Law

My Thoughts Regarding Mr. Leonard Weiser-Varon and Mr. William Kannel of Mintz Levin’s Blog Post

On March 17, 2014, Mr. Leonard Weiser-Varon and Mr. William Kannel of Mintz Levin published an entry in his blog titled “Legislative Balloon for Puerto Rico Public Corporation Insolvency Attracts Bondholder Attention”.   Although I agree with much of what is said there, a few issues need clarification.

Puerto Rico defaulting on its bond obligations is not an if, but rather a when. The island’s economy has not grown since 2006, with the exception of one quarter of .1% in 2012, clearly a case of depression rather than recession.  The idea of Puerto Rico’s default has been discussed all over the bond and business media and there seems to be a general agreement that it will happen in the next three years. Hence, a orderly process for the reorganization of Puerto Rico’s public corporations and even municipalities is a must.

Felix Salmon recently stated that “[t]he default will be messy, however, since there is no chapter of the US bankruptcy code that encompasses Puerto Rico. A lot of different court cases will be held in a passel of different jurisdictions, and a lot of lawyers will get rich. In the end, everybody is going to have to take a nasty hit—including the island’s retirees, whose pension funds are woefully underfunded.” (footnote omitted).  Given this scenario, it is in bondholders interest to have the administration of this impending default in the hands of one court with a clear statute to guide it. Moreover, Puerto Rico’s public corporations owe over $25 billion and municipalities, not yet included in the statute, owe $3.88 billion more. See, GBD presentation to investors of October 15, 2013, at page 56.   It must also be remembered that the Puerto Rico Electric Power Authority, according to its financial statements of 2013, has $791,385,000 more in liabilities than in assets. See page 8.  See also my blog entry.

The entry mentions Governor Garcia Padilla’s opposition to the proposed measure but this must be taken with boulders of salt. As it is very common, he speaks with one side of his mouth to the voters in Puerto Rico and from another to investors. His only comments in the local press were that he had not participated in its writing and that no specific plans for restructuring of corporations had been adopted. In addition, given that the next administration, coming in on January 2, 2017, will have to assume the bulk of payment of the new $3.5 billion bond emission, the measure could very well garner minority vote to override any veto by the Governor.

The entry continues with a general questioning of Puerto Rico’s power to enact a liquidation or reorganization law. Although the power to enact bankruptcy laws was delegated to Congress via the U.S. Constitution, it is nevertheless a fact that for a large part of our history it was not used. The first bankruptcy law was enacted by Congress in 1800 to 1803 when it was repealed. Later it was enacted twice and repealed twice but in 1898 it was here to stay, with several amendments and a complete overhaul in 1978. In the interim, several state laws were enacted to fill the void.

In this framework and considering that Puerto Rico’s public corporations and municipalities are explicitly excluded from Chapter 9 of the Bankruptcy Code, 11 U.S.C. § 101 (52), Puerto Rico can legislate since there is no preemption. With a doubt, however, any filing of a Puerto Rico public corporation or municipality pursuant to this law would trigger litigation but it would not take several years to resolve. Let us imagine that PREPA filed for protection of this new reorganization law. What would be the bondholder’s reaction? Rush to Federal Court to question the laws constitutionality? Very likely, but then they would be faced with several abstention doctrines, to wit, Railroad Commission v. Pullman Co., 312 U.S. 496 (1941); Burford v. Sun Oil Co., 319 U.S. 315 (1943) or Louisiana Power & Light Co. v. City of Thibodaux, 360 U.S. 25 (1959). Pullman requires the federal court to abstain when there are federal and state constitutional questions and send the case back to state court to litigate them. Unless plaintiff makes a specific reservation of federal rights via England v. Louisiana State Board of Medical Examiners, 375 U.S. 411 (1964), all claims will be litigated in state court and will be res judicata in federal court, see, Duty Free Shop Inc. v. Administración de Terrenos, 889 F.2d 1181 (1st Cir.1989). If there is such a reservation via Pullman, the plaintiff may return to federal court. Burford and Thibodaux are a bit more complicated for they involve undecided questions of state law of great public policy import. Case law is not clear if an England type reservation of rights would be possible pursuant to these abstention doctrines, see, Front Royal and Warren County Industrial Park Corporation v. Town of Front Royal, Virginia, 135 F.3d 275 (4th Cir. 1998) and Fields v. Sarasota Manatee Airport Auth., 953 F.2d 1299 (11th Cir.1992). Hence, the cases would be sent back to Puerto Rico’s courts.

Moreover, even if bondholders made a reservation of rights, the issues would be quickly decided. The Puerto Rico Supreme Court has very actively exercised its discretion to certify issues in the Courts of First Instance for quick decision. This was done in Trinidad v. ELA, 2013 TSPR 73 and Domínguez Castro et al. v. E.L.A. I, 178 D.P.R. 1 (2010), cert denied, Domínguez Castro v. Puerto Rico, 131 S. Ct. 152  (2010) Both Trinidad and Domínguez Castro were decided in a year or less on issues of the constitutionality of altering contractual obligations.

