Puerto Rico Electric Power Authority Bondholders, PROMESA Oversight Board Reiterate Competing Views on Net Revenue Calculations in Summary Judgment Cross-Motion Responses

Relevant Documents:
Bondholders’ Brief
Herman Declaration
Oversight Board’s Brief (Exhibits)

Briefs from the PROMESA oversight board and the PREPA bondholders opposing each other’s respective cross-motions for summary judgment reinforce their competing views on calculating PREPA’s net revenues, which constitute the bondholders’ collateral under the 1974 trust agreement. The cross-motions, which concern the bondholders’ equitable accounting counterclaim, are the latest briefing in the long-running lien litigation adversary proceeding within the utility’s Title III debt restructuring case.

The bondholders say that the trust agreement and PREPA’s course of performance determine how net revenues must be calculated. The bondholders point to PREPA’s monthly operating reports, or MORs, and other documentation in support of their course-of-performance argument.

The bondholders say that PREPA’s revenues are not limited to cash generated by its operations and include set-offs for contributions in lieu of taxes, or CILTs, and municipal subsidy obligations, as well as federal funding and funds held for PREPA’s benefit. The bondholders also contend that current expenses, which are deducted from PREPA’s revenues to determine its net revenues, do not include capital expenditures.

The oversight board disputes the accuracy of PREPA’s MORs and asserts that not even the bondholders believed they were realistic or binding. The oversight board also contends that the trust agreement’s definition of revenues excludes federal and noncash items and that current expenses include capital expenditures. According to the board, the bondholders have not met their burden to show that net revenues existed and that they were “wrongly diverted” from debt service.

Under the schedule set by U.S. Magistrate Judge Judith Gail Dein, supporting briefs from additional parties are due today. Replies in support of summary judgment are due Nov. 6 before oral argument at the next omnibus hearing, set for Nov. 18 at 8:30 a.m. ET, or a date and time to be determined.

Bondholders

The bondholders reiterate their course-of-performance position, emphasizing that they and PREPA have a “common understanding” of how net revenues are calculated under the trust agreement, that their common understanding tracks the agreement’s “text and structure” and that PREPA sold the bonds based on that understanding, “certifying to the investing public in no fewer than 31 bond issuances over the last 40 years precisely how” net revenues are determined.

The brief adds that PREPA “followed that methodology consistently for decades in its internal accounting and its ordinary course financial reporting” to its governing board and the trustee and “continues to follow that same methodology today.”

“[E]ven now, no one from PREPA supports the Board’s position,” the bondholders say.

The bondholders contend that the oversight board now “seeks to override” the trust agreement and PREPA’s performance with a “new methodology invented by litigators decades after the fact” to eliminate revenues and inflate current expenses, which are deducted from top-line revenues in the process of determining net revenues. Specifically, say the bondholders, the oversight board is attempting to reduce PREPA’s net revenues by “billions of dollars” by limiting revenues to cash received by the utility and expanding current expenses to include capital expenditures.

According to the brief, this approach conflicts with the trust agreement’s “plain text” and “radically” departs from how PREPA “consistently understood, disclosed, and performed its own contractual obligations.” It also contradicts Puerto Rico law, which “interprets contracts according to the party’s stated intentions and performance” and contradicts the Uniform Commercial Code, which “likewise considers the party’s course of performance as part of the ‘bargain of the parties in fact,’” the bondholders say.

To support their textual argument, the bondholders cite the trust agreement’s definition of revenues: “all moneys received by [PREPA] in connection with or as a result of its ownership or operation of the System, including the income derived by the Authority from the sale of electricity generated or distributed by the System.” They also cite the agreement’s definition of current expenses, saying such expenses are “limited to the reasonable and necessary current expenses of ‘maintaining, repairing and operating the System.’”

The bondholders push back against the oversight board’s position that revenues in the trust agreement are limited to cash, contending that the term “moneys received” in the agreement’s definition of revenues includes more than just cash.

The brief stresses that the definition of revenues expressly includes “income derived by the Authority from the sale of electricity generated or distributed by the System” and asserts that the setoff of CILT and subsidy obligations that PREPA receives in exchange for providing electricity to municipalities meets that standard. The bondholders add that PREPA has accounted for such noncash income as revenues “for decades.”

