Wednesday, July 1, 2015

Puerto Rico's Debt - Update

WSJ today reported that Puerto Rico Electric Power Authority (PREPA) and its bondholders are close to a deal that would cover the $400 million plus due to bondholders and avoid default.

Yesterday, Dealbook ran "The Bonds that Broke Puerto Rico" offering an explanation of how Puerto Rico could issue "enough debt to crush it."  The answer:  "a confluence of factors, including American investors' desire to avoid taxes; the mutual fund industry's practice of competing on the basis of yield; complacency about the practice of long-term borrowing to plug holes in budgets; and laws [Puerto Rican] that supposedly give bond buyers ironclad guarantees."  

MoneyBeat ran  Puerto Rico's Crisis Deals a Blow to Municipal-Bond Funds providing more detail on the impact of Puerto Rico's debt problems on the municipal bond market.   Puerto Rico's $3.5 billion in general-obligation bonds issued in 2014 had a yield of 8.7%, compared to the yield on 10-year U.S. treasury notes which was around 2-3% over the same period.   Interest on Puerto Rican bonds is federal and state tax free for investors in every state.  Interest on other municipal bonds is exempt from federal tax, but exempt from state tax only if the investor lives in the state that issued the bonds.  Single-state municipal bond funds have used Puerto Rican bonds to diversify and boost yield.


Tuesday, June 30, 2015

Why Don't We Care About Puerto Rico?


Late Sunday, Puerto Rico's governor announced that the U.S. territory would likely default on $72 billion in debt. Yesterday, the White House said that the Treasury Department will offer advice, but there will be no "bailout." Rather, the White House urged Congress to pass legislation that would amend the Bankruptcy Code so Puerto Rico could reorganize its debts under chapter 9. Chapter 9 is available only to municipalities (defined as a "political subdivision or public agency or instrumentality of a state," 11 USC 101(40)), and only when state law specifically permits the municipality to use it. Puerto Rico is a U.S. Territory, not a municipality or a State, and thus is not eligible to seek relief in chapter 9.

Detroit filed for relief under chapter 9 in July 2013.  Puerto Rico's $72 billion is about 4 times bigger than Detroit's $18 billion debt problem.  Detroit confirmed a plan of debt adjustment in November 2014.  Retired Bankruptcy Judge Steven Rhodes presided over Detroit's bankruptcy and is now working to assist Puerto Rico.  "It's exactly like Detroit," he said.

There is some support in Congress for a bill offered by Puerto Rico's non-voting Congressman to open chapter 9 to Puerto Rico.  Supporters of the bill say that extending chapter 9 would be consistent with federal bankruptcy policy and would offer Puerto Rico an orderly way to extend debt maturities, reduce the principal or interest rates, or refinance with new loans.  A chapter 9 bankruptcy proceeding is not a federal taxpayer-funded bailout.  It would provide a judicial forum to consider which creditor groups and other stakeholders feel which part of the pain of Puerto Rico's debt problem. The legislation met opposition from Republicans who say they are worried that offering Puerto Rico a chance to restructure its debts in a federal bankruptcy case would relieve the Puerto Rican government from responsibility for decades of fiscal mismanagement, and disrupt the expectations of creditors who incurred debt in reliance on the current law.  Of course that's exactly what happened in Detroit.

About a third of the population of Puerto Rico relies on government support to survive.  Government workers make up about a quarter of the work force.  Just 41% of Puerto Ricans are working or looking for work (compare to 63% on the mainland). To raise revenue, in 2014, the government raised taxes, $1.3 billion in new taxes.  Public debt as a percentage of GDP is 64.9%; for Haiti it is 21.3%.  With an economic situation as grim as this, it's hard to imagine that even a chapter 9 proceeding could result in a plan to put Puerto Rico's economy back on track.  

