By Maria Chutchian
The Commonwealth of Puerto Rico was once known mostly for tourism, but is now recognizable for turmoil. The US territory has been ravaged by natural disaster and political chaos, all while becoming the test case on how to free a financially overburdened municipality from its crushing debt load.
As Puerto Rico navigates through the first court-supervised public debt restructuring of its kind, one of the most watched aspects of its bankruptcy-style case is the amount of money earmarked to pay the professionals tasked with providing the island with advice. Having already run up a $400 million tab, current estimates predict the total bill for lawyers and advisors in the case to reach $1.5 billion through 2024.
For comparison, professional fees in the 2008 collapse of Lehman Brothers – a storied global financial institution that once had more than $600 billion in assets – amounted to $1.9 billion over four years to sort out the largest corporate bankruptcy filing in American history. In the municipal world, Detroit previously held the title of most expensive restructuring, spending $177.9 million in legal and advisory fees to turn its finances around.
While case watchers debate how much is financially at stake, Debtwire Investigations set out to explore the legal mechanics that allow advisors to charge the territory hundreds of millions of dollars in fees to reduce its approximately $70 billion debt load. A review of reports from a court-appointed examiner and the professionals’ invoices shows that the firms representing the most visible players – the federally-appointed oversight board and Puerto Rico’s Fiscal Agency and Financial Advisory Authority (FAFAA) – are charging some of the lowest hourly rates of the New York, Chicago and Washington, DC-based firms, but due to volume of hours billed, have still reaped the most from their work. Other firms working on behalf of lower-priority creditors and the island’s sales tax authority charge some of the highest rates in the case, but clock fewer hours, and therefore have taken home less overall than the oversight board and FAFAA advisors.
In effort to keep expenditures in check, the appointed examiner reviews all invoices before they are submitted to a judge. But interviews with experts in bankruptcy law and public finance show that even the examiner and his team have only so much power to rein in the ballooning costs. At the moment, attorneys’ rates span anywhere from $200 to more than $1,000 per hour, with some financial and operational advisory firms billing more than $1 million per month.
The law governing Puerto Rico’s revitalization, known as the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA), says these payments to lawyers and consultants are acceptable as long as the costs are deemed “reasonable” and “necessary.” Those words, however, can carry different meaning depending on whom you ask. Puerto Rico’s bills may appear staggering to anyone concerned that high professional rates for a town, city, state, or territory means less money for public services, because the bills are paid out of a general fund.
Bob Fishman, who served as the fee examiner for the city of Detroit’s 2013 bankruptcy, understands the sentiment. “In Chapter 9 [bankruptcy], citizens of Detroit felt like the whole thing was ridiculous. Their mantra was, ‘You owe us all this money, why aren’t you paying it to us instead of lawyers?’” he said. “I imagine if I was a guy out on the street, that might be how I feel about it.”
But those who are well-versed in the world of corporate restructuring do not blink an eye at the thought of paying top attorneys up to $1,000 per hour, in a situation that they know will take years to complete.
Breaking it down
Despite the world’s leading law firms handing out their versions of coupons to help keep costs down, many are still raking in tens of millions of dollars apiece. And those figures don’t include charges that aren’t in public fee applications because they fall under a different category of compensation under the law. Moreover, even with discounts, their rates are substantially higher than those charged by Puerto Rico-based firms. Local firms, while a bargain comparatively, generally don’t have the resources or experience to handle an undertaking of this magnitude alone.
For its part, the Financial Oversight and Management Board (FOMB) – the group that Congress tasked with overseeing Puerto Rico’s restructuring – has acknowledged the high cost of the process but touted efforts to bring in local professionals to reduce costs. Even with local firms taking on some of the work, the central government anticipates spending $176 million to cover fees for the in-court proceeding, also known as Title III, in fiscal year 2020.
The FOMB’s external legal counsel, the law firm Proskauer Rose, started the case charging an average $730 per hour for the board’s work on behalf of the commonwealth. As of Jan. 31, 2019, Proskauer led the pack as the highest paid legal team in the case. The firm has charged $68.4 million for its work, according to public fee documents. O’Melveny & Myers came in second, billing $54 million for its representation of the government through the FAFAA, the documents show.
