Agreement as security for the bonds, subject to the application thereof to the purposes and on the conditions permitted by this Agreement[.]’” With this backdrop, Judge Swain reaches the ultimate conclusion that “Bondholders have been pledged payment on the Bonds from the Net Revenues of the System, but their claim is only partially secured by a lien and charge on moneys actually received and deposited into the Sinking Fund and other Specified Funds” (emphasis added).

Judge Swain next considers whether the trust agreement grants the bondholders an enforceable security interest in future income derived from “the sale of energy that PREPA has not yet generated, which PREPA has not yet received.” Judge Swain notes that the bondholders correctly state that PREPA has the authority under the Authority Act to secure payment of its bonds by pledging or granting a lien on future income of the authority. However, she finds that there is no evidence that PREPA used that authority to grant a security interest in future revenue when it issued these bonds. The “‘future revenues’” upon which the bondholders claim to hold a security interest are “‘mere expectancy’ until they are rendered collateral i.e., received and deposited into the liened Funds,” Judge Swain says. Citing to the First Circuit’s Andalusian decision, the judge reiterates, “Puerto Rico’s law does not recognize such an expectancy as property in which an entity is capable of granting a creditor a security interest.”

Accordingly, the court concludes that the “bondholders have no currently enforceable security interest (indeed, they have no interest at all) in future revenues the Authority has not yet received and deposited into the Sinking Fund or other Funds in which the Trust Agreement specifically grants them interests.”

Judge Swain also rejects the bondholders’ argument that under section 928 of the Bankruptcy Code, which continues prepetition liens on special revenues postpetition, they would have a lien on all future special revenue credited to the sinking fund. The judge reasons that the trust agreement says that “the only moneys that become subject to a lien and charge under the terms of the Trust Agreement are moneys that have already been deposited in the Sinking Fund and the Specified Funds.” Meanwhile, section 928 similarly refers to revenues acquired in the past tense, and it does not support the bondholders’ interpretation that it “captures revenues not yet received by PREPA and deposited in the Funds.”

Judge Swain notes that the oversight board and creditors’ committee do not dispute that the bondholders’ liens persist postpetition insofar as they attach to funds that are in the sinking funds postpetition. Judge Swain agrees with the oversight board that section 928 does not apply to revenues that PREPA has not acquired yet, and that any claim increasing due to the accretion of liened moneys in the liened funds can be satisfied through confirmation and discharge via a plan of adjustment, as with any non-executory contract.

Ultimately, Judge Swain holds that the bondholders’ liens persist on special revenues deposited in the funds postpetition, but because of section 982, their security interests do not extend to future revenues that have not been received. She also finds that the bondholders’ security interest is limited to the amounts on deposit in the liened funds, to the extent such liens are perfected, and the provision “will continue to operate to render any special revenues in the Funds subject to the Bondholders’ liens until such time as a plan of adjustment is confirmed that cuts off accretions of the security interest.”

According to the opinion, “the Sinking Fund, Self-insurance Fund, and Reserve Maintenance Fund are under the control of the Trustee, and the Bondholders therefore have perfected security interests in them.” “It is unknown if the liens are perfected or if the oversight board can avoid the Bondholders’ liens on the money in the Construction Account and the Capital Improvement,” the opinion says. The court considers whether the liens on these two accounts could be avoided under the strong-arm powers of section 544 of the Bankruptcy Code, finding that a hypothetical judicial lien could exist on the accounts under both the trust agreement and Puerto Rico law. Moreover, Judge Swain determines that the oversight board has hypothetical lien creditor power as of the commencement of the case.

Judge Swain declines to grant summary judgment with respect to perfection of liens on the construction fund or capital improvement fund, because neither the oversight board nor the bondholders put forward sufficient evidence to establish that the bondholders liens are or are not perfected. To the extent to the extent the liened moneys are in deposit accounts not within the control of the bond trustee, the oversight board “has the right to avoid the Bondholders’ liens and recover and/or preserve the collateral for the benefit of PREPA pursuant to Bankruptcy Code sections 544, 550 and/or 551.”

Unsecured Net Revenue Claim

After reviewing the court's rulings on summary judgment solely with respect to the oversight board’s motion, the opinion analyzes the bondholder counterclaim Count I and the complaint’s Count VII, whether the bondholders have an unsecured net revenue claim arising from the trust agreement’s covenants. Specifically, the bondholders seek a declaration that under the trust agreement, the trustee has recourse to the sinking fund and the right to obtain specific performance of covenants to fund the sinking fund, and in the event of default it has recourse to all PREPA revenues and other money. In contrast, the oversight board contends that the bondholders are precluded from asserting an unsecured deficiency claim.