Puerto Rico is an economic disaster area. So why the lack of  federal interest in the Puerto Rican debt problem?  Perhaps Puerto Ricans don't matter because Americans don't think of Puerto Ricans as "Americans."  But they are as American as the citizens of Detroit.  The term "United States" includes the 50 states. DC and Puerto Rico, Guam and the Virgin Islands.  8 USC 1101 (a)(38).  Puerto Ricans are US citizens and can move and work anywhere in the US without passports or green cards.   And move they did.  An August 2014 Pew report showed that from mid 2010 to 2013, more Puerto Ricans left the island than during the entire decades of the 1970's, 80's and 90's. The recent migrants are less educated than those who stayed, and are more likely to hold less skilled jobs.  640,000 Puerto Rican voters make up about 10% of the population of central Florida.  Although residents of Puerto Rico do not have voting representation in the U.S. Congress and are not entitled to electoral votes in a Presidential election, the votes of Puerto Ricans who live on the mainland count in local and national politics.  In Florida, Puerto Ricans are 28 percent of Hispanic registered voters with real political clout in that state and in the 2016 Presidential race.  (When Obama won Florida over Romney in the 2012 presidential election, he did so by a margin of 74,000 votes.)  So, Puerto Ricans in Florida matter.  But, nobody seems too concerned about the Puerto Ricans in Puerto Rico.

Thursday, June 25, 2015

What's in Your Wallet?

Consider these findings by Scott Fulford, Claire Greene and William Murdock III, Federal Reserve Bank of Boston as part of their study of U.S. consumers' holdings of $1 bills based on data from the 2012 Diary of Consumer Payment Choice, a national online survey tracking payments made by participants over a three day period during October 2012.  2,467 people ages 18-94 participated in the survey and reported 12,647 transactions for combined spending of $453,655.

  • About 64% of adults 18 years or older start the day with at least one dollar bill on their person.  The median holding is two dollar bills; the mean is slightly below three dollar bills.  Hardly anyone had more than ten dollar bills in his or her pocket.   To compare, the median holding in cash (all bill denominations) is $27.  The mean is larger at $62 dollars.  Some people carry a large amount of cash.
  • For consumers who hold some cash on their persons, 71% of the consumers who started the day with no dollar bills ended the day with none.
  • Around 50% of consumers make at least one transaction with cash on any given day.
  • Consumers appear to be managing their dollar bills actively.  Consumers who start the day with few dollar bills tend to acquire some during the day.  Consumers with many dollar bills at the start of the day tend to end the day with fewer dollars.
  • People who make a transaction during a day tend to gain one dollar bills in larger numbers than they lose dollar bills.  The median gain of dollar bills over the course of a day is three bills; the median loss is two bills.

Monday, June 22, 2015

Fight over Arbitration in Consumer Financial Contracts

Dodd-Frank required the CFPB to conduct a study on the use of pre-dispute arbitration clauses (PDAA's) in consumer financial markets.  Sec. 1028(a).  It also gave the CFPB authority to issue regulations on the use of arbitration clauses in other consumer finance markets "if the Bureau finds that such a prohibition or imposition of conditions or limitations is in the public interest and for the protection of consumers."  Sec. 1028.

The CFPB posted a public inquiry on arbitration terms in Aprils 2012 and released preliminary research results in December 2013.   It issued its final report in March 2015.  In a press release accompanying the report, the CFPB noted that "very few consumers individually seek relief through arbitration or the federal courts, while millions of consumers are eligible for relief each year through class action settlements."  Also, "more than 75 percent of consumers surveyed did not know whether they were subject to an arbitration clause in their agreements with their financial service providers, and fewer than 7 percent of those covered by arbitration clauses realized that the clauses restricted their ability to sue in court." 

In May 2015, 58 Democratic Congressmen signed a letter to CFPB Director Richard Cordray urging the CFPB to promulgate rules prohibiting PDAA's.  Last week, the House Appropriations Committee adopted an amendment offered by Reps. Steven Womak (R-Ark,) and Tom Graves (R-Ga.) to a 2016 appropriations bill for funding for agencies that regulate financial services.  The amendment conditions CFPB appropriations on completion of a new study on PDAA's.  The American Banker's Association wrote to support the amendment, calling the CFPB's study "a deeply flawed piece of research that excludes critical information, misinterprets key data...."