This brings us to the issue of the alteration of contractual obligations pursuant to the U.S., rather than Puerto Rico’s constitution. Federal courts, however, have been accommodating of a government’s efforts to alter its obligations. It is allowed as long as evidence of crisis and failure of other efforts is discussed in the legislation. This was affirmed by the First Circuit in the firing of over 12,000 employees due to the 2009 financial crisis, see, United Auto., Aerospace, Agr. Implement Workers of America Intern. Union v. Fortuño, 633 F.3d 37 (1st Cir. 2011). As evidenced by the dates in these cases, these controversies were decided in less than two years at the state Supreme Court level and the Circuit Court of Appeals level. Given the strictures of the U.S. Supreme Court’s certiorari practice, it is unlikely it would be granted. Also, irrespective of which court decides the case or when, the fact remains that once the reorganization filing occurs, bondholders will cease to be paid.

The entry also points out, quite correctly, that the law as it is now, does not provide for a cram down of a plan. However, the Senators who wrote the act knew that it was incomplete and were expecting input from several sources, including my own.   Mr. Weiser-Varon and Mr. Kannel’s insight will undoubtedly be examined and adopted by the Puerto Rico legislature.

Consecuencias Legales de que Puerto Rico No Pague a los Bonistas

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¿Cuales son las consecuencias legales de que PR no pague a los bonistas? ¿Puede demandarse a PR? ¿En que corte? ¿Quien puede demandar?  Todas estas son importantes preguntas para los inversionistas y público en general después de que Standard & Poor’s y Moody’s degradaron el crédito de PR y la última también los bonos respaldados por COFINA.  Aquí, trataré de predecir los posibles escenarios.

El más obvio es que PR, como cualquier estado de la Unión, esta impedido de buscar protección de la ley de quiebras federal ya que no provee pare eso. Además, ninguna corporación pública o municipio puede hacerlo. No solamente la ley de PR no provee expresamente para ello, si no que el 11 U.S.C. § 101(52) expresamente excluye PR y Washington DC  de protección del Capítulo 9. Por ende, la organizada reorganización que Detroit lleva a cabo es imposible para PR.

Puerto Rico no es una nación independiente ni es un estado de la Unión. Es un territorio no incorporado con gobierno propio, ver, Harris v. Rosario, 446 U.S. 651 (1980). Pero para propósitos de la 11ava Enmienda a la Constitución Federal es un estado, ver Fresenius Medical Care Cardiovascular Resources, Inc v. Puerto Rico and the Caribbean Cardiovascular Center Corp., 322 F.3d 56, 61 (1st Cir. 2003). Esta Enmienda fue incorporada a raíz de la decisión de Chisom v. Georgia, 2 U.S. (2 Dall.) 419 (1793), la cual determinó que se podía demandar a un estado de la Unión en la Corte Federal aún si no se podía hacer en sus cortes. Poco después, la 11ava Enmienda fue aprobada. Por lo tanto, PR no puede ser demandada en Corte Federal sin su consentimiento.

PR ha dado su consentimiento a ser demandado en sus cortes en cobro de dinero, Ver, Hato Rey Stationery, Inc., v. Commonwealth of Puerto Rico, 119 D.P.R. 129 (1987) y Montalvo & Comas Electric Corp. v. Commonwealth of Puerto Rico, 107 D.P.R. 558 (1978). La pregunta, sin embargo, no termina ahí.

Aunque usualmente se entiende que PR debe alrededor de $70 mil millones, no toda la deuda es del  Estado Libre Asociado de P.R., nombre oficial de gobierno de la isla. Conforme la página 56 de The Commonwealth of Puerto Rico,  Update on Fiscal and Economic Progress, FY 2014 Q1 Investor Webcast – October 15, 2013  esta el desglose de lo que se debe. Corporaciones públicas como la Autoridad de Energía Eléctrica que genera sus propios fondos y son susceptibles a demandas en la Corte Federal, deben alrededor de $25 mil millones. Además, los municipios, tampoco protegidos por la 11ava Enmienda, deben mas de $3 mil millones. Más aún, solo  $16.233 mil millones son obligaciones generales (GO) respaldadas por crédito del ELA y constitucionalmente requeridas a ser pagadas antes que cualquier otra cosa, ver, Artículo VI, secciones 2 and 8 de la Constitución.

Por ende, el tenedor de bonos o la compañía de seguros que se subrogue en los derechos de sus asegurados, tiene que examinar quien emitió la deuda, que protección, si alguna tiene de la 11ava Enmienda tiene y entonces determinar donde demandar en cobro de dinero.