The two firms’ billed hours, however, are neck-and-neck. Proskauer billed for 98,236.4 hours, and O’Melveny reported 98,582.2 hours.
While the price-tags are already sky high, the amount those two firms have charged is actually “millions” higher, according to a source close to the matter. Both firms also do work that falls outside of the Title III umbrella and is therefore not subject to public disclosure requirements, the source said.
Moreover, the rates grow slightly each year. As of the first quarter of 2019, Proskauer lawyers charged an average hourly rate of approximately $750, which is a 3% increase from its initial rates two years earlier. Paul Hastings, the law firm representing a committee of unsecured creditors (UCC) – whose fees are paid by Puerto Rico – started out at an average $772.31 per hour. The firm is now charging $812.03 per hour, a 5% uptick.
With the firms billing thousands of hours per quarter, those extra percentage points add up quickly. Similar to large or particularly complicated bankruptcies, the fee examiner team reviews and assesses all quarterly invoices. To be sure, Puerto Rico pays the examiner fees as well.
Complicating matters further are the differing payment methods and discounts the firms have negotiated with Puerto Rico. Many apply discounts of around 10% to each quarterly invoice.
Paul Hastings, for example, requests payment of 80% of its fees each payment period, but also states that its hourly rates do not take into account the “the precise fees to be waived to attain the 20% reduction to be designated by Paul Hastings (in its sole discretion)” when it has finished its work for the UCC, according to its March 2019 fee application. As a result, the fee examiner is reviewing, and the judge approving, invoices with varying methods for applying said discounts.
Due to the firms’ inconsistent methods of presenting their bills, the resulting Debtwire Investigations data is based on the final amounts submitted for examiner and judge approval, with all known discounts taken into account.
Even with these rate reductions, the commonwealth is shelling out hundreds of millions of dollars annually. Proskauer makes a point in court filings of highlighting a 45% cut its most senior partners take for their Puerto Rico work, compared with typical Chapter 11 rates.
That estimate largely pans out, as the $730 hourly rate the firm’s partners started at in Puerto Rico is an approximately 45% reduction from $1,325, which falls in the range of hourly rates Proskauer’s partners were charging in other cases at that time. When the firm was hired in November 2016 by the oversight board, its partners charged between $925 and $1,475 per hour as lead counsel to Breitburn Energy Partners in its Chapter 11 bankruptcy, according to court papers. Two months earlier, the partners charged between $925 and $1,350 per hour as counsel to the unsecured creditors committee in Penn Virginia’s Chapter 11.
Still, Proskauer’s associates, who typically have lower rates than partners, were also charging the oversight board $730 per hour for that time period. (Some of the partners and associates are now charging the commonwealth up to $789 per hour.) The associates’ rates ranged from $495 to $1,275 in Breitburn and from $495 to $900 in the Penn Virginia case.
By contrast, Puerto Rico-based firms involved in the case are charging less than half the hourly amount of the non-Puerto Rico firms that largely hail from New York. Those Puerto Rico firms work in tandem with the outside firms, often assisting in the navigation of local laws and statutes.
Lower rates for local firms compared with lead counsel is not out of the ordinary. In fact, it’s the norm. When Proskauer represented a company called Motorsports Aftermarket Group in its Delaware bankruptcy in 2017, its partners were charging between $935 and $1,550 per hour. The top attorneys at Cole Schotz, which served as Delaware co-counsel, charged $435 to $920 per hour, about 46% to 59% of Proskauer’s rates.
But the Puerto Rico-based firms’ rates are even lower: while Proskauer is creeping toward $800 an hour for its services, the San Juan-based firm it’s working with, O’Neill & Borges, has yet to crack $300, or 37.5% of Proskauer’s rates. In some cases, the mainland counsel’s paralegals – who are not lawyers – charge more per hour than the lawyers at the Puerto Rico firms. Throughout the case, Proskauer’s paralegals have charged $250-$270 per hour. During that same time, O’Neill’s average attorney rate was $198 per hour.
