Mr. Felix Salmon from Reuters has come up with a very interesting and thought provoking piece on PR defaulting on its bonds. The gist of his piece is “The point here is that the concept of seniority doesn’t really make a lot of sense when you’re not operating in the context of a formal bankruptcy regime.” Obviously, he is referring to the seniority of the new $3.5 billion issue but more information is required to really understand the situation.
PR’s debts are owed by the Commonwealth of Puerto Rico (Estado Libre Asociado in Spanish), the different public corporations, some of which can invoke 11th Amendment protection and some that cannot and the Municipalities. As such, none of these debts has any seniority, EXCEPT the following: General Obligation bonds issued pursuant to Article VI, sec. 2 of the Commonwealth’s Constitution These bonds, however, are only around $16.233 billion of the $70 billion owed by the island. See slide 56 of the GBD’s presentation to bondholders of October 15, 2013 They are senior debt because the Constitution states that they must be paid BEFORE any other debt, which includes other bonds, guarantees and even salaries. The Constitution also provides a cause of action to bondholders to sue in the PR Treasury Secretary for payment. Hence, it is clearly a first lien. Hence, there is some seniority in GO bonds if PR law applies. Doubt there will be one in New York. The type of waiver of sovereignty contemplated by the PR Legislature is not exclusive jurisdiction in New York Courts but rather a concurrent jurisdiction with any other court with jurisdiction, i.e., PR Commonwealth Courts or the United States District Court for the District of Puerto Rico. Why is this important? Simple, if PR believes it is close to default it can file in the Commonwealth Courts a suit for declaratory judgment in order to determine if the waiver is valid, if PR law or New York law is applicable to the emission, etc. Knowing PR courts, it will be years before bondholders get their money back. Moreover, don’t count on the Puerto Rico Federal District Court for help. Given the issues I have mentioned, abstention via 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), sending any removal back to Commonwealth Courts. Of course, that would require footwork Governor García Padilla, himself a lawyer, has never shown.
I concur with Mr. Salmon that any debt adjustment will be cumbersome without bankruptcy law, but since the Bankruptcy Code cannot protect PR or its public corporations or municipalities, the local legislature could write its own version of Chapter 9 and liquidation procedures. Bondholders will cry foul but modernly, states are given leeway to alter contractual obligations. See, 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).
I believe it would be best if PR would not take this loan, admit it cannot pay what it owes and negotiate some type of amnesty or debt reduction but since this government wants to be reelected, it will not happen this year. A final note, as I am writing, the press reports there is great reluctance from the PR House of Representatives on approving the limited waiver of immunity the Senate approved, even when it had done so before. Will keep you posted.