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Puerto Rico And (Very) Soft Executive Power

posted by Mark Weidemaier

Melissa's post asked what the executive branch could do to facilitate restructuring of Puerto Rico's debt. I'll get to that, but I first want to talk about Puerto Rico itself. At first glance, the Commonwealth seems to be in a uniquely terrible position. It has the disadvantages of a sovereign (e.g., no bankruptcy) but lacks the advantages (e.g., legal and/or practical immunity from legal enforcement). In fact, it lacks only most of the advantages. One advantage of sovereignty it does enjoy--and that many "true" sovereign borrowers are obliged to forego when they borrow--is that much of its debt is governed by its own law. That law can be changed (subject to constraints in the U.S. constitution) or interpreted in ways that give the Commonwealth needed restructuring flexibility. 

To begin, there are questions about whether the Commonwealth incurred much of its debt (COFINA in particular) in violation of its constitutional debt limits; if so, whether creditors can enforce claims to the unauthorized debt; and, if not, the scope of any right to restitution. These are questions of Puerto Rico law. Moreover, because the vast majority of the debt issued by the Commonwealth and its instrumentalities is subject to Puerto Rico law, the Commonwealth can amend that law in ways that enable restructuring--think of Greece's retro-fit CAC. The U.S. constitution limits the Commonwealth's ability to make such changes, of course, but it is far from clear that the Constitution would prohibit such a move. (Changes affecting debt issued by the Commonwealth itself, as opposed to its municipalities, would not raise bankruptcy preemption issues.)

Reader reactions to such proposals will vary; some will no doubt view them as lawless. From my perspective, that reaction is misplaced, as an important function of a local law bond is to allow the issuer discretion to change its law in reaction to new circumstances. Certainly every informed institutional investor knows this.

So, what does this have to do with the executive branch? A successful restructuring demands incentives for participation (i.e., new bonds with attractive features) and disincentives for holding out. Doubt about the enforceability of debt, and fears of bankruptcy-type "cram down," are potent disincentives. Just how potent, however, depends on a number of uncertain questions. At a minimum, these include: (i) the facts underlying the issuance of COFINA bonds, (ii) once the facts are known, the legal question of whether that debt was authorized, and (iii) the legal question of the extent to which the U.S. constitution limits Puerto Rico's ability to change and interpret its law in ways that facilitate restructuring. Executive branch officials have at least some indirect influence over such questions. Federal "technical assistance" can be conditioned on a searching inquiry into the facts underlying the COFINA debt. Officials can communicate to potential holdouts that the U.S. government will submit amicus briefs in support of Puerto Rico. I'm sure readers can think of other possibilities. These are not major interventions, and they will not radically change any party's leverage. On the margin, however, they can make holding out a less attractive proposition.


Can the Executive establish some sort of PR financial oversight committee that facilitates a kind of mediation with a stay mechanism and a cram-down mechanism? This clearly would exceed the bounds of "(very) soft" executive power. But sometimes sticks are more effective than carrots.

And then under that Exec order, institute local, fiscal reforms--including formal audits and federal oversight--that will incentivize creditors to restructure under the enforced mediation. And as a condition to the committee, PR consents to federal oversight of utilities, public finances, etc.

Puerto Rico Government Debt and the U.S. Federal Government:Potential Assistance Tools and Policy Practice
By Dr. Arturo Estrella, Professor of Economics, Rensselaer Polytechnic Institute

Great resources, FC, thank you!

It seems that one of (if not the most) important issues regarding Puerto Rico’s ability to restructure its debt is not necessarily the vast amount it currently owes, but instead can be attributed to the different types of debt that it owes. Although I am not necessarily persuaded that the Executive branch has a particularly strong influence over Puerto Rico’s restructuring, I agree that there are certain ways that the Puerto Rican government may be able to incentivize a debt restructuring considering the lack of clarity concerning priority and enforcement to a vast majority of their debt holders.

It is estimated that more than 40% of Puerto Rico’s total debt comes from its GO and COFINA bonds. At first glance, it seems that holders of the GO bonds have priority over any other debt based on Article VI, Section 8 of the Constitution of Puerto Rico which states that public debt (which includes GO bonds) holds a first claim on “available resources.” However, the GO bonds explicitly state that taxes pledged to service COFINA bonds do not constitute “available resources” under Article VI, Section 8. To make things even less clear, the GO bonds also mention that the COFINA tax pledge has never been challenged in court, which is essentially their way of saying, “We aren’t really sure if the COFINA legislation is constitutional, but feel free to sue and find out.” To complicate things further, the most recent GO bonds issued in 2014 which constitute $3.5 billion of the approximately $14 billion worth of GO bonds are governed by New York law, while the rest of the earlier issued GO bonds are governed by Puerto Rican law.