The following graphics present a comparison of each legal and advisory firm’s average rate in Puerto Rico, compared with average rates in other recent sizeable representations.
A crash-course in crisis
Puerto Rico’s intricately complicated debt – and now political – crisis has been years in the making, thanks to what some experts say were ill-advised bond issuances mixed with rampant corruption throughout the commonwealth’s government. Underneath it all, a 1996 repeal of a US corporate tax break for manufacturers prompted plant closures and led to an exodus of jobs over the last two decades, exacerbating economic distress and pushing more residents to leave for better job prospects on the US mainland.
The territory’s troubles took a deadlier, more devastating turn in September 2017, when Hurricanes Maria and Irma hit back-to-back. After the hurricanes – which descended upon the island about four months after the court-supervised bankruptcy process began – even more money was needed to rebuild the island’s infrastructure and electrical system. The federal government has allocated tens of billions of dollars in disaster relief aid, but that money has largely been caught up in a bureaucratic no-man’s land, with less than half of the funds approved by Congress actually distributed throughout the island as of this spring.
To top it all off, protests this summer led to the resignation of the sitting governor, Ricardo Rossello, which set off weeks of chaos as the government and courts scrambled to determine who, exactly, was in charge. Though they ultimately settled on the commonwealth’s former secretary of justice, Wanda Vázquez, who was sworn in as governor this August, the damage to an already fraught political system had been done.
The hurricanes and political drama only added to Puerto Rico’s existing economic concerns. The commonwealth’s gross domestic product (GDP) for 2018 was $101.1 billion, down from $104.3 billion the prior year, according to World Bank data. (Utah, the state closest to Puerto Rico in terms of population, reported $183.2 billion GDP for 2018.)
The island, whose population was around 3.2 million in 2018, carried a 43.1% poverty rate that year, according to US Census Bureau data. That’s more than twice as much as the US state with the highest poverty level – Mississippi, at 19.7%.
Puerto Rico entered its own unique form of bankruptcy in May 2017 with $73 billion in debt, much of which is owed to bondholders and pensioners. PROMESA, the law enacted the previous year that enabled the territory to conduct a bankruptcy process, was modeled in part after the existing framework of the US Bankruptcy Code.
Since then, warring factions of bondholders have been fighting over limited pots of money, many knowing full well that they are not going to get the return they initially expected. Some retirees will see their pensions reduced, though to a lesser extent than bondholders, and cuts to public services appear inevitable. The island’s main electric utility is in the midst of a complete overhaul, with the government hoping to find private investors to take control of the operation or management.
Meanwhile, Puerto Rico is paying some of the most expensive lawyers and financial advisors in the world to come up with a solution.
Under a microscope
With the future of the commonwealth at stake, options beyond getting anything but the best, albeit most expensive advice, are limited for both the island and the creditors who are owed billions, public finance experts say.
Some of Puerto Rico’s bondholders are institutional investors like banks and private equity funds that have a long, sophisticated history of municipal style lending. Others are retirees across the US mainland and Puerto Rico itself, who invested their personal savings in the bonds. The institutional investors have the means to hire the best lawyers and financial consultants to fight battles for recoveries on their debt holdings – which can benefit the mom-and-pop investors who own the same type of debt.
“There is real benefit to good legal advice and counsel,” municipal finance consultant and Chapman Strategic Advisors managing director James Spiotto said. “And it should be paid for. It’s just ... when dealing with tax dollars, you want to be careful, especially in dire circumstances like Puerto Rico, that that money is all spent very wisely.”
Under the section of PROMESA dedicated to professional compensation, Congress determined that lawyers and advisors to the government, the board, or an officially-appointed committee, could be paid “reasonable compensation for actual, necessary services rendered by the professional person, or attorney and by any paraprofessional person employed by any such person,” and could be reimbursed “for actual, necessary expenses.”
The bills are then overseen by the court-appointed examiner, and eventually must obtain approval from the judge overseeing the Title III proceedings. The judge’s decision to authorize the payments each quarter depends largely on the examiner’s recommendations.
