Welcome to your weekly Title III update for August 27, 2018. Important things came about inside and outside the case.
Unbeknownst to most of us, the GDB and AAFAF filed case, 18-1561, on August 10, 2018 for the approval of its RSA on the agency’s debts. The case was not filed in the PROMESA docket but rather in the Puerto Rico Federal District Court and was assigned to Judge Swain. What is surprising is the number of entities that notified the Court their intention of objecting to the agreement. The Federal Government, Siemens Transportation, Fundación Biblioteca Rafael Hernández Colón, Bank of New York Mellon, Fidelity & Deposit Co. of Maryland, Zurich American Insurance Company, National Public Finance Guarantee Corporations, Adsuar, Muñoz, Goyco, Seda & Pérez-Ochoa and the Unsecured Creditors Committee, all filed a notice of intent to object to the agreement. In addition, Ambac reserved its rights to file a notice as well.
These individuals would prefer that this Court “bury” GDB before the Committee and other interested parties have the opportunity to perform the autopsy. To that end, GDB commenced a judicial proceeding that is premised on multiple violations of the Title III automatic stay. That judicial proceeding – the GDB Restructuring – proposes, among other things, to (a) offset the public funds deposited with GDB by the Title III Debtors against GDB’s alleged outstanding loans to the Title III Debtors, (b) transfer all of the valuable assets at GDB (much of which consists of deposits of public funds held in trust or in a fiduciary capacity) to the Recovery Authority (as defined below) for the exclusive benefit of GDB’s bondholders, (c) release GDB and its current and former directors, officers and other representatives from any claims that could be brought against them by the Title III Debtors, and (d) burden the Commonwealth with the obligation to repay hundreds of millions of dollars on account of federal funds deposited with GDB.
[T]he entry of the Proposed Order, substantially in the form attached hereto, pursuant to sections 105(a) and 362(a), enforcing the automatic stay against GDB and AAFAF by declaring that (a) the GDB Restructuring violates the automatic stay under section 362 of the Bankruptcy Code and the Stay Order, (b) any limitations on claims that have been or may be asserted by the Title III Debtors against GDB or related third-parties are void, and (c) any transfer or “shielding” of assets pursuant to the GDB Restructuring that could have been used, prior to the implementation of the GDB Restructuring, to satisfy claims of the Title III Debtors by GDB, is void.
Given that so many parties have notified their intent to object to the Title VI agreement, including the UCC and the Federal Government, the hearing may not be on November 7 after all. If this Title VI agreement does not garner sufficient votes or if the Court were to agree with some of the objections, the GDB may join other Title III agencies. Hard to tell at this stage. In any event, the UCC, in concurrence with AAFAF and the Board, asked for an order that any objections be filed by August 29 and reply by September 6. This would leave the issue ripe for adjudication during the September 13 Omnibus.
All actions which result in injuries arise from two categories of conduct: (1) the failure to abide by a pact or (2) an activity separate from any previous legal relationship between the wrongdoer and the victim. Ricardo de Angel Yágüez, La Responsabilidad Civil 21 (1988). In the first instance, the duty to indemnify arises from another duty, the duty to comply with obligations engendered by a contract which has been infringed upon, that is, a contractual responsibility. Id. at 22. In the second scenario, the obligation to indemnify arises by the mere fact of having caused damages because the wrongdoer has infringed upon the general norms of respect towards others imposed by society, i.e. civil responsibility. Id.
In contract infringement cases a previously existing relationship between the parties is present whereas in torts, the duty to plaintiff commences at the time of the injury. Jaime Santos-Briz, Derecho de Daños 13-14 (1963).
Consonant with this line of reasoning, we conclude that the conduct charged in the FIRST CAUSE OF ACTION of the complaint must fall within the torts ambit since any liability arising from the alleged misrepresentation is not premised on any contractual obligations the contract had not yet materialized but on a general obligation to negotiate in good faith. IV-II José Ramón Vélez Torres, Curso de Derecho Civil 61-67. The obligation to negotiate in good faith is based on a general duty pervading in society whereas objective responsibility is limited to those situations expressly identified in a statute. Id.at 64-65.
Moreover, fraud or deceit as the Puerto Rico Civil Code calls it in English, may occur at the onset of the obligation or during the performance of the obligation, see, Pérez Rosa v. Morales Rosado, 172 D.P.R. 216, 229 (2007). Moreover, if we are dealing with bonds, the Puerto Rico Uniform Securities law has a two-year statute of limitations, not one year, nor fifteen years as for other contractual obligations in the Civil Code, see, Olivella Zalduondo v. Seguros de Servicios de Salud de Puerto Rico, Inc., 2013 TSPR 2 and PaineWebber, Inc. v. First Boston, Inc., 136 D.P.R. 541 (1994). Moreover, in cases of malpractice, although there may be a contract between the parties, the statute of limitations is one year, see, Colon v. Geigel, 115 D.P.R. 232 (1984)(legal malpractice).
In keeping with the structure and spirit of the Investigative Subpoenas Resolution, we attempted first to interview all witnesses voluntarily, with the aim of seeking testimony under oath only if voluntary interviews were refused, or if any specific circumstances warranted testimony under oath. Further, in consultation with the Special Investigation Committee, we determined that it would be sufficient for the specific purposes and goals of the investigation, as outlined in PROMESA, for us to formulate our conclusions and recommendations on statements made by witnesses substantiated, wherever possible, by documentary evidence. For those reasons, and because the Independent Investigator conducted a voluntary interview with each individual and entity witness for which an interview was sought, we did not take testimony under oath, nor were the interviews transcribed.
In other words, the Board told the Investigator that if the witnesses came voluntarily, they would not be under oath and therefore they could lie to their hearts content. Moreover, if there is no transcript of the interview, unless they were recorded, it becomes you said/he said. UNBELIEVABLE!
(5) A monthly reconciliation of bank account balances.
Both Thomas Rivera Schatz and Johnny Méndez roared that they would not obey. How dare the Board request that they show their attendance record (which the Board did not require). The Board said it would do everything in its powers to obtain the information. Again a legal confrontation that will be paid by the Puerto Rico taxpayers.
In addition, Mr. Christian Sobrino from AAFAF said the Commonwealth would not provide the information the Board requested on the tax agreements since 2017. Probably another confrontation paid by taxpayers. And, speaking of legal confrontations, the Commonwealth and the Board informed the Court they were close to an agreement which would allow the Commonwealth to dismiss the rest of its case over the Fiscal Plan so there could be a final judgment and it could appeal Judge Swain’s decision. Important that the Board stated it would otherwise oppose any interlocutory appeal.
The Board also sent the Commonwealth a letter requiring that a new Fiscal Plan for COFINA be presented, all in preparation to the possible filing of the corporation’s Plan of Adjustment. Moreover, the Government filed a new Fiscal Plan for the Commonwealth, reducing the amount of money available for debt service, although its share of the SUT will increase. Who understands the Government’s logic?
Finally, the Board recommended to the Commonwealth that it rescind the Executive Order Governor Rosselló issued increasing the minimum wage for workers in the construction industry from $7.25 to $15. Although the Board quoted that the median construction wage in the US was $8.69 and gave the Governor 90-days to answer, he immediately rejected the recommendation. Another legal confrontation that will be paid by the Puerto Rico taxpayers.
Welcome to your weekly Title III update for August 20, 2018. Some important things came about inside and outside the case.
Previously, I discussed the UCC motion on the COFINA deal, which has not been answered by the Board as of Sunday, August 19. To that we must add that El Vocero reported on August 18 that due to demographic changes that seem to increase the number of inhabitants in the island, the Board requested that the Commonwealth amend its Fiscal Plan. El Vocero adds that there will be a greater need for medical services and hence less money for debt service. Given the Board’s alleged new deals of around 75% payment of bond debt, it behooves the mind that now these numbers may be reduced because the population will not decrease as much as expected. Constant changes in the Fiscal Plans do not make it credible and will undermine any plan of adjustment based on it. Seesaw on the Fiscal Plan helps no one.
As relevant here, the Policy applies to any proposed rule, regulation, administrative order, or executive order in connection with (i) the establishment, governance, management, or operation of the Office of the CFO, and (ii) rightsizing of the Commonwealth or related to procurement, contracting policy, or employee compensation or benefits. The Policy states that any rule, regulation, administrative order, or executive order must be sent in English before issuance to the Oversight Board at [email protected]romesa.gov with an explanation of how the particular rule, regulation, administrative order, or executive order is consistent with the approved Fiscal Plan.
On August 13, 2018, the Department of Treasury submitted three letters in Spanish on Administrative Orders, without an explanation of how or whether the Administrative Orders were consistent with the applicable Fiscal Plan, that had been issued prior to the date of adoption of the Policy, and which the Oversight Board had not requested to review. Accordingly, no review or approval by the Oversight Board is required at this time. However, going forward, please abide by the Policy, including by submitting any rule, regulation, administrative order, or executive order in English, prior to adoption, and with an explanation of how it is consistent with the applicable Fiscal Plan.