Esto no quiere decir que los tenedores de bonos o sus agentes o subrogados van a cobrar de PR. La isla puede unilateralmente cambiar las condiciones del contrato. La garantía contra el menoscabo de obligaciones contractuales de la Constitución Federal y de PR ha sido erosionada por años. Esto se ve en  United Auto., Aerospace, Agr. Implement Workers of America Intern. Union v. Fortuño, 633 F.3d 37 (1st Cir. 2011); Trinidad v. ELA, 2013 TSPR 73 and Domínguez Castro et al. v. E.L.A. I, 178 D.P.R. 1 (2010), cert denied, Domínguez Castro v. Puerto Rico, 131 S. Ct. 152  (2010).  Esto quiere decir que es muy probable que un Tribunal concluya que PR puede imponer una moratoria o hasta repudiar su deuda o la de sus subdivisiones políticas. Ese paso sería radical y dudo mucho que la presente administración lo considere, pero esta ahí para considerarse.

LEGAL RAMIFICATIONS OF PUERTO RICO NOT PAYING BONDHOLDERS

What are the legal consequences of Puerto Rico not paying bondholders? Can Puerto Rico be sued? In which Court? Who can sue? All these are important questions for investors and the general public after Standard & Poor’s and Moody’s downgrades, which include the latter’s actions on the COFINA backed bonds.  Here, I will try to predict the possible scenarios.

The most obvious is that PR, nor any state of the Union, can file for US Bankruptcy law protection for the Code does not provide fro them to do so. In addition, none of PR’s municipalities or public corporations may do so. Not only does PR law expressly allow it, but 11 U.S.C. § 101(52)  expressly excludes PR and Washington DC from Chapter 9 protection. Hence, the organized reorganization that Detroit is undergoing is not possible for PR.

Puerto Rico is not an independent country nor is it a state of the Union. It is a self-governing non-incorporated territory of the United States, see, Harris v. Rosario, 446 U.S. 651 (1980). But for purposes of the Eleventh Amendment, it is a state, see, Fresenius Medical Care Cardiovascular Resources, Inc. v. Puerto Rico and the Caribbean Cardiovascular Center Corp., 322 F.3d 56, 61 (1st Cir. 2003). This Amendment was incorporated on the heels of Chisom v. Georgia, 2 U.S. (2 Dall.) 419 (1793), which decided that a state of the Union could be sued in Federal Court, even if it could not in its own courts. Soon after, the Eleventh Amendment was enacted and approved. Hence, PR cannot be sued in Federal Court without its consent.

PR has given its consent to be sued in its own courts for breach of contract, see, Hato Rey Stationery, Inc., v. Commonwealth of Puerto Rico, 19 P.R. Offic. Trans. 153 (1987)  and Montalvo & Comas Electric Corp. v. Commonwealth of Puerto Rico, 7 Offic. Trans. 613 (1978). The inquiry, however, does not end there.

Although it is usually agreed that PR owes around $70 billion, not all of the debt is owed by the Commonwealth of Puerto Rico, the official name of the island’s government. According to slide 56 of The Commonwealth of Puerto Rico,  Update on Fiscal and Economic Progress, FY 2014 Q1 Investor Webcast – October 15, 2013 , has a general breakdown of who owes what. This brings several issues to bear. Public corporations such as the PR Electric Power Authority that generate their own income are subject to federal court jurisdiction and these owe around $25 billion. In addition, municipalities owe over $3 billion and are not protected by the 11th Amendment. Moreover, only $16.233 billion which is GO debt backed by the full faith and credit of PR are Constitutionally protected and are required to be paid before anything else, see, Article VI, sections 2 and 8 of Puerto Rico’s Constitution, available here in English.

Hence, the bond holder or the insurance company that subrogates on its insured’s rights, has to examine who is the issuer of the debt, what if any 11th Amendment protection it may have and then determine where to sue for collection of moneys.

This does not mean that bond holders or their agents or subrogees will collect from PR. The island may unilaterally change the conditions of the contract. The guarantee against the impairment of contracts provided by the Contract Clause of the US and Puertorrican Constitution have been greatly eroded in the past years. This can be seen in United Auto., Aerospace, Agr. Implement Workers of America Intern. Union v. Fortuño, 633 F.3d 37 (1st Cir. 2011); Trinidad v. ELA, 2013 TSPR 73 and Domínguez Castro et al. v. E.L.A. I, 178 D.P.R. 1 (2010), cert denied, Domínguez Castro v. Puerto Rico, 131 S. Ct. 152  (2010).  This means that it is very likely that a court could conclude that PR may put a temporary moratorium or even repudiate part of its debt or that of its political subdivisions. Such a step would be radical and I doubt if the present administration would even consider it, but it is there to consider.