Judge Swain concludes that the bondholders have an “Unsecured Net Revenue Claim” for a general unsecured claim against PREPA based on PREPA’s “promise” in the trust agreement to pay bond principal and interest from pledged net revenues of the system. These funds are partially secured by the money in the sinking fund and the specified funds, and otherwise unsecured, Judge Swain rules, and the bondholders also have the ability to obtain relief against PREPA pursuant to the trust agreement remedy provisions.

The opinion summarizes the bondholders’ argument that, when read together in conjunction with the trust agreement as a whole, the remedies in the pertinent sections 804 and 805 provide them with recourse against PREPA outside of the sinking fund. This is because the bondholders may obtain “either judgments requiring PREPA to apply Net Revenue-derived assets from outside of the Sinking Fund to payments through the Fund, or - through specific performance of the right to appoint a receiver - to effectively increase Net Revenues through efforts to raise rates pursuant to the Authority Act and the covenants of the Trust Agreement.” The opinion states that the bondholders also argue that their equitable remedies determine the amount of their claim, because under section 101(5)(b) of the Bankruptcy Code, “a ‘right to an equitable remedy for breach of performance’ is a ‘claim,’ under the Bankruptcy Code, if ‘such breach gives rise to a right to payment.’”

According to Judge Swain, the bondholders’ argument is correct except for the one assertion that the rights and remedies resulting from PREPA’s breach of the trust agreement covenants can be resolved by the Title III process “if but only if” they give rise to a right to the payment of damages in the full amount of the claim. Judge Swain says she cannot “simply value” the unsecured net revenue claim at the full amount of the PREPA bond claim. Further, in the event the bondholders obtain specific performance and a receiver raised rates to cover the bond payments, “the Revenues received would not be paid ahead of Current Expenses, and the receiver would not have the freedom to charge rates that are not reasonable or be completely untethered from the Trust Agreement - any such remedies and Revenues would still be subject to the payment restrictions and priorities of the Trust Agreement” (emphasis added).

The opinion adds that any equitable claim reduced to payment arising from the trust agreement “must have no greater value than the value that could be achieved through the application of the equitable remedies to fulfill the Trust Agreement’s unsecured covenant to pay the Bonds from the Net Revenues of the System.” Judge Swain notes that PREPA did not pledge payment out of gross revenues but instead covenanted to pay the bonds out of the net revenues of PREPA, “subject to all of the payment provisions and limitations of liability contained within the previous sections of the Trust Agreement” (emphasis added).

Determining the value of the bondholders’ claim must be carried out with reference to the value of net revenue that would have, under the waterfall provisions of the trust agreement and applicable nonbankruptcy law, become collateral upon being deposited in the specified funds and payable to the bondholders over the remainder of th term of the bonds, Judge Swain writes. She notes that this may require accounting for the likelihood of payment of bondholder claims in relation to claims of higher priority in the waterfall. Instead, the court will require valuation of the claims through section 502 of the Bankruptcy Code unless the parties resolve the matter consensually.

Next, Judge Swain addresses whether section 927, regarding recourse for special revenue bonds, is applicable to the bondholders’ claim. The opinion notes that in a Title III case under PROMESA, section 927 of the Bankruptcy Code confines the creditor’s recovery to its collateral if (i) the agreement is nonrecourse, and (ii) the claim is payable solely from “special revenues” which include receipts derived from the operation of a utility system. This differs from section 1111(b) of the Bankruptcy Code, in which a creditor has the choice whether to (i) receive an unsecured deficiency claim - permitting the creditor to vote their claim and receive payment pro rata with general unsecured claims, or (ii) to elect to have the undersecured claim treated and satisfied under a plan as a fully secured claim - and potentially benefit from any appreciation in the value of the collateral.

According to Judge Swain, the oversight board’s position - that section 927 applies here and precludes the bondholders from seeking payment of outstanding amounts from any assets other than those in the sinking fund and specified funds - is wrong, and the bonds constitute recourse instruments. Specifically, she says that the position is “contradicted by the unambiguous terms of the Trust Agreement which channel Revenues through a payment waterfall until they reach the Sinking Fund and the Specified Funds on which the Bondholders have been granted liens, but also include equitable remedy provisions that permit the Bondholders either to obtain judgments requiring PREPA to apply Net Revenue-derived assets from outside of the Sinking Fund to payments through the Fund, or - through specific performance of the right to appoint a receiver - to effectively increase Net Revenues through efforts to raise rates pursuant to the covenants of the Trust Agreement and the Authority Act.”
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