Why the public reminder of what the governor must do? Simply because the governor said he was not going to comply with this “request.” This way, there can be no doubt the Board is bending over backwards to resolve any controversies with the governor in an “amicable” fashion while at the same time, publicly chastising him for not obeying. A very bad situation in my opinion.
a)Are the funds for the contract included in the budget? i) If yes, in which allotment? Please specify (A) the line item(s) in the budget that this contract will be funded from and (B) what other expenses have been committed or planned for that budget item.
b)Does the existing budget fully cover the cost of the contract? If multiple line items, please specify the amount against each budget line. i) If not covered in the budget, which allotments need to be reprogrammed?
c)If the contract extends past the current fiscal year, does the current budget line item include the full cost of the contract or only the portion applicable to the current budget time period? i) If only the portion applicable to the current budget, how much will be funded from the future budget? Are the budget line items the same and are there sufficient funds within those? Please provide supporting evidence.
a)Is the contract consistent with the applicable Fiscal Plan? Please provide some commentary on why or why not.
b)Does the contract constitute separate and additional disaster aid spending?
i)Will the contract be partially or fully federally funded?
Although this is clearly important information for the Fiscal Plan and budget, tax policy, tax assessment and tax abatement is one of the most important powers any government can wield. Although the information will probably be provided, what if the Board disallows any of these contracts? Will Governor Rosselló again mount Rosinante and attack the windmills of the Board? Questions, questions.
1.[Name of Agency], its officials and employees have complied with all applicable conflicts of interest laws, rules, regulations and policies in connection with the procurement and negotiation of the contract2.
2.To the best knowledge of the signatory (after due investigation), no person has unduly intervened in the procurement, negotiation or execution of the contract, in contravention of applicable law.
3.To the best knowledge of the signatory (after due investigation), no person has: (i) offered, paid, or promised to pay money to; (ii) offered, given, or promised to give anything of value to; or (iii)otherwise influenced any public official or employee with the purpose of securing any advantages, privileges or favors for the benefit of such person in connection with the contract.
4.To the best knowledge of the signatory (after due investigation), neither the contractor, nor any of its owners3, directors, officials or employees, or its representatives or sub-contractors, has required, directly or indirectly, from third persons to take any action with the purpose of influencing any public official or employee in connection with the procurement, negotiation or execution of the contract.
The above certification shall be signed by the head or general counsel of the agency submitting the contract for review.
In the event that the agency is not able to provide any of the above certifications, it shall provide a written statement setting forth the reasons therefor.
This smacks of the Board investigating whether these contracts are nothing more than favors to political contributors or obtained through fraudulent means. Again, this is a very reasonable request but will the governor comply? We will soon find out.
In addition, the New Bonds are complex financial instruments with unique characteristics that are unlike many similarly named instruments. Because of the unique nature of the New Bonds, substantial uncertainty and risk exist with respect to the New Bonds that may not exist with respect to other debt instruments. For example, the Issuer is a newly formed statutory public trust and governmental instrumentality with no existing operations, and the New Bonds will be secured by, and payable solely from, Collections on certain assets of GDB that will be transferred by GDB to the Issuer on or after the Closing Date. Holders of New Bonds should not expect to receive payment in full in cash of principal and interest due on the New Bonds. While there are scenarios that may result in full payment of principal and interest on the New Bonds in accordance with their terms, there is considerable uncertainty as to whether the Restructuring Property will provide sufficient cash flow to pay interest in cash on the New Bonds and amortize the principal amount (and any PIK Amounts) thereof completely. In addition, if the Qualifying Modification is consummated and the Participating Bond Claims are mandatorily exchanged for the New Bonds, rights and remedies under the New Bonds will be dramatically different, and may be less favorable to holders of the New Bonds, than the rights and remedies holders of Participating Bond Claims currently have. For additional information on the New Bonds, see the Offering Memorandum attached hereto. At the same time, there is substantial uncertainty regarding the value of the Participating Bond Claims if the Requisite Approvals are not obtained or the Qualifying Modification is otherwise not consummated. GDB is insolvent and has operationally wound-down and substantially terminated its operations, other than the completion of the Qualifying Modification and the management of certain assets thereafter; the outcome of its liquidation or other resolution is highly uncertain. A holder of Participating Bond Claims could realize more or less value on its Participating Bond Claims in such a liquidation or resolution than in the Qualifying Modification.
In other words, if you vote for the Title VI qualifying modification, you may not be paid but if you don’t vote, we may go into Title III. Since the only asset that the GDB has is loans to public corporations and municipalities, the minute these stop paying, the GDB will not pay its bonds and there will be no recourse since that is the only source of payment. I have always said that this Title VI, if approved, would end in Title III. Might as well do it now with full value of your bonds than later when you have a 45% haircut.
On the litigation side, Judge Swain sided, once again, with the Board and decided that certain ERS bonds did not have a lien because the liens were not properly recorded. Although the Judge may very well be right, this case will be appealed and Judge Swain is 0-3 on appeals at this time.
The issues on appeal in Ambac are sufficiently related to the issues presented by Plaintiffs’ complaint to warrant a limited stay of these proceedings. Through their complaint in this proceeding, Plaintiffs claim that the April 19, 2018 Fiscal Plan for Puerto Rico violates PROMESA §§ 201(b)(1)(B), 201(b)(1)(M), 201(b)(1)(N), and 407 and § 928 of the Bankruptcy Code; that the Fiscal Plan Compliance Law (Act No. 26‐2017) violates PROMESA §§ 201(b)(1)(N), 201(b)(1)(M), and 201(b)(1)(B); and that the April 19, 2018 Fiscal Plan does not meet the definitions prescribed by PROMESA §§ 5(10) and 5(22). Plaintiffs contend that they are entitled to an order declaring that no plan of adjustment under PROMESA Title III can be confirmed based on the April 19, 2018 Fiscal Plan; that no confirmation hearing will be held on that plan; that a series of moratorium laws enacted by the Commonwealth and corresponding moratorium orders (“Moratorium Laws” and “Moratorium Orders”), the April 19, 2018 Fiscal Plan, and the Fiscal Plan Compliance Law violate the Contracts Clause, Takings Clause, and Due Process Clauses of the U.S. Constitution; that the Moratorium Laws, Moratorium Orders, Fiscal Plan Compliance Law, and the April 19, 2018 Fiscal Plan are preempted by PROMESA §§ 303(1)(3); and that if this Court determines that PROMESA bars review of the April 19, 2018 Fiscal Plan, Plaintiffs are entitled to a ruling that PROMESA violates the Due Process Clause of the United States Constitution and is an unconstitutional delegation of legislative power. See Dkt. No. 1.
In Ambac, Ambac Asssurance Corporation also questioned the legality of the Moratorium Laws, Moratorium Orders, the Fiscal Plan Compliance Law, and an earlier version of the Fiscal Plan for Puerto Rico. See Amended Adversary Complaint (Dkt. No. 35 in 17‐AP‐159). On appeal, Ambac Assurance Corporation presents eleven issues for the First Circuit to consider including, inter alia; whether the District Court erred in holding that the Moratorium Laws, Moratorium Orders, and the earlier Fiscal Plan do not qualify as laws preempted by PROMESA § 303(1); whether the District Court erred in interpreting the Contracts Clause and Takings Clause of the United States Constitution; whether the District Court erred in issuing an opinion on PROMESA § 106(e); and whether the District Court erred in interpreting PROMESA § 106(e) to preclude judicial review of the Fiscal Plan for compliance with the requirements of PROMESA § 201(b).
While this Court appreciates the distinctions and clear differences between Plaintiffs’ complaint here, and the claims brought in Ambac, many of the questions presented on appeal in Ambac either directly overlap with or significantly bear on the determinations this Court will have to make in deciding any dispositive briefing in this proceeding.
If there are “distinctions and clear differences between Plaintiffs’ complaint here, and the claims brought in Ambac” why grant the motion? For Judge Swain clearly states that is not the norm, especially when there are issues that will have to be decided in this case irrespective of what the First Circuit decides. My opinion, however, is of no importance. Judge Swain’s opinion is what counts.
On the Utier challenge to the Board’s appointment, essentially the same argument that Aurelius made, unsurprisingly Judge Swain dismissed the complaint. The next day, Utier filed their notice of appeal. I am sure the union’s counsel will hustle to see if it can join the Aurelius oral argument presently set for September 10, 2018. Irrespective, that is going to be an epic argument. Wish I were there.
In the Pinto Lugo v. USA, a hodgepodge of legal claims, the USA filed a motion to dismiss challenging standing and the actual causes of action, saying among other things that “[t]here Is No Private Right of Action under the Declaration of Independence.” I expect this complaint to be dismissed as it is another attempt by those who refuse to understand or accept Congressional power over Puerto Rico.
As expected the Legislature filed a notice of appeal from the dismissal of their complaint. Once this was done, Governor Rosselló, who is at odds with Senate President Thomas Rivera Schatz, vowed he would also appeal. As of August 19, 2018, he had not, nor requested leave to do so.
The COFINA Deal… on the Verge of Collapsing?
The Commonwealth Agent in the Commonwealth v. COFINA adversary proceeding – the Unsecured Creditors Committee (UCC) –filed an informative motion on Monday on the Oversight Board’s agreement with COFINA bondholders and monolines.
The motion states that the UCC-COFINA Agent deal was done with the May 2018 certified Fiscal Plan, meaning that the deal was feasible based on the numbers projected in that plan. On June 29, 2018, a new Fiscal Plan was certified with entirely different numbers and economic calculations. Instead of using those new numbers, the Board used the May 2018 to reach the COFINA deal.