Adding contractual context, the bondholders point out that the trust agreement “repeatedly uses the word ‘cash’ in other provisions” and could have – but did not – use the word to limit the definition of revenues. The bondholders also point to the U.S. Court of Appeals for the First Circuit’s November 2024 revised bondholder lien ruling, saying the appellate court held that the lien on net revenues is not limited to cash and rejected the oversight board’s position that the lien only covered “moneys deposited into bank accounts.”

In particular, the brief says, the First Circuit held that “the security interest in PREPA’s Net Revenues received now or in the future that are not held in the form of currency are best classified as general intangibles,” meaning that revenues “are not limited to cash because a lien on a ‘general intangible’ is a lien on something other than ‘money’ (i.e., hard currency), a ‘deposit account’ (i.e., a bank account and the funds within it), or an ‘instrument’ (i.e., a check or note payable).”

The bondholders say that capital expenditures are not current expenses deducted from revenues to calculate net revenues under the trust agreement or PREPA’s course of performance. The trust agreement defines current expenses and capital expenditures as “separate, mutually exclusive categories,” according to the brief, which adds that the trust agreement only allows capital expenditures to be paid from subordinate funds after debt service is paid. The bondholders assert that this structure is “exactly as PREPA represented in selling the bonds and in performing under” the trust agreement. The bondholders also note that the Puerto Rico Energy Bureau in its April 15 rate order “rejected approximately $2.1 billion of proposed capital expenditures, explaining that ‘capital projects should be charged to customers only as a last resort’ and that federal funding – not ratepayer funds – should be used to pay for capital expenditures.”

Capital expenditures also are not necessary operating expenses with priority over the bondholders’ lien under section 928 of the Bankruptcy Code, according to the brief. Reasoning that section 928 “preserves secured creditors’ prepetition liens” rather than “gut[ting] them,” the bondholders assert that capital expenditures are distinct from operating expenses and say the oversight board “cannot prove that all of its expenditures were ‘necessary.’”

According to the bondholders, section 928 “does no more” than the trust agreement “already does,” and reasonable and necessary operating expenses under section 928 are functionally equivalent to current expenses under the trust agreement. Section 928 also does not replace the trust agreement, says the brief.

The bondholders criticize what they call “double-collecting” by the oversight board for federally funded expenses. According to the brief, such double collection would occur if federal funds were used to pay expenses – including capital expenditures – and those expenses were also categorized as current expenses or necessary operating expenses to reduce PREPA’s net revenues.

The bondholders say they do not include federal funding in their calculation of net revenues because “that funding and the associated expenditures net out.” The brief adds that the oversight board has “previously conceded” that federal funds are revenues and contends that the trust agreement’s definition of revenues is broad enough to include such funds.

The bondholders dispute the oversight board’s position that revenues under the trust agreement are recognized on a cash basis while current expenses are measured on an accrual basis, asserting that PREPA’s intent to calculate revenues on an accrual basis is demonstrated by the utility’s course of performance, including through its MORs.

The bondholders also contend that a “mixed methodology” violates the trust agreement, which “requires PREPA to keep its accounts ‘according to standard practices for public utility systems similar to the properties and business of the Authority and applicable in such circumstances.’” This means using accrual accounting, according to the brief.

The bondholders additionally argue that $683 million in funds held in the Energy Sector Reserve are revenues and are available for restitution.

The brief is supported by a declaration by David Herman of Dechert, counsel for the PREPA ad hoc group, one of the bondholder parties seeking summary judgment.

Oversight Board

The oversight board criticizes the bondholders’ reliance on PREPA’s course of performance and says their position relies on a disputed material fact: “the accuracy of monthly operating reports they themselves concede are in need of alteration.”

According to the board, the bondholders believe net revenues are “whatever PREPA computed them to be in [its] unaudited, preliminary monthly operating reports (except for the various ways they concede those computations are wrong and must be changed).” The board says that although the bondholders “work hard to paint a harmonious picture of PREPA’s prepetition performance, pretending the parties shared an understanding that the MORs accurately reflected that PREPA was generating billions” in net revenues, “no party considered the MORs as showing realistic representations of PREPA’s Net Revenues, let alone binding computations.”

Citing PREPA’s fiscal year 2014 MORs, which included statements of revenues and current expenses that showed “hundreds of millions of dollars” in net revenues, the brief points out that the bond trustee “did not demand turnover of this alleged collateral” and instead worked with bondholders, monoline insurers and other stakeholders to negotiate forbearance agreements allowing PREPA to delay payments because it lacked sufficient net revenues.