The fight over PDAA's is hot, but based on the data, it's not clear what stake consumers have in the outcome.  The CFPB"s study concluded that arbitration was important in only 8% of the 562 class action cases it studied.  The defendants moved to compel arbitration in 94 of the 562 class actions.  The CFPB study does not support the conclusion that PDAA's are a tool to crush consumer redress, or have been particularly effective in eliminating consumer class action litigation.

Friday, June 19, 2015

Reg A+ is Effective Today; Still Waiting for Crowdfunding Rules

The SEC's rules to facilitate Regulation A+ become effective today.  The rules implement Title IV of the Jumpstart Our Business Startups Act of 2012 (the JOBS Act).  Title IV Small Company Capital Formation  raised the cap on the amount of securities that can be sold in a 12 month period from $5 million (under Reg A) to $50 million (under new Reg A+), subject to disclosure requirements (e.g., a certified audit) not required for ordinary Reg A offerings.

Market watchers are not expecting that the newly effective Reg A+ rules will have much of an impact on start ups and small businesses that don't already have the cash necessary to comply with its  requirements.  The big development yet to occur is SEC adoption of final rules for Title III of the JOBS Act titled Crowdfunding.  In Title III, Congress directed the SEC to write rules implementing an exemption from securities laws for crowdfunding via the internet, and rules for a funding portal by which internet-based platforms could facilitate a market for securities without registering with the SEC as brokers.  The SEC published proposed rules for comment in October 2013 and the public comment period closed in February 2014.  The SEC announced that the final rules will be released in October 2015.

Crowdfunding sites are already operating to offer securities for accredited investors only under Regulation D.  Some commentators see a bleak future for crowdfunding for non-accredited investors under the rules the SEC has proposed.   The SEC estimates that to raise $100K via non-accredited investor crowdfunding, an issuer would have to incur around $39K in fees for accountants, lawyers and the funding portal.  To raise $1 million the estimated costs tops $150K.  An offering under Reg D, although restricted to accredited investors, is relatively light on required disclosure and much cheaper.  So, if/when the SEC promulgates the final crowdfunding rules, it may be that only the most desperate issuers will use it.




Tuesday, June 16, 2015

No Fees to Defend Fees

In Baker Botts LLP v. ASARCO LLC, the Supreme Court held that law firms that represented the debtor in possession (DIP) cannot recover from the estate for fees incurred defending their fee petition.  Two firms representing the DIP had successfully litigated a fraudulent transfer claim against ASARCO's parent corporation and obtained a judgment in favor of the estate worth around $7-10 billion.  The  parent objected to the fees and after a six day trial, the court awarded the firms about $120 million for legal services, a $4.1 million enhancement for exceptional performance, and over $5 million for time spent defending their fee petition.  The parent corporation appealed and the Fifth Circuit reversed on the award of fees for defending fees.  It held that absent express statutory authority, each party pays his own attorney's fees (the "American Rule"), and although the Bankruptcy Code provides for payment of fees for legal services rendered to the estate, it does not provide a statutory basis to shift to the estate the fees incurred defending a fee petition. 

Justice Thomas wrote the opinion for the majority (Thomas, Roberts, Scalia, Kennedy, Alito).  Justice Sotomayor concurred in part and concurred in the judgment.  Justices Breyer, joined by Ginsburg and Kagan, dissented.  Justice Thomas invoked the Court's general jurisprudence regarding attorneys' fee awards under the American Rule.  Under the Bankruptcy Code, the bankruptcy court may "award...reasonable compensation for actual, necessary services rendered by" such lawyers but only after "notice to the parties in interest and the United States Trustee, and a hearing....."  11 U.S.C. sec.330(a)(1).  The U.S. Trustee regulates and monitors the fee petition process and requires compliance with its guidelines for compensation which impose timekeeping and reporting standards for professionals who submit fee petitions.  The Court held that the phrase "reasonable compensation for actual, necessary services rendered" in section 330(a)(1) limits recovery of fees to those rendered for services to the DIP.  In contrast, the law firms' claim for attorneys' fees were incurred in representing themselves in the fee petition process. 