The UCC claims a $28 billion cash flow deficit as a result of the deal.
The Commonwealth Agent was not included in the negotiations between the Oversight Board, the COFINA bondholders, and monoline insurers regarding the terms of a COFINA plan of adjustment. In fact, the Commonwealth Agent only received a copy of the COFINA Plan Presentation when it was made public.
Right there, you know something is wrong.
The UCC negotiated the first agreement in principle but wasn’t included in the most recent COFINA deal orchestrated by the Board. Although the Board is obviously the one who deals with the Plan of Adjustment – where the payment of the debt is outlined – not having the Commonwealth Agent involved raises suspicions and with good reason.
Moreover, if it is such a good deal for COFINA, it raises the significant, but dormant issue of potential conflicts of interest of the Board members.
To recap the potential conflicts of interest for new readers of the Control Board Watch, here they are. First, José Carrión’s relationship with Banco Popular, which had significant involvement with COFINA. Second, Carlos M. García, a former Santander executive and GDB President who issued a huge chunk of COFINA debt under former Governor Fortuño. Third, Ana Matosantos’s company, Matosantos Commercial Corporation, has a Banco Popular executive on its Board of Directors. And finally, José Ramón González, another Santander executive deeply involved with COFINA.
The Oversight Board’s June 29, 2018 certified fiscal plan materially revised certain of the underlying assumptions that formed the basis of the May 30, 2018 certified fiscal plan, which was in effect when the Agents entered into the Agreement in Principle on June 5, 2018 and on which the Commonwealth Agent relied when entering into the Agreement in Principle.
In stark contrast to the cash flow projections in the May 30, 2018 certified fiscal plan, the revised assumptions in the June 29, 2018 certified fiscal plan result in a significant cash flow deficit (when including the COFINA debt service payments under the contemplated settlement) in the aggregate amount of approximately $28 billion (in nominal dollars), even assuming that the fiscal plan contemplated making no plan distributions to Commonwealth creditors. Obviously, assuming that there would be no payments to any Commonwealth creditors is unrealistic and would lead to an unconfirmable plan of adjustment for the Commonwealth.
Given that the Commonwealth Agent must consider the interests of the Commonwealth itself, the Commonwealth Agent does not believe that a settlement can be executed and/or consummated which would lead to a significant cash flow deficit (and thus the Commonwealth’s inability to pay current expenses) of approximately $28 billion (in nominal dollars). The Commonwealth Agent believes that this Commonwealth feasibility issue needs to be resolved prior to execution and/or consummation of a settlement agreement. It also does not appear that this issue was addressed in the COFINA Plan Presentation.
The UCC is warning that Puerto Rico cannot pay the COFINA deal with the currently certified Fiscal Plan. Of course, the Board has not answered this motion and may not do so since it is an informative motion, but it probably will.
In addition, the Board may amend the current Fiscal Plan to conform it to this and future deals. As a matter of fact, the Board has already stated they may do so. If the Board does amend the Fiscal Plan, and does so in a manner that allows the COFINA deal to comply, is the Board greenlighting a sweetheart deal for COFINA for the benefit of certain interests, and possibly the conflicted Puerto Rican Board members? Let’s see.
Furthermore, under paragraph 4(i) of the Stipulation, any settlement requires the consent of at least one of the two Commonwealth Creditor Representatives. At the time of execution of the Agreement in Principle, only the Official Committee of Retirees (the “Retiree Committee”), which is one of the Commonwealth Creditor Representatives, had advised the Commonwealth Agent that it supported the Agreement in Principle. In connection with the negotiation of settlement documentation, the Retiree Committee has advised the Commonwealth Agent that it also views the resolution of the Commonwealth feasibility issue as a pre-condition to execution and/or consummation of a settlement agreement.
The Commonwealth Agent remains dedicated to attempt to resolve this issue to allow for a settlement to proceed, although it recognizes that the formulation and certification of a revised fiscal plan is completely outside of its control. Nevertheless, the Commonwealth Agent will proceed with its discussions of this issue with parties in interest and continue its collaborative process with the COFINA Agent in order to reach agreement on a settlement agreement that conditions consummation thereof on the Oversight Board having certified a fiscal plan that projects Commonwealth net cash flows (after measures) over the next 40 years in an amount not materially less than the net cash flows (after measures) projected in the May 30, 2018 certified fiscal plan.
The Commonwealth agent is saying that for the deal to go through, the Board and COFINA bondholders need either the UCC’s support or that of the Retirees’ Committee (who are owed over $52 billion and are non-secured creditors). Although the Retiree’s Committee is closer to supporting the deal, the UCC makes it clear that they still don’t have their support. Could it be that one of the two important deals the Board has achieved is slipping away?
This development brings us to the another question, what will the GO’s do? Undoubtedly, the GO’s will want a good deal, better than that of COFINA. Question is, will the Board provide one? If the GO’s cannot get a deal, what can they do? There are many avenues. The Commonwealth v. COFINA litigation is stayed until September 13. With the UCC’s motion, it is obvious the deal is in peril. The GO’s were allowed to intervene in the Commonwealth v. COFINA litigation and filed dispositive motions expounding their views on the validity of these bonds. The GO’s may request that the Court decide on their arguments. If denied, they can file an adversary proceeding. Moreover, the GO’s may object to any COFINA Plan of Adjustment and we must remember that Judge Swain has said that at that stage she will be able to review the Fiscal Plan since the Plan of Adjustment must conform to the Fiscal Plan. If she decides that the UCC is right or that COFINA is not constitutional, she may deny the confirmation of the Plan of Adjustment. In addition, even if the GO’s are not allowed to object to the COFINA Plan of Adjustment, as part of the stipulation, the COFINA settlement must be approved in the Commonwealth Title III case, where undoubtedly the GO’s will have a say.
The UCC’s motion has thrown a monkey wrench into the COFINA deal, one which unless carefully explained by the Board could well derail it. Much more is to come. Stay tuned.
Welcome to your weekly Title III update for August 13, 2018. Many important things came about this week, but I discussed Judge Swain’s decision on the Commonwealth and Legislature’s complaints and the Commonwealth-COFINA deal in separate postings. The First Circuit, however, reversed Judge Swain in two cases and developments in and outside the Title III have developed.
In the first of the Circuit opinions, the Court (Judge Kayatta writing the opinion) decided that Peaje did not have a statutory lien—however, that did not end the discussion. The First Circuit affirmed Judge Swain’s determination not to allow evidence of any other type of lien in the adversary proceeding but hinted that if raised in another case, it could be litigated. In addition, Judge Kayatta reversed her findings, “that Peaje failed to establish irreparable harm and that defendants established adequate protection of Peaje’s interests.” Since the Court had already decided the main issue of the case, it did not have to analyze this topic. Nevertheless, anticipating further litigation, it reversed the “brief treatment” of these essential issues. I project either further litigation or a prompt settlement of these bonds by the Board.
The Title III court did try to deflect these problems by stating that its refusal to lift the stay arose in the context of a request for a receiver, certainly a robust form of interference with the debtor’s finances and property. The implication – which the debtor’s brief makes express — is that perhaps the Title III court would lift the stay to allow another court to provide some other type of protection of collateral. But neither the Title III court nor the debtor points to any toehold in the language of Section 305 that would accommodate a distinction allowing the Title III court to lift the stay to allow another court to interfere with the debtor’s property sometimes but not others. Either Section 305 only bars the Title III court itself from interfering, or it bars that court also from lifting the stay to allow another court to do that which it cannot do. And it is only the latter, broader possibility that creates a situation in which the creditor is deprived of any means of protecting its property interest.
The Title III court also pointed out that Section 305 would not bar section 362(d) relief when the Oversight Board consents to the requested relief. But the principal aim of section 362(d)(1) is to protect the creditor when protection is needed, which is customarily when the debtor is not obliging. In short, saying that a creditor can get relief from the stay when the debtor’s representative consents effectively wipes out section 362(d)(1) precisely when it is most likely needed.
We also find no inconsistency between the apparent purpose served by Section 305 and a reading of that section as only barring the Title III court itself from directly interfering with the debtor’s powers or property. Like the Title III court, we read Section 305 as respectful and protective of the status of the Commonwealth and its instrumentalities as governments, much like section 904 of the municipal bankruptcy code respects and protects the autonomy of states and their political subdivisions. See 11 U.S.C. § 904. When a bankruptcy or Title III court acts directly, it impinges on that autonomy. But when it merely stands aside by lifting the automatic stay, it allows the processes of state or territorial law to operate in normal course as if there were no bankruptcy.
To me, it is obvious the First Circuit is inviting Judge Swain to allow the receiver but to tailor what it can or cannot do. In their briefs and during oral argument, plaintiffs emphasized that this receiver would substitute the PREPA governing board and would not only be subject to the Board’s Fiscal Plan, but also to its budget and its general powers. Moreover, the last sentence above from Judge Kayatta hints that the Board could consent to a receiver with specific duties and responsibilities. After I heard the oral arguments in this case, I wrote that the First Circuit was likely to reverse Judge Swain. This may have been a catalyst for the Board’s agreement with PREPA bondholders. Food for thought.
