Puerto Rico’s current fiscal problems are bringing up unprecedented issues that will likely be subject to interpretation by local and federal courts if the government defaults on its debt and bondholders decide to defend their contractual rights via the lawsuit route.
Without a legal framework, such as access to Chapter 9 provisions of the U.S. Bankruptcy code or the validation of the Puerto Rico Debt Enforcement and Recovery Act, the possibility of a debt restructuring could “create a chaos that will benefit no one,” said Sergio Marxuach, public policy director for the Center for a New Economy.
Puerto Rico is facing $902 million in debt service payments in January, involving a number of credits issued by 14 of the government’s 18 issuing entities, including $331 million in constitutionally protected General Obligation bonds.
In the absence of liquidity, the government may have to decide which creditors will get paid first, and will likely prioritize the debt according to a hierarchy the CNE broke down in a paper released this week.
First in line are GO bonds, which are backed by the Commonwealth’s good faith, credit and taxing power. While those bondholders are probably protected, there are several open issues that could complicate matters, Marxuach said.
First, there is a discrepancy in the wording used in the Spanish and English versions of the Constitution, which establish first claim mechanisms for bondholders. While the original version in Spanish speaks of “resources,” the version in English talks about “revenues.”
“It will depend on which court sees the case. If it’s a Puerto Rico court, they will likely use the Spanish version of the Constitution, which talks about resources. It is not clear what remedies bondholders may seek to enforce their claim,” Marxuach said.
The payment order then moves on to holders of bonds and notes guaranteed by the Commonwealth’s good faith and credit, which are considered “public debt” for constitutional purposes and have the same priority of payment and protection as GOs.
Next are bonds issued by the Puerto Rico Sales Tax Financing Corporation, otherwise known as COFINA. According to an opinion by the Justice Secretary sales and use tax allocated to COFINA is not available for the payment of principal of and interest on GO bonds.
“The validity of this legislative allocation, however, has not been challenged in or ruled upon by any court and thus remains an open question,” Marxuach said.
The matter of using COFINA revenue to pay for other debt, or the possibility of issuing a so-called “superbond” to restructure the Commonwealth’s $73 billion debt has already raised concerns by holders of that debt.
“As one of the very few secured creditors in the Puerto Rico debt structure, we expect that our property rights will be protected. COFINA has been the Puerto Rico debt issue that individuals and institutions both on and off-island have most trusted with their capital, retirement accounts and life savings. The Commonwealth must respect the rights of retirees and creditors,” the senior creditors said in a statement released Nov. 30.
The next group of creditors in the order is Municipal Finance Agency bondholders, whose investments are secured by property taxes collected by municipalities that issue the debt. Next come holders of revenue bonds issued by state-owned corporations, such as the Puerto Rico Electric Power Authority and the Puerto Rico Aqueduct and Sewer Authority. Those two entities are negotiating separately with their creditors to restructure their debts. Bondholder rights and remedies are established in the contracts executed by each of the utilities.
Next is debt supported by Commonwealth appropriations and taxes that depend on the legislature for repayment. One example is Public Finance Corp., which missed a $58 million payment due in August 2015 because the funds were not allocated.
The final two classes in the lineup are bonds issued by the Puerto Rico Employees Retirement System and limited obligation and non-recourse debts.
“This statutory ‘waterfall’ is useful in providing some guidance as to how government funds would be allocated in the event of a liquidity crisis, but the statutory language is so ambiguous as to practically invite litigation,” Marxuach said.
The CNE has been advocating the approval of Chapter 9 inclusion for Puerto Rico in Congress during recent Senate hearings, arguing that it is not a federal bailout and would cost the U.S. government nothing.
“Puerto Rico’s debt is spread across a variety of debtors representing a complex web of claims in an uncertain regulatory and legal framework,” he said.
“This situation makes it very difficult for creditors to work as a class because one set of creditors will worry that any relief they provide the island will simply make it easier for a different set of creditors to recover a larger amount of their claims,” he said.
While the Republican-controlled Senate has been unreceptive to taking action to allow Puerto Rico to re-gain access to the legal framework — which it was allowed to recur to until an amendment was introduced in 1984 — there is a possibility that a move could come this week. Congress is expected to vote on a spending bill that could benefit Puerto Rico either through Chapter 9 or tax benefits.
Another element that has come into play is last Friday’s surprising decision by the U.S. Supreme Court to allow Puerto Rico to defend its Debt Enforcement and Recovery Act, which was declared unconstitutional last year.
“It’s a good thing for the government to have that card up its sleeve because they can now go to Congress and say, look, if you don’t take action, the Court may roll the dice,” Marxuach said. “This opens the door for Congress to rethink. This may change things.”
David Hitchcock, senior analyst with Standard & Poor’s, said in an analysis released last week that Puerto Rico’s inability to file for Chapter 9 bankruptcy under federal law strengthens bondholders’ ability to pursue their claims.
“In our view, resulting litigation from default on any type of tax-supported debt could be costly, disorderly, and disruptive,” he said.