When reviewing fee applications, examiners typically look at how many professionals are working on one task, their level of seniority within their firm, how many hours are dedicated to that particular task, and the ultimate work product, according to William S. Boyd School of Law professor Nancy Rapoport, who served as a fee examiner in the Caesars Entertainment and Toys ‘R’ Us bankruptcies. But that doesn’t mean the examiner is always looking for the cheapest staffer, because sometimes that person takes too long to complete the task, she said.
“Although every court looks at every fee application itself, what they count on all of us fee examiners to do is analyze the fees and provide recommendations for reasonableness of the fees and expenses,” Rapoport said. “What I think fee examiners do best is save the court’s time on some granular details.”
Puerto Rico’s examiner, a restructuring attorney named Brady Williamson of law firm Godfrey & Kahn, is tasked with ensuring the fees are “reasonable,” as loosely defined by PROMESA. The law effectively leaves it up to the court to determine reasonability, instructing it to consider the time, rates, and necessity of the services provided.
Because the examiner takes on the burden of determining reasonability, and at the same time is frequently negotiating payments privately with the firms, there is room for the professionals themselves to make “reasonable” mean what they want it to mean.
Though Williamson has extensive experience reviewing fees in large bankruptcy cases, including Lehman Brothers, General Motors, and Energy Future Holdings, Puerto Rico presents vastly different circumstances. In fact, Williamson has specifically noted in court papers that with respect to compensation, “PROMESA did not anticipate all of the challenges professionals would face in these proceedings, and new challenges seem to arise regularly. For some issues and professionals, there is little or no precedent on particular compensation questions.”
Williamson has publicly laid out a series of past decisions from federal courts surrounding the reasonable fees that would guide him in his mission. But, with a situation like Puerto Rico’s that is entirely new to this judicial system, none of those decisions have any connection to Puerto Rico or public debt restructurings.
One of his citations dates back to 1984, a decision out of the US Court of Appeals for the First Circuit in a case dealing with the issuance of liquor licenses in proximity to a church in Cambridge, Massachusetts. The court’s decision, known as Grendel’s Den v Larkin, established a basic set of standards for attorneys’ fees intended to address the difficulty “of decision-making that is fair to the parties and understandable to the community at large yet not unnecessarily burdensome to the court themselves.” Those standards include the need for lawyers to keep consistent time records as well as evidence to support the contention that the number of hours was appropriate, in light of the nature of the task and the results of that work.
Williamson also relies on guidelines established by the US Trustee’s office, the agency within the federal government that oversees bankruptcies, in establishing his own standards. In several reports filed with the court, Williamson has lamented the failure of some firms to provide sufficient evidence or explanation to back up their payment demands for what he viewed as overstaffing – multiple attorneys charging several hundred dollars an hour on one task or to attend one meeting or court hearing.
On top of individual overstaffing, Williamson has raised concerns about what he described as duplicative efforts. In a report dated Oct. 31, 2018, he put some of the blame on the rising cost of the case on this particular issue.
“Undisciplined duplicative representation is one reason professional fees have become so large so quickly,” Williamson wrote. “When two or three firms address identical issues on behalf of one client, without a showing of special need, it is generally not reasonable.”
In his most recent account – published more than two years into the Title III proceedings – the examiner noted that while he has seen improved compliance with the standards and guidelines, he “remains concerned about the potential for inefficiency and duplication of efforts in the management of this significant portfolio of litigation.” He pointed to the newly formed special claims committee, established for the purpose of overseeing the nitty-gritty payment disputes brought by thousands of purported creditors, which has already hired at least four professional firms.
In just the first few months of the case, Williamson and his team reviewed more than 100,000 individual time and expense entries. There are currently more than 50 firms whose fees are paid by Puerto Rico, including all of the creditor advisors, according to Williamson’s latest report.
Some firms structure their billing differently than others. One in particular, McKinsey, has been accused of an especially opaque system of charging its clients and disclosing potential conflicts of interest, which was the subject of a Wall Street Journal investigation. In Puerto Rico, an independent committee probed the potential conflicts of interest and determined earlier this year that McKinsey had not engaged in any wrongdoing.