José Ortiz, the new executive director of PREPA gave an interesting interview to Caribbean Business . Caribbean Business reports Ortiz admitted that the “Ad Hoc deal comprises $5 billion in unsecured debt. “And we negotiated with 35 percent of them [the creditors], or about $2.7 billion. The rest we are going to have to pay…that has not been said publicly,” he told Caribbean Business.’” Since the Board has admitted that this group does have a lien, I assume that Mr. Ortiz meant the insured bonds, which I pointed out before would probably get a better deal. Here, he is saying they will get paid in full and the only way this can be achieved is with an increase of the rates. WOW! So much for the Board’s insistence on a 20 cent per K/H rate!
Please be advised that the new contract, scheduled to commence October 1, 2018 with Physician HMO, Inc., must be submitted to the FOMB prior to execution and with sufficient time to review (e.g., two weeks minimum). It should be noted that given that the contract extension is expected to generate $840,000 in savings, it is the expectation of the FOMB that DCR must generate a further $4,159,731 of healthcare related savings through both procurement and personnel measures.
Are “difficult recruitment employees” (as such term used in the original documentation) covered under the new agreement?
The savings for FY20 increase to $13,236,605 for procurement of healthcare services for inmates and $6,762,317 for personnel related to these healthcare services. Can you please provide the pathway to deliver these savings?
Right after the Board announced it was not going to appeal Judge Swain’s decision on Zamot but announced it would require new Fiscal Plans, I said the Board wanted to rule from the Fiscal Plan. After Judge Swain’s decision on the Commonwealth and Legislature’s challenges, that is exactly what it is doing. I frequently criticize the Board for its actions but it is trying to put some limits to political spending in Puerto Rico. Politicians continue to believe that they can spend without limit, without understanding that at some point in the near future, debt service will recommence. Then what?
On August 8, 2018, the Commonwealth and COFINA Agents announced a new, more lucrative deal on COFINA.
In fact, this is a coup for the COFINA bondholders: the aggregate recovery is almost 75%, and a 93% for COFINA Seniors.
This is a stunning turn of events. COFINA faced months of heavy attacks both from the GOs questioning their constitutionality, and from the Governor, who wanted access to the lockbox monies. Moreover, in April 2017, COFINA holders were offered a 39.2% recovery.
Essentially, 53.65% of the “Pledged Sales Tax Base Amount (“PSTBA”) cash flow through and including 2058 (40 years) is fully allocated to the New COFINA Bonds.” The Commonwealth will keep the remaining 46.35% of this PSTBA, plus any excess of up to 5.50% of the SUT, which the Board calculates will increase in value. Hence, the new bonds will be secured (senior pledge) but by a decreased part of the SUT. The Board still believes it is a large amount of money. Also, from the terms of the agreement, it seems the monolines are on board with the deal.
This tentative agreement, however, leaves a lot of questions unanswered.
Is the deal a result of pressure from Congress?
Is the deal a realization that the Board and Governor lack credibility in Washington?
A big question will be what the GOs do, if anything? Can the Commonwealth afford such a sweetheart deal after 2 years of non-stop claims by the Board and Governor that Puerto Rico is broke, and unable to pay her debts? We should assume the confirmation of the COFINA Plan of Adjustment will be challenged in the Commonwealth Title III confirmation hearing. Although I am sure Judge Swain will sweep aside any objections, the First Circuit may not.
The Commonwealth may believe it is entitled to a bigger part of the 5.5% of the pledged SUT. Will it insist on more? What will Judge Swain do?
Moreover, the GO’s were allowed to intervene in the Commonwealth v. COFINA litigation and to file a motion for summary judgment. What if they insist on having a determination on their claims? Seems easier to come up with a deal for them than to continue litigating.
Does the deal have the requisite 2/3 amount majority and 50 +1 number of creditors required by the Plan of Adjustment or are the parties still working on it?
Now that we have almost 75% recovery for COFINA and 77.5% recovery for PREPA, is this the new bench mark? It is true that the GDB agreement has only 55% recovery, but its law states that the Commonwealth is not liable for its debts and has no assets except loans. It is only reasonable to wonder if other bondholders will receive the same deal. If so, the Title III may be resolved quickly and cheaply, and we may have wasted hundreds of millions of dollars and precious time that the Board and Governor cannot bring back. Let’s see what happens.
Although PROMESA grants the Oversight Board exclusive authority to certify fiscal plans and “also insulates the Oversight Board’s certification determinations . . . from challenge by denying all federal district courts jurisdiction to review such challenges,” Section 106(e) does not deprive the district court of jurisdiction to entertain all conceivable litigation touching on certified documents. See Ambac, 297 F. Supp. 3d at 283-84 (holding that PROMESA Section 106(e) did not preclude consideration of federal constitutional challenges to fiscal plan). Here, Plaintiffs seek determinations as to whether PROMESA grants the Oversight Board authority to promulgate certain provisions of the certified Fiscal Plan and Budget, and as to whether such challenged provisions of those documents are merely, as a matter of law, recommendations that the Governor and Legislature are free to ignore. There is a material difference between an action seeking review of the Oversight Board’s determination that a plan or budget meets the requirements for certification or is compliant with particular aspects of PROMESA Section 201(b) (specifying required features of a fiscal plan), and litigation seeking clarification as to the effect of particular provisions of a certified fiscal plan or budget on preexisting Puerto Rico law, or on the powers of the executive and legislative branches of the government of Puerto Rico. The questions before the Court implicate the impact, rather than the propriety, of the certification of the Fiscal Plan and Budget, and their determination is not precluded by Section 106(e).
As I said, a constrained interpretation indeed, which assures that the governor will go back every time he does not agree with some action by the Board.
Furthermore, Swain dismissed without prejudice claims as to agency consolidation, saying the Board argues the Fiscal Plan does not require it (page 16-17) and employee benefits reduction (pages 17-19) because the Fiscal Plan does not require hiring freeze or elimination of Christmas bonuses. This will come back if they are required but they may be specific recommendations by the Board, which will stick, as we will see later.
The power bestowed on the Oversight Board by Section 205(b)(1)(K) of PROMESA allows the Oversight Board to make binding policy choices for the Commonwealth, notwithstanding the Governor’s rejection of Section 205 recommendations. This power is consistent with PROMESA’s framework, particularly in light of (i) the mandate that the Oversight Board “provide a method for [Puerto Rico] to achieve fiscal responsibility and access to the capital markets” (48 U.S.C.A. §2121(a) (West 2017)), (ii) the Oversight Board’s “sole discretion” to certify fiscal plans and put budgets of its own devising into effect (id. §§ 2141, 2142), (iii) PROMESA’s preemption of laws inconsistent with its provisions (id. § 2103), and (iv) PROMESA’s prohibition of gubernatorial oversight and of implementation of any policy that would “impair or defeat the purposes of [PROMESA] as determined by the Oversight Board” (id. § 2128(a)(2)). “[A]ppropriate,” as used in Section 201(b)(1)(K), means appropriate in the judgment of the Oversight Board, which has sole discretion as to fiscal plan and budget certification and the determination of whether and to what extent policies would impair or defeat the purposes of PROMESA, as informed by the Governor’s articulated reasons for opposing the recommendation. Section 201(b)(1)(K) does not distinguish between recommendations that are ultimately approved by the Government and those that are rejected. Instead, Section 201(b)(1)(K) speaks only of recommendations that were “submitted” by the Oversight Board, regardless of whether or not they were rejected by the Government. Consistent with this structure, PROMESA also provides that a budget or fiscal plan that is certified by the Oversight Board is “deemed approved by” the Governor. Id. § 2141(e)(2). Something that is “deemed approved” by the Governor need not actually have been approved by the Governor.
Any fiscal plan provision adopting a recommendation over the Governor’s objection can be certified only after the Governor has had a formal opportunity to make his objections public and, indeed, to communicate any such objections to Congress and to the President. Those bodies could take negative legislative action or exercise powers affecting the composition of the Oversight Board were they to believe that the Governor had the better of the argument. Furthermore, the Oversight Board, in adopting a policy over such objections, faces the challenge of managing implementation of the policy in a way that garners the genuine cooperation of Puerto Rico’s elected government and the citizens of the island who voted for them, as well as the confidence of stakeholders and potential new investors whose interest in doing business with the Commonwealth will be crucial to the Oversight Board’s ability to fulfill its charge of providing a method to achieve access to the capital markets.
Key point: “statutory structure in which neither of them holds all of the cards.” I hope that now the two sides can grow up and start acting like adults. After all, this is what Chairman Bishop wants and has asked for.
As to reprogramming, which is if there is money left over in a budget, can the governor use it without seeking permission from the Board, importantly, the Judge at pages 31-32, stated that it could not.
The Judge did give the Government small, probably meaningless victory by not dismissing the claims that automatic budget reductions are not allowed by PROMESA but she did warn that sec. of PROMESA 203 provides for the appropriate process. For the discussion, see pages 32-34.