Given the uncertainty of enforceability and priority over much, if not all, of Puerto Rico’s outstanding debt, they seem to be in a unique position to incentivize current bondholders to exchange their bonds for a more uniform type of bond. This restructuring would hopefully help Puerto Rico avoid a severe default and would offer current bondholders greater predictability regarding the enforcement and priority of their debt.

Isn't there a recent PR Supreme Court opinion announcing execution immunity over assets?

To follow up on the immunity from execution point, doesn't PR also have some degree of immunity from suit?

I have heard others say that PR has common law immunity (even if one concludes that it does not have 11th Amendment immunity). But what does that mean? And where would it apply? Only in PR courts? Or in courts outside PR as well?

If PR has some substantial degree of immunity from suit and execution, isn't that "game over"? That is a big stick with which to engineer the restructuring.

Presidents in the past have exercised great authority in times of crisis and congressional gridlock, so why not dream bigger?

As Mark pointed out, Puerto Rico occupies the unfortunate position of having the responsibilities of a state without all the fun perks of being a state like bankruptcy or legal immunity (however, Puerto Rico does get to enter its own contestant into the Miss Universe pageant, so there’s that). Puerto Rico’s unusual circumstances remind me of the predicament in which the District of Columbia found itself during the early 1990s. The District of Columbia, like Puerto Rico, suffered from a similar combination of government mismanagement and Congressionally created problems with its taxing power. However, unlike today, the Congress and President of the 1990s were paragons of cooperation, so they were able to come together to establish a plan to put D.C. back on the path of righteous fiscal policy. Without going into too much detail, Congress passed legislation installing the D.C. Control Board to insure that the District could continue to provide essential services and finance its debts. Of course, this required taking over the District’s democratically elected system, a controversial impact of financial managers.

Why mention the D.C. Control Board when the United States has a Congress that has continued to fail at even its most basic constitutionally delegated responsibilities? Because the United States (yet again) has a President who has proved willing to use executive power to sidestep the inconveniences of the democratic process with wide sweeping and controversial executive orders (Gun Control, Dreamers Act…). I don’t think issuing an executive order to create a similar informal “steering” agency to the DC Control Board addressing Puerto Rico’s woes could be considered a bridge too far in light of the history of executive orders overall.

There is a precedent of U.S. presidents using executive orders to create administrative agencies without congressional support. The only downside is that once the agency runs out of its initial funding, Congress can put the kibosh on the agency by refusing to provide it with the funds it needs to continue operating. In 1961 President Kennedy created the Peace Corps through an executive order. The organization was initially opposed by Republican Congressman believing it to be a “haven for draft dodgers.” However, Congress eventually got on board and continued to fund the agency.

President Obama could create via executive order a federally managed agency which could assist Puerto Rico in its attempt to restructure its debts. This agency would serves Puerto Rico in much of the way the D.C. Control Board served D.C. Of course, a problem would arise once the agency ran out of money. Furthermore, conservatives would certainly challenge the measure in court. However, it would send, in the interim, a powerful signal to creditors that the executive is willing to use all its tools to back Puerto Rico. It also sends the signal that the creditors should not expect a bailout.

To address a more general issue of both Mark's post and several of the comments that followed - although it would be hugely beneficial for Puerto Rico if the federal government - in whatever form - stepped up and lent its help, relying on it should be the last resort. After all, looking to the federal government would be largely like saying "yes, we absolutely cannot figure this stuff out, and we are at your mercy." While desperate, I am willing to bet money that Puerto Rico is looking for a less dependent solution.

To that end, Mark's proposal regarding changing Puerto Rico law seem like one of the strongest options. First, Puerto Rico can do it by itself. Second, although there are limits imposed by the U.S. constitution, these are not an absolute straight-jacket. For example, it has been held that a state's change in the maturity date of bonds via legislation did not violate the Contracts Clause. Thus, one stick (and Puerto Rico would likely need several) could be to change enough terms in the current bonds - within the limits of the Constitution and applicable law - to make them even less attractive to hold, especially when compared to whatever bonds offered by Puerto Rico in exchange.

Generally, I think this is the key to a succesful restructuring for Puerto Rico: small changes here and there that together amount to enough incentive and pressure on bondholders to force through a restructuring with the economoic terms that Puerto Rico needs.

There seems to be some hope that the US govt can help PR without the executive branch resorting to executive orders.

The NY times