The law firms, of course, saw it differently.  They argued that the litigation over the propriety of their fees was part of "services rendered" to the estate.  The Court called that argument "untenable" and noted that the dissent rejected it too.  The balance of the opinion addressed the arguments made by the United States as amicus curiae.  The government conceded that defense of a fee application is not "service to the estate."  But, it argued that such fees should be borne by the estate because costs incurred in defending fees affect the net compensation an attorney receives.  This is the effect of the American Rule in every context in which it applies. 

The United States argued that the unique nature of bankruptcy litigation justified a "judicial exception" to the American Rule.  Outside of bankruptcy, a dispute about attorneys' fees is a private matter between the lawyers and the client.  In a bankruptcy proceeding, the court supervises attorneys' fees (and other professional fees), with notice to and an opportunity to be heard from "parties in interest" who may raise their own objections to the fees on the merits or for strategic reasons.  Justice Thomas concluded that whether bankruptcy litigators are especially vulnerable to fee dilution due to abusive litigation over their fees, "Congress has not granted us 'roving authority... to allow counsel fees...whenever [we] might deem them warranted. (citation omitted).  Our job is to follow the text even if doing so will supposedly undercut a basic objective of the statute.'"

Tuesday, December 18, 2012

I Am Not Going to Tell You Again

The New York Court of Appeals decided that Warren County, NY did enough to notify  a delinquent taxpayer before foreclosing on his property.  In MacNaughton v. Warren County, the court considered the lament of the owner of a piece of undeveloped real property in Warren County who lost the property at a tax foreclosure sale.  The MacNaughtons lived in New Jersey.  They moved in 1993, their forwarding order at the post office expired in 1994, the last year they paid any property tax.  In 1998 the county sent a notice of foreclosure to the MacNaughton's last known address by mail which was returned as "undeliverable-- forwarding order expired."  The county began foreclosure procedings and sold the property at auction in 1999 for $3,700.  The MacNaughton's learned of the sale in 2003, and two years later sued the county claiming that the sale was void as a violation of their due process and equal protection rights.  They lost at trial and on appeal and  before New York's highest court.

In Jones v. Flowers (2006), the U.S. Supreme Court considered what process is due to a delinquent taxpayer before a foreclosure sale.  It held "that when mailed notice of a tax sale is returned unclaimed, the [taxing authority] must take additional reasonable steps to attempt to provide notice to the properyt owner before selling his property, if it is practicable to do so" but that the steps required "must be such as one desireous of actually informing the absentee might reasonably adopt to accomplish it."

The New York court distinguished Jones and held that the county did enough.  It would have been futile in this case to send notice of foreclosure to "occupant" at the MacNaughton's last known address.  Moreover, MacNaughtons did not show that had the county would have discovered their current address if it had consulted the post office.  (New York law tax foreclosure law changed to become more tax payer protective since the foreclosure sale, and under the new law, the county would have been required to check with the post office for the MacNaughton's current address.) 

The MacNaughton's were peeved that Warren County personally served notice of foreclosure sale on Warren County residents whose mailed notices were returned as undeliverable but for out of county taxpayers, did nothing to locate them.  The Court of Appeal's simply noted that MacNaughton's equal protection claim was without merit.

Didn't the MacNaughton's wonder about the taxes on their property in Warren County when they received no bill, and paid no tax year after year?  It's not relevant in the cosntitutional due process analysis (what process the county owes the taxpayer), but MacNaughton's clearly could have saved themselves a heap of aggravation by making sure the county had their current address.