Sections 203 and 204 of PROMESA prescribe procedures and limited remedies in the event of noncompliance with certified budgets and fiscal plans. Neither authorizes the Oversight Board to write into the law of Puerto Rico a general declaration that violations of the provisions of the appropriations provisions of the budget are an independent violation of law and, while PROMESA specifies certain consequences upon the Commonwealth’s failure to correct a inconsistency of expenditures versus the budget, the statute itself does not impose affirmative obligations on the Commonwealth or any or its officers or agents to take corrective action. Nor does PROMESA, by virtue of its provision rendering an Oversight Board-certified budget effective, create new liability under Puerto Rico law for violations of the budget. Defendants disclaim any intent effectively to amend Act 230 (the criminal provision) or claim prosecutorial authority, asserting at oral argument that the resolutions merely state the Oversight Board’s position that a violation of the certified budget is a crime within the meaning of the statute. (See Reply § III.D; Tr. at 113:19-25.) Nonetheless, these provisions of the Resolutions, read in the light most favorable to Plaintiffs, appear to claim powers and impose consequences in excess of those authorized by PROMESA.
The Court did not dismiss paragraphs 89-90 of the Complaint so it is still alive, albeit for the automatic budget reductions and criminal liability. Small victory indeed.
As to the Legislature’s complaint, the Judge decided that the Board can reduce the budget of the Legislature and that the Board is who decides, which budget is in effect and not the Legislature. She then dismissed the complaint outright. In effect, without saying it, Judge Swain decided it is irrelevant within PROMESA.
Both the Government and the Legislature are hinting that they will appeal the decisions. While the Legislature can appeal, the Government’s complaint was not dismissed and hence will have to seek permission from Judge Swain to do so. In the meantime, as long as these issues are alive, there can be no plan of adjustment. Welcome to Puerto Rico, the intersection of Macondo with the Twilight Zone.
Welcome to your weekly Title III update for August 6, 2018. Well, I don’t know about you, but it definitely seems like there is movements due largely to rising political pressures on the Oversight Board and the governor from Washington.
First, last week I mentioned that two independent sources have confirmed that the Commonwealth-COFINA deal is very close to completion. In a sign that there is still room to go, the Commonwealth and COFINA agents requested an extension until September 13, 2018 to complete the settlement, which interestingly is the same date as the Omnibus hearing. The motion seems to indicate the agreement does not have the necessary number of approvals. The Court gave the parties one day to object and since no one did, agreed to the extension. Both the Government of Puerto Rico and the GO bondholders had reserved their right to object, but did not raise one at this time. Either they did not have an objection or they realized the Court would grant it anyways and are bidding their time. My sources tell me that Fortaleza will sign-up to the deal, as the Governor desperately needs a win in the face of non-existent credibility outside of Puerto Rico in the lead up to his 2020 re-election campaign. Let’s wait and see.
Also of great importance, as I had predicted, the First Circuit set oral argument for the Aurelius case for September 10, 2018. If a decision comes down by November, not an unrealistic forecast, the case could be before SCOTUS by December. In addition, if certiorari were granted, a decision would come down no later than June 30, 2019. In the same vein, Assured filed an adversary proceeding challenging the Board’s appointment as unconstitutional. Last week, the Board and Assured filed a stipulated judgment, which the Court quickly entered, accepting the applicability of Judge Swain’s decision in Aurelius to the case. Right after the judgment, Assured filed a notice of appeal and it is likely the case will be consolidated with the Aurelius oral argument. Case moving right along.
A group of ERS bondholders filed a supplementary motion for the lifting of the stay, including 1,264 pages of documents, seeking a timetable for the hearing. The Board objected saying that the Court had ruled it would determine at the next Omnibus hearing whether the ERS bondholders have a lien. The Retirees Committee joined the Board. To me, it’s more efficient to have the whole thing at the Omnibus rather than piecemeal, but let’s see what Judge Swain decides.
I discussed the proposed PREPA bondholders deal in [another posting], but what is related to it is the Board’s certification of a new Fiscal Plan for the utility. In the past, the Board had insisted that the utility’s rate should be at or below 20 cents per kilowatt/hour. In the new Fiscal Plan however, the Board states that due to increase in fuel costs, in the next few years, the rate would fluctuate between 27-30 cents per kilowatt/hour. This is in addition to the Transition Charge that will be imposed on consumers if the agreement comes through. In addition, the Fiscal Plan mentions that in June and July there would be meetings with the unions to discuss different matters. I asked Utier’s attorney about said claims and he said there had been no such meetings. The Fiscal Plan calls for reductions of PREPA’s contribution to the employees’ medical plan and elimination of Christmas bonuses. Although PREPA may alter the collective bargaining agreement even before it is rejected, see, NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984), the common sense thing to do would be to meet with the union beforehand to see if there could be areas of agreement. The last thing PREPA and Puerto Rico need is for the Government to unilaterally impose changes to the collective bargaining agreement and have the unions go on strike without previous negotiations.
Predictably, Governor Rosselló instructed the PREPA Board to reject the Fiscal Plan or at least those parts dealing with the rate increase and labor provisions. As disagreeable as a rate increase may sound, there is no doubt that they would come given that PREPA’s fuel costs, as per the Fiscal Plan, have increased in 34%. In addition, the reduction of labor benefits is consistent with what the Board has mandated to the Commonwealth and the governor has resisted. More importantly, the actions from the Board and the governor over electricity rates is deplorable. They are simply not being honest with the Puerto Rican people or the courts. Clearly, the path to de-politicization has a long way to go.
Finally, in a little reported case in Federal Court named Consejo de Salud de PR v. USA, federal judge Gustavo Gelpi reserved his ruling on a petition by the U.S. Department of Health. The U.S. Agency is trying to dismiss a lawsuit filed by the Puerto Rico Health Center “MedCentro Centro” and several Medicare and Medicaid beneficiaries alleging violations of the Equal Protection clause in regards to unequal Medicare funds to U.S. citizens residing in Puerto Rico. Essentially, plaintiffs and the government are trying to convince Judge Gelpí that Puerto Rico is an incorporated territory, while the defendant U.S. Government warned the Court that Puerto Rico had cited with approval the territorial cases in the PROMESA litigation. If Puerto Rico is deemed an incorporated territory, then it will receive more Medicaid funds. But, with that decision, the Board, Puerto Rico and the U.S. Government’s arguments against the Aurelius case would be weakened. It seems that the parties need to decide what battle is worth fighting. The U.S. Government also reminded the Puerto Rican Government that it doubted it wanted to have the 5th Amendment challenges in several adversary proceedings to be reviewed under strict scrutiny, like it wants done in Judge Gelpí’s case. I warned about these actions by the Rosselló administration in a Caribbean Business column and specifically mentioned the doctrine of judicial estoppel, which is what the U.S. was clearly referring to. That is what happens when you put short-term goals ahead of long-term initiatives.
Well, here we go again. Another day, another PREPA RSA. We’ve had almost a week to digest the RSA and listen to the myriad of press conferences on whether this will or won’t lead to higher electricity prices.
But here is the most important question we should be asking: Will this time be any different than the previous RSAs?
In the almost 2 years since the Oversight Board came into existence and Governor Rosselló walked backed his campaign pledge to do deals, one thing has become patently obvious: the credibility of these parties is as bankrupt as Puerto Rico.
The Oversight Board and Governor Rosselló need to show progress and to regain credibility. They are also worried about federalization.
To start, the agreement is not much different from the RSA previously rejected by the Board in June of 2017. Nothing in this RSA accomplishes the Board’s original vision when they decided to rebuke the will of Congress, and take PREPA to Title III. This included wiping out PREPA’s lien and erasing the entirety of the contractual debt of PREPA, raising the specter of a Takings Clause claim. With this RSA, none of that gets accomplished and there is no Taking Clause claim.
Without limitation to the provisions of the Term Sheet, the reasonable fees and reasonable expenses of the members of the Ad Hoc Group incurred in connection with the RSA, the Definitive Restructuring Support Agreement, and any documents and transactions (including a plan of adjustment) relating to or implementing the foregoing on or after July 23, 2018, limited to one (1) primary law firm, one (1) municipal bond counsel law firm, one (1) Puerto Rico law firm, one (1) financial advisor, and one (1) utility consultant, shall be reimbursed by PREPA on a monthly basis within forty-five (45) days following submission of an invoice and redacted time detail summary to counsel to the FOMB, PREPA and AAFAF.
Section 10 notes that the agreement may be terminated by mutual consent, or by a breach of the agreement. The only remedy for a breach is the termination of the agreement as listed in section 11.13. In addition, section 10.02(b) says the agreement ends on August 27, 2018, at 5 pm, New York City time, but can be renewed through another agreement. Moreover, New York state law on contracts applies and jurisdiction for any disputes is the Title III court, section 11.03, and the parties obligations are several, not joint and several, as stated in section 11.14.
 The members of the Ad Hoc Group and any other holders of PREPA Bonds subject to the RSA (the “Supporting Holders”) shall commit to exchange all of their uninsured bonds for Securitization Bonds (as defined below) on the terms and in the manner set forth below.
 The Puerto Rico Electric Power Authority Revitalization Corporation or a new bankruptcy-remote special purpose vehicle as may be agreed upon shall issue Tranche A and Tranche B Securitization Bonds, secured by the Transition Charge.
 Tranche A Bonds will extend beyond the stated maturity if not paid in full on the stated maturity, until paid in full, including unpaid interest.
 Unpaid interest on the Tranche A Bonds will accrete.
 PIK interest to accrue annually starting in Year 1.
 Tranche B Bonds shall receive 100% of total excess cash flow after repayment of the Tranche A Bonds. Potential recovery on the Tranche B Bonds shall be capped at the exchange amount, plus PIK interest.