For its work on behalf of the oversight board, McKinsey has charged $47.2 million since the outset of the case. Williamson estimated the firm’s average hourly rate (which McKinsey does not provide itself, as it charges a flat monthly fee) for the first several months of the case to be around $689, though that estimate dropped to $514 in a more recent report. This summer, Williamson asked the court to revisit McKinsey’s fee procedures in light of a report from the inspector general of the US General Services Administration (GSA) that accused the firm of billing $69 million in improper pricing through contracts with the federal government.
Though its work in the Title III cases is separate from those contracts, Williamson noted that McKinsey “represented that the team-based pricing in the GSA Pricelist was a key reason it could not maintain hourly timekeeping records, as the Fee Examiner had initially requested.”
The reports make clear that Williamson is keeping a close eye on costs, and at the same time demonstrate a preference for avoiding public confrontations over questionable charges. Instead, he raises concerns privately, sometimes resulting in a small reduction of charges. To date, Williamson has never filed a formal objection to any of the requested fees or expenses in Puerto Rico’s case.
Objecting to fees in court is unusual, according to fee examiners who have worked on large bankruptcy cases. In fact, it could almost defeat the purpose of disputing a certain charge by forcing the lawyers to defend that charge before a judge – potentially leading to more fees. If examiners come across a line item they find questionable, they prefer mutual compromise.
In a July 2018 report, Williamson noted that he and Proskauer lawyers “engaged in extensive good faith discussions” about issues that ranged from “expenses inappropriately billed to the Board” to “travel, in-house catering, research, and other expenses over the caps or not permitted under the established standards,” among other matters that caught his attention. The firm either provided additional evidence to back up their charges or agreed to reductions, he said in the report.
No end in sight
To date, two of the entities being restructured by Puerto Rico have successfully negotiated with creditors and wrapped up their workouts. But there are still four to go. The Employees Retirement System, the Highways and Transportation Authority, the Puerto Rico Electric Power Authority (PREPA), and the commonwealth itself are still trying to find solutions with their bondholders.
PREPA has a tentative agreement with some of its creditors, but still needs court approval. The commonwealth recently submitted the first draft of its debt adjustment proposal. The other two have yet to propose a plan. The committee recently formed to pursue the thousands of claims that have been filed against Puerto Rico comes with its own legal costs.
On top of the central restructuring, the entities are still tied up in litigation over who, exactly, is legally entitled to certain revenues collected by the commonwealth. The most contentious lawsuit, however, questions the constitutionality of the oversight board itself. The dispute has been appealed all the way to the US Supreme Court, which is scheduled to hear arguments in the case on Oct. 15.
Simultaneously, lawyers for the oversight board, FAFAA, and bondholders have been in mediation supervised by a team of judges in the hope of resolving their disputes over debt recoveries. That mediation “requires a full complement of lawyers and financial advisors spending additional time constituting an added cost to the restructuring expenses,” according to the oversight board’s 2019 annual report. The hope is that the mediation will eventually result in a deal that will end many of the ongoing lawsuits and related conflicts.
In terms of public awareness, many of the legal issues surrounding Puerto Rico’s restructuring take a backseat to the more urgent matters of who is running the territory or where hurricane recovery efforts stand. The individual legal disputes are so granular, it can be difficult to connect them to the island’s broader problems. For that reason, the professionals involved can sometimes appear a world away from Puerto Rico’s political troubles and the concerns of the island’s citizens, even if their fundamental goal is to get the commonwealth back on its feet.
The day Ricardo Rossello stepped down from his position as governor following mass protests in San Juan’s streets, for example, lawyers debated the scope of the oversight board’s powers with respect to the commonwealth’s budget in a Boston courtroom. The resignation of Rossello – who was a plaintiff in that budget-related case – went entirely unmentioned during the hearing.
With litigation and debt negotiations ongoing, in addition to a fragile political infrastructure and lasting damage from the hurricanes, Puerto Rico has a long way to go in its economic recovery. In the meantime, the lawyers’ and advisors’ fees will continue to roll in – assuming, of course, that they’re reasonable.
-- additional reporting by Farhin Lilywala and Maura Webber Sadovi