The oversight board adds that even though the next two years of MORs reflected “a billion dollars” of net revenues, PREPA “continued to deteriorate and was required to issue new bonds to satisfy its bond payments, with the forbearing bondholders and monolines purchasing those bonds with the debt service owed to them.”

“The billions of dollars of Net Revenues were nothing more than numbers on a schedule that no one took as truth. The MORs did not reflect reality then, and do not change reality now,” according to the oversight board, which adds that PROMESA was enacted “in part because financial reporting at the Commonwealth and its instrumentalities, including PREPA, could not be relied upon.” Independent investigations also determined that the financial reporting in PREPA’s official statements was inaccurate, according to the brief.

The oversight board also disputes that the MORs constitute a course of performance, contending that there is no applicable course of performance rule under Puerto Rico law.

The oversight board contends that the MORs are insufficient to support the bondholders’ requested summary judgment that net revenues are calculated using PREPA’s historical methodology, that PREPA has generated at least $2.85 billion of net revenues since the petition date and that PREPA is required to disgorge to the trustee net revenues existing now or in the future.

The oversight board says the bondholders have not met their burden of proof to show “undisputed facts entitling them to an accounting remedy,” because any such remedy must be based on a showing that the bondholders “entrusted property to which they were entitled to PREPA and that PREPA subsequently breached its obligations with respect to that property.” This means that the bondholders must show that net revenues existed and that they were “wrongly diverted from debt service” in violation of the trust agreement, according to the brief. However, according to the oversight board, the bondholders “skip past this burden and wrongly assume its satisfaction,” justifying denial of the bondholders’ motion “on this basis alone.”

The oversight board also contends that the MORs are not binding because they are “extrinsic documents that cannot override” the trust agreement’s “clear and unambiguous definitions.” In addition, the brief says, because the MORs “employ different accounting conventions” than the trust agreement requires, they are “not reflective” of “any amount” of net revenues. The oversight board adds that the bondholders have “never treated the MORs as definitive statements” of net revenues, pointing to the MOR “modifications” reflected in the bondholders’ motion and the bondholders’ prepetition dealings with PREPA.

Reiterating its position that revenues are determined on a cash basis, the oversight board says that the word “received” in the trust agreement’s definition of revenues means “having come into possession of” and that calculating revenues on an accrual basis “would inherently include ‘money’ that has not been ‘received’ and is instead only ‘receivable’ in the future.”

“PREPA has not ‘come into possession of’ money that it has billed but has not collected,” the board says, adding that the First Circuit indicated for this reason in its bondholder lien ruling that the lien does not encompass accounts.

The oversight board asserts that federal disaster relief funds are not revenues and can, “at most,” only be used to offset expenses, because the trust agreement’s definition of revenues “makes clear it covers only money directly derived from the sale of electricity, investment decisions required under the Trust Agreement, or the disposition of assets.” Further, only “real” revenues and current expenses of PREPA’s CILT and municipal subsidy programs should be counted in calculating net revenues, according to the board.

Turning to section 928 of the Bankruptcy Code, the oversight board says that the bondholders’ “own arguments” show that they are not entitled to summary judgment that section 928(b) “must be co-extensive with any prepetition net pledge of special revenues.” The brief reasons that this interpretation would give section 928 “a different meaning in every case.” The statute’s legislative history also “establishes a statutory minimum standard of ‘good’ operation that must be satisfied before Bondholders are entitled to a dime,” and the “scant case law interpreting this provision further supports the Court’s need to assess this question on a factual basis, and not at summary judgment,” according to the oversight board.

The brief disputes the bondholders’ contention that capital expenditures are not current expenses under the trust agreement or capital expenses under section 928, reasoning that the document and statute do not contain “any such categorical restriction.”

The oversight board also contends that there are genuine factual disputes about whether any of PREPA’s cash on hand constitutes net revenues or can be subject to disgorgement and contends that factual disputes preclude summary judgment dismissing the board’s affirmative defenses – failure to state a claim, preclusion by the First Circuit’s lien ruling, lack of standing, lack of jurisdiction, section 928, Title III preemption, mootness, authorization for the acts taken, laches, estoppel and unclean hands.