 Tranche B Bonds will mature at stated 45 year maturity, and all unpaid debt service will expire unpaid.
 No default on either Tranche A or Tranche B Bonds for failure to pay scheduled debt service, so long as full amount collected under the Transition Charge (minus administrative fees) is used to pay debt service. Interest shall continue to accrue (and pay-in-kind, as applicable) and accrete at the original Coupon rate.
 The Transition Charge shall extend, and interest shall continue to accrue (and pay-in-kind, as applicable) at the original Coupon rate, until the later of (1) the date necessary to pay the Tranche A Bonds in full, even if past their stated maturity, and (2) the earlier of (i) the stated maturity of the Tranche B Bonds, and (ii) the date on which the Tranche B Bonds are paid in full.
 Remedies will be mutually agreed upon and will include, at a minimum, the right to replace the Transition Charge servicer and the right to enforce the Securitization Bonds’ trust agreement, the servicing agreement, and non-impairment covenants. Requirements for replacement servicer to be mutually agreed upon as part of Definitive Documentation.
The Ad Hoc Group shall not object if other legacy debt holders (including fuel line lenders) receive the same treatment with the same terms as the Ad Hoc Group is receiving, so long as such treatment does not adversely affect the Ad Hoc Group’s recoveries. Adjustments to coupons and par are authorized, so long as total cash flow payable each year remains the same (with proportional adjustments for the varying claim sizes of varying legacy debt claims), and so long as such treatment shall not adversely affect the Ad Hoc Group’s recoveries.
In other words, the deal for the insured bondholders may be better as long as the amounts to be received by the non-insured’s does not change. That also applies to the fuel line lenders who are owed around $700 million. Hence, the haircut per bond may decrease further, taking it closer to the 20% of the rejected RSA. In addition, the monolines could get other valuable considerations, as Syncora did in the Detroit bankruptcy (i.e., a parking lot concession worth millions). On July 31, Assured Guarantee rejected the agreement, insisting in the previous RSA they claim is grandfathered. Don’t doubt they will insist on getting a better deal than the non-insured.
This deal begs the question, what happened?
Up until recently, the Board and the government were claiming that PREPA bondholders only had a net lien, meaning that the utility’s expenses were paid first. If there was anything left over, only then were the bonds paid–hence they had no collateral. Now, it is given new collateral and will increase the rate consumers pay for electricity. What changed? I think the Board and the government are worried about Congress taking over PREPA in one way or another and want to show that they can get the job done in a way that is very similar to the previous RSA, which Chairman Bishop insisted should not have been rejected. With the COFINA deal pending, this would show that the Board and governor are serious about doing deals.
One of the many unanswered questions is whether this deal will make it more difficult to privatize PREPA. I have mentioned before that I don’t think the politicians in the island want to sell it, not even the generation part, but the Board was insistent on it. We will see.
The PREPA unions and the PDP have already voiced opposition to the deal. Very likely they will sue to block it. The next few months are going to be very interesting indeed.


text:
Sheriff of Kankakee County, Defendant-Appellant.
Sheriff of Carroll County, Illinois, Defendant-Appellant.
Timothy T. McLaughlin, Oak Lawn, Ill., for Jimmie R. Sweeney, Jack L. Thulen and Harlan L. Carbaugh.
Marilyn Longwell, Charmaine E. Dwyer, Kerr & Longwell, Chicago, Ill., for Derrell E. Upton.
James G. Sotos, Charles E. Hervas, James R. Schirott, Michael W. Condon, Schirott & Associates, Itasca, Ill., Richard R. Haldeman, Williams & McCarthy, Rockford, Ill., for Marvin Bausman.
Charles E. Hervas, James G. Sotos, Michael W. Condon, Phillip A. Luetkehans, Schirott & Associates, Itasca, Ill., for Bernie C. Thompson.
Before CUMMINGS, COFFEY and MANION, Circuit Judges.
These two cases before us on appeal, while distinct lawsuits, raise the same legal issues from similar facts making them suitable for disposition in a single integrated opinion.
Both cases involve appeals from denials of qualified immunity on motions for summary judgment by Sheriffs sued by their discharged deputies. The deputies claim that their discharges were impermissibly motivated by the Sheriffs' opposition to their political party affiliations, thus infringing on their First Amendment rights. The Sheriffs insist that the deputies' right to be free from this type of patronage firing was not clearly established at the time of the terminations, and therefore they are protected from liability under a theory of qualified immunity. The district courts in each case disagreed and denied qualified immunity to the Sheriffs. We conclude that at the time of the deputies' firings it was not clearly established that the deputies were protected from patronage firings under the prevailing doctrines. We further conclude that political considerations are appropriate for determining qualifications for the position of deputy sheriff. We reverse the decisions of the district courts.
In late August, 1986, Derrell Upton was hired as a probationary deputy sheriff in Kankakee County, Illinois. In November, 1986, Sheriff Scroggins, a Republican, lost the sheriff's election to the defendant, Bernie Thompson, the Democratic candidate. The Sheriff's Department of Kankakee County serves a rural Illinois community and employs between 70 and 80 deputy sheriffs. Thompson was sworn in as Sheriff on December 1, 1986. On December 6, 1986, Thompson terminated Upton. At the time of his termination, Upton was a probationary deputy, subject to at-will dismissal by the Sheriff (Ill.Rev.Stat. ch. 125, p 160 (1985)). Upton, an active member of the Kankakee County Republican Party, alleges that his termination resulted from his failure to support the Democrat Thompson for Sheriff in the November 1986 election and was in retaliation for his political affiliation in general.
During the campaign for Sheriff, Upton personally supported the incumbent Sheriff Scroggins in his bid for reelection and displayed a Scroggins bumper sticker on his car. During that same time Upton held the politically influential post of vice-president and acting president of the local chapter of the Illinois Fraternal Order of Police. Although Upton urged neutrality, the union members, by a majority vote, decided to endorse Sheriff Scroggins. In his capacity as a union official, Upton was questioned by reporters concerning the endorsement. Upton was clearly a political adversary of Thompson's, and was in a position to organize political opposition to Thompson.
Upton brought a civil rights action against Sheriff Thompson pursuant to 42 U.S.C. Sec. 1983 alleging that his dismissal was an impermissible punishment for his exercise of his First Amendment right to support the incumbent Sheriff Scroggins in the 1986 election. Although Sheriff Thompson denies the allegations of any political motivation in Upton's firing, for the sake of Thompson's affirmative defense of qualified immunity, the parties have stipulated that Thompson fired Upton for political reasons.
Sheriff Thompson moved for summary judgment on the grounds of qualified immunity, arguing that the termination of a deputy sheriff in 1986, even for political reasons, did not violate Upton's clearly established constitutional rights. The district court concluded such rights were clearly established and denied the Sheriff's motion for summary judgment. Sheriff Thompson appeals the denial of qualified immunity.
The Carroll County Sheriff's Department is a small, rural office located in Mt. Carroll, Illinois. It employs only four full-time deputy sheriffs and 16 full-time employees.
The plaintiff, Jack Thulen, served as a Deputy Sheriff for Carroll County for 13 years under the administration of his brother and former Sheriff Jimmie Thulen, a Democrat. Jack Thulen's tenure began on the same day his brother Jimmie assumed the office of sheriff in 1970, and he served as chief deputy until Sheriff Thulen was defeated in the November 4, 1986 sheriff's election by the Republican candidate, Marvin Bausman.
During the 1986 campaign, Jack Thulen actively supported his brother's bid for re-election. In addition to being an outspoken supporter of Jimmie's candidacy, Jack Thulen helped the campaign by putting up signs and attending fundraisers. In his campaign against Jimmie Thulen, Marvin Bausman espoused a platform which was very critical of the Thulen administration. Specifically, candidate Bausman charged the incumbent administration with imprudent use and waste of public funds, poor leadership and lack of aggressive law enforcement.
Upon assuming office on December 1, 1986, Sheriff Bausman terminated Jack Thulen, who then filed a Sec. 1983 civil rights case against Bausman in both his individual and official capacities. Thulen claims he was fired for political reasons in violation of his First Amendment rights to freedom of association and expression. Bausman sought summary judgment on all allegations, including a claim for qualified immunity on the individual charge. The district court denied summary judgment on all claims.
Both Sheriffs appeal the district court denials of their summary judgment motions for qualified immunity. A district court's denial of a claim of qualified immunity is an immediately appealable final decision within the meaning of 28 U.S.C. Sec. 1291. Mitchell v. Forsyth, 472 U.S. 511, 530, 105 S.Ct. 2806, 2817, 86 L.Ed.2d 411 (1985). This court reviews de novo a district court's summary judgment determination in qualified immunity cases where the facts are not disputed. Jackson v. Elrod, 881 F.2d 441, 443 (7th Cir.1989). Upon appeal this court determines whether the substantive law has been properly applied by the district court. Id.
Under Harlow v. Fitzgerald, 457 U.S. 800, 102 S.Ct. 2727, 73 L.Ed.2d 396 (1982), "governmental officials performing discretionary functions, generally are shielded from liability for civil damages insofar as their conduct does not violate clearly established statutory or constitutional rights of which a reasonable person would have known." Id. at 818, 102 S.Ct. at 2738. "For executive officers in general, ... qualified immunity represents the norm." Id. at 807, 102 S.Ct. at 2732.1 The right the official is alleged to have violated must have been "clearly established" in a "particularized" way and "the contours of the right must be sufficiently clear that a reasonable official would understand that what he is doing violates that right." Anderson v. Creighton, 483 U.S. 635, 640, 107 S.Ct. 3034, 3039, 97 L.Ed.2d 523 (1987). In Davis v. Scherer, 468 U.S. 183, 104 S.Ct. 3012, 82 L.Ed.2d 139 (1984), the Supreme Court stated that "whether an official may prevail in his qualified immunity defense depends upon the 'objective reasonableness of his conduct as measured by reference to clearly established law.' " Id. at 191, 104 S.Ct. at 3017 (quoting Harlow, 457 U.S. at 818, 102 S.Ct. at 2738). The principle behind the doctrine is that " '[i]f the law at the time was not clearly established, an official could not reasonably be expected to anticipate subsequent legal developments, nor could he fairly be said to know that the law forbade conduct not previously identified as unlawful.' " Greenberg v. Kmetko, 840 F.2d 467, 472 (7th Cir.1988) (quoting Harlow, 457 U.S. at 818, 102 S.Ct. at 2738). See also Cygnar v. City of Chicago, 865 F.2d 827, 843 (7th Cir.1989). What is important, in the final analysis, is "whether the legal norms governing [the government official's] behavior were clearly established at the time of the challenged actions." Wrigley v. Greanias, 842 F.2d 955, 958 (7th Cir.1988) (quoting Wade v. Hegner, 804 F.2d 67, 71 (7th Cir.1986)).
In further characterizing the suitability of applying qualified immunity, this court stated that "[q]ualified immunity is designed to shield from civil liability 'all but the plainly incompetent or those who knowingly violate the law.' " Hughes v. Meyer, 880 F.2d 967, 971 (7th Cir.1989) (quoting from Malley v. Briggs, 475 U.S. 335, 341, 106 S.Ct. 1092, 1096, 89 L.Ed.2d 271 (1986)). Immunity should be applied unless "it has been authoritatively decided that certain conduct is forbidden." Alliance to End Repression v. City of Chicago, 820 F.2d 873, 875 (7th Cir.1987). To prove the presence of a clearly established constitutional right, the plaintiff must point to "closely analogous cases" decided prior to the defendants' challenged actions. Rakovich v. Wade, 850 F.2d 1180, 1205 (7th Cir.), cert. denied, 488 U.S. 968, 109 S.Ct. 497, 102 L.Ed.2d 534 (1988).
The district courts rejected the Sheriffs' arguments that under these guidelines they should be held immune from suit for the politically motivated firings of deputy sheriffs. The district courts in both cases found that the firings violated the discharged employees' "clearly established" First Amendment rights under Elrod v. Burns, 427 U.S. 347, 96 S.Ct. 2673, 49 L.Ed.2d 547 (1976), Branti v. Finkel, 445 U.S. 507, 100 S.Ct. 1287, 63 L.Ed.2d 574 (1980), and their progeny. According to the district courts, at the time the firings occurred (December 1986) it was clearly established under the First Amendment that a deputy sheriff could not be fired because his political affiliation and activity was different than the sheriff's. As such, the firing of the deputies in opposition to the "clearly established" prohibition vitiated the Sheriffs' immunity from suit for damages under 42 U.S.C. Sec. 1983.
As the district court accurately notes in its order in the Thulen case, the law "is unsettled"2 as to whether partisan political affiliation is a proper job requirement for deputy sheriffs. The propriety of politically based firings of deputy sheriffs (as well as other positions) has received conflicting and confusing treatment when federal courts attempt to apply Elrod and Branti principles. In his dissent in Branti, Justice Powell predicted the problem we now confront: "The standard articulated by the court [in Branti ] is framed in vague and sweeping language. Elected and appointed officials at all levels ... no longer will know when political affiliation is an appropriate consideration in filling a position." 445 U.S. at 524, 100 S.Ct. at 1297-98.
In her 1989 article titled "A Decade of Branti Decisions: A Government Official's Guide to Patronage", Susan Martin outlines the variations and conflicts among the federal circuits in their application of Branti to patronage dismissal cases. Martin catalogues the cases decided under Branti, and reveals that there is a large middle ground of public employment for which the propriety of patronage dismissal receives ambiguous treatment under the Branti test. Martin writes: "After Branti, the test is whether party affiliation is an appropriate requirement for effective job performance. Jobs requiring party affiliation for effective job performance may or may not be of the policymaking or confidential variety." 39 Am.U.L.Rev. 11, at 22 (1989). That is, between the strictly menial govemment worker (who, under Elrod and Branti, is clearly and completely protected from patronage firing) and the policymaker/confidential assistant (whose protection from patronage firing is non-existent), there is a range of government positions for which the propriety of patronage firing has depended largely on the courts' juggling of competing constitutional and political values. The results have not been consistent. The failure of the courts to develop and apply a consistent set of principles concerning patronage dismissals creates a context in which the Sheriffs (absent a direct holding on the issue) could have no clear understanding as to whether the deputy sheriffs had any constitutional protection from a politically based discharge. The lack of clarity on this issue, as demonstrated by the analysis below, necessarily extends the protection of qualified immunity to the Sheriffs.
The grant of qualified immunity to the Sheriffs properly depends upon whether the deputies' right to be free from politically based firings was clearly established. A number of Supreme Court and Seventh Circuit cases govern our thinking. In Elrod v. Burns, supra, the Supreme Court addressed the question whether dismissal of public employees for political reasons violates the First Amendment. Elrod involved the dismissal of a number of noncivil service employees of the Cook County, Illinois, Sheriff's Department by the newly elected Democratic sheriff. The employees (none of whom were deputy sheriffs) were fired because they were not members or functionaries of the Democratic Party. In examining the role of the First Amendment in Elrod, the Court analyzed the history and purpose of the patronage system in American government. The Court acknowledged the administrative importance of having an elected official select employees who would be loyal to the official and his electoral mandate. Derivative of this would be greater efficiency in government with the introduction of politically compatible and highly motivated workers disinclined to subvert the incumbent administration's efforts to govern effectively. Therefore, politically based firings of the opponent's sympathizers are necessary to make way for accommodating and cooperative employees.
Contrasted to this, the Court observed a strong constitutional legacy of protecting the individual's freedom of association and his right to meaningfully exercise his political beliefs. A patronage system would be offensive to the constitutional rights of the government worker whose ability to enjoy the benefit of public employment should not ordinarily be contingent on his coerced association with the dominant political party or on the sacrifice of his own political activity. To accommodate the conflicting demands for efficient and responsive government and the First Amendment rights of government workers, the Court limited patronage dismissals to "policymaking positions." In the Court's view, limiting patronage dismissals to policymaking positions would sufficiently "insur[e] ... that representative government not be undercut by tactics obstructing the implementation of policies of the new administration, policies presumably sanctioned by the electorate." 427 U.S. at 367, 96 S.Ct. at 2687. "Non-policymaking individuals usually have only limited responsibility and are therefore not in a position to thwart the goals of the in-party." Id.
Since Branti, the courts of appeals have devised various tests for determining when "affiliation is an appropriate requirement" for employment or discharge. One major authority in the Seventh Circuit interpreting Elrod and Branti is Tomczak v. City of Chicago, 765 F.2d 633 (7th Cir.), cert. denied, 474 U.S. 946, 106 S.Ct. 313, 88 L.Ed.2d 289 (1985). Tomczak antedates the firings in the present controversy and is therefore significant to this case. In Tomczak, this court reversed a district court decision and held that a long-term employee who had worked his way up to the second-highest ranking position in Chicago's water department was not protected by the First Amendment's prohibition on patronage firings. This court noted that "Elrod and Branti require examination of the powers inherent in a given office, as opposed to the functions performed by a particular occupant of that office." Id. at 640 (citations omitted) (emphasis added). In specifying the official powers to be examined this court explained: "[t]he test is whether the position held by the individual authorizes, either directly or indirectly, meaningful input into government decisionmaking on issues where there is room for principled disagreement on goals or their implementation." (emphasis added). Id. at 641, citing Nekolny v. Painter, 653 F.2d 1164, 1170 (7th Cir.1981), cert. denied, 455 U.S. 1021, 102 S.Ct. 1719, 72 L.Ed.2d 139 (1982).
The primary function of any local governmental entity is the provision of services such as police and fire protection.... Elections often turn on the success or failure of the incumbent to provide these services, and as campaigns develop, the opposing sides put forth varying proposals about how best to provide services. While the ultimate goal of all sides might be the same, there is clearly room for principled disagreement in the development and implementation of plans to achieve that goal. Therefore, the fact that plaintiff's position concerned the provision of water to all citizens does not mean that the Water Department had no goals about which there could be principled disagreements.
Id. at 641 (emphasis added).
A public prosecutor ... exercises broad public responsibilities in the performance of his duties. A prosecutor's "client" is not an individual, but society as a whole. And the prosecutor has the broad discretion to set whatever policies he or she believes necessary to protect the interests of society.
One of the problems faced by a prosecutor ... is that his policies are implemented by subordinates. Indeed, an Assistant State's Attorney may, in carrying out his or her duties, make some decisions which will actually create policy.... The public interest in the efficient administration of justice requires that decisions made by such assistant prosecutors conform with the broad objectives chosen by the prosecutor.
Id. at 800-801. For the above reasons, the prosecutor was "entitled to demand absolute loyalty from his assistants" and was permitted to dismiss anyone in whom he "lost confidence ... for whatever reason," including political reasons. Id. at 801.
Although this circuit has not specifically addressed the propriety of a sheriff's dismissing a deputy for political reasons, Tomczak and Livas provide definite guidance in resolving the question. In both Tomczak and Livas, nonpolicymaking officials were deemed subject to politically based firing because they were vested with substantial discretionary authority in the implementation of the policy goals of elected officials. The facts of these present cases suggest that a deputy sheriff helps to implement his superior's policies to the same degree as an assistant prosecutor or a deputy city commissioner, making deputies suitable for similar treatment under the First Amendment.
Like the prosecutor, the Sheriff is elected by the voters in a county to serve the public at large. His selection is based significantly on the popular approval of his expressed political agenda. The Sheriff, like the prosecutor, has "broad discretion to set whatever policies he or she believes necessary to protect the interest of that society." Livas, 711 F.2d at 800. Particularly in a small department, a Sheriff's core group of advisers will likely include his deputies. A deputy sheriff, in implementing the Sheriff's basic policy, will "make some decisions that will actually create policy." Id. at 801. As with the assistant deputy prosecutor in Livas, deputies on patrol or other assignment frequently work autonomously, giving them wide latitude and discretion in the performance of their duties and in the implementation of department goals. In order to promote public confidence in law enforcement, the Sheriff depends on his deputies to publicly project his competence and the competence of the office. Deputies are also expected to provide the Sheriff with truthful, accurate and beneficial information which he needs to make decisions and administer his office. While the circumstances of the Sheriff departments do not present an employment situation identical to a prosecutor's office, or that of a city water commissioner's, the position of these deputy sheriffs seems to fit within the Branti, Tomczak, and Livas exceptions to the prohibition on patronage firings, eroding any belief that the deputies' right to be free from political firing had been "clearly established."Given the dependency of the sheriff (and his political survival) on his deputies' job performance, it is understandable why a sheriff might believe that party loyalty is an appropriate consideration for a deputy sheriff. This conclusion is especially true in the case of Jack Thulen, who was the outgoing sheriff's brother and chief deputy in a very small department for many years. Thulen took a high profile in a hotly contested campaign which involved critical policy disputes relating to the proper operation of the Sheriff's Department. Thulen's political involvement extended beyond mere party affiliation; it included active opposition to Marvin Bausman, who became the newly elected Sheriff. To the voting public this could make Thulen appear hostile and unreliable in carrying out the policies of the new Sheriff. Deputy Upton, while apparently not as active (or at least as high profile) in campaign events as Jack Thulen, had certainly made his opposition to candidate (later Sheriff) Thompson well known. In addition, Upton's leadership of a policemen's union which opposed Thompson's candidacy made it questionable whether he could execute Thompson's policies. Even though Thompson's department was larger, thus diluting the potential disruptiveness of one deputy's opposing political alignment, Tomczak and Livas would still provide a reasonable legal foundation for the sheriff to terminate a deputy whom he concluded would interfere in carrying out his stated policies based upon that deputy's prior political activity. Thus it was not clearly established at the time of Upton's and Thulen's discharges that deputy sheriffs were protected from patronage firings under Elrod and Branti.
The deputies, however, claim that the Tomczak and Livas analyses are irrelevant because Perry v. Larson, 794 F.2d 279 (7th Cir.1986), directly answers in their favor the question of whether Elrod and Branti apply to deputy sheriffs. In Perry, a case decided about six months before the deputies' discharges, this court affirmed the sufficiency of a jury's verdict awarding damages in favor of a deputy sheriff in Wisconsin who was suspended and later discharged from his position, allegedly in retaliation for his decision to run against the defendant, the incumbent sheriff, for the office of Sheriff. The deputies suggest that by upholding the jury's verdict, which included punitive damages for the firing, this court implicitly held that the plaintiff's political activity was constitutionally protected and he was free from reprisals.
Other circuits have split on the question of whether a deputy sheriff is protected from political discharge. In Jones v. Dodson, 727 F.2d 1329 (4th Cir.1984), the Fourth Circuit, applying Branti, did not believe that the duties of a deputy sheriff, "could be found to involve policymaking related to 'partisan interests' and to involve access to confidential information bearing ... on partisan political concerns ... no matter what size the office, or the specific position of power involved, or the customary intimacy of the associations within the office, or the undoubted need for mutual trust and confidence within any law enforcement agency.... On this basis we hold that if [the deputy sheriff's] discharge was solely because of his political party affiliation, it could not as a matter of law be justified under the Branti test." Id. at 1338 (emphasis added). But if the deputy's political activity was the basis for discharge, Jones would apply a more open-ended "balancing" inquiry.
This circuit in Tomczak and Livas has acknowledged a greater role for loyalty among those charged with the implementation of government programs than that expressed in Jones, although Jones did seem to allow considerable leeway for sanctioning combative political activity as opposed to mere political affiliation. We have permitted patronage dismissals to accommodate the need for loyalty in cases where loyalty is essential in the transmission of services. Unlike the court in Jones, this court, in determining whether political affinity is an appropriate job requirement for a position, has examined factors like "the specific position of power involved," (see Tomczak ) the "customary intimacy of association with the office," (see Livas ) and the "need for mutual trust and confidence" (see Livas ).
The closeness and cooperation required between sheriffs and their deputies necessitates the sheriff's absolute authority over their appointment and/or retention.
Under the Elrod-Branti standard, loyalty to the individual sheriff and the goals and policies he seeks to implement through his office is an appropriate requirement for the effective performance of a deputy sheriff.... We can find no less restrictive means for meeting the needs of public service in the case of the sheriff's deputy than to acknowledge a sheriff's absolute authority of appointment and to decline to reinstate those who did not support him.
Rutan v. Republican Party of Illinois, --- U.S. ----, 110 S.Ct. 2729, 111 L.Ed.2d 52 (1990), has recently complicated the patronage question by extending the termination rule of Elrod and Branti to all government personnel actions. "We hold that the rule of Elrod and Branti extends to promotion, transfer, recall, and hiring decisions based on party affiliation and support." Rutan, 110 S.Ct. at 2739. But the fundamental rule of Elrod and Branti remains the same, presumably as interpreted in this circuit by Livas and Tomczak. With the expanded coverage, new questions naturally arise. In the sheriffs' setting, promotion, transfer, recall, and hiring decisions within the Sheriff's Department could come under the same constitutional scrutiny as the terminations we examine here, unless otherwise controlled by statute, regulation, or contract. Justice Scalia in his dissent to Rutan (joined by three other Justices), highlights the impossibility of the courts' and government officials' position when trying to apply Branti: "interpretations of Branti [within the federal circuits] are not only significantly at variance with each other; they are still so general that for most positions it is impossible to know whether party affiliation is a permissible requirement until a court renders its decision." Id. at 2756. Justice Scalia in his dissent follows this observation with a litany of federal cases which itemize the various government positions in which one is or is not protected from patronage dismissals under Branti and Elrod. The comparison of the itemized positions receiving different treatment under Branti illustrate "that the tests used to implement Branti have produced inconsistent and unpredictable results." Id. at 2756-2757, including nn. 5-21 (emphasis added). Truly, as Justice Scalia points out, the indefiniteness of the applicable Branti standard has resulted in judicial confusion and inconsistency, a confusion that has naturally transpired to government officials having to apply Branti.
We conclude therefore that since the law was not clearly established in 1986 the sheriffs in these cases are protected by qualified immunity. What about 1991? As we noted in Livas, "The Branti court recognized that the pivotal inquiry is not whether a position is confidential or policymaking in character, but rather 'whether the hiring authority can demonstrate that [political considerations are] an appropriate requirement for the effective performance of the public office involved.' " Livas, supra at 800, quoting Branti, supra 445 U.S. at 518, 100 S.Ct. at 1295. We are thus confronted with the same question faced in Livas--"whether [political considerations] can be an appropriate requirement for the effective performance" of a deputy sheriff's duties. Id. In this situation we believe the answer is yes. Based on this court's approval of political terminations in other contexts, we conclude that deputy sheriffs operate with a sufficient level of autonomy and discretionary authority to justify a sheriff's use of political considerations when determining who will serve as deputies.
In some states a politically silent deputy would officially align with a party simply by voting in the primary election.6 This contrasts sharply with the politically active deputy who, by vociferously campaigning for the loser, encounters Matthew 26:52: "All they that take the sword shall perish with the sword." State legislatures may choose to adjust state laws to protect some level of party affiliation or participation. Suffice it to say that under the First Amendment as interpreted by Branti, Livas, and Tomczak, a sheriff may use political considerations when determining who will serve as deputy sheriff. The judgments of the district courts with respect to the issue of qualified immunity are reversed. We further remand these cases to the district courts for proceedings consistent with this opinion.
(3) except when in uniform or on duty, solicit votes or campaign funds for the officer or others.
See also Wis.Stat. 59.21(8)(b)(1); but see Ill.Rev.Stat. ch. 34, p 859.1, titled Merit System for Deputy Sheriffs, repealed by P.A. 81-1475 eff. Jan. 1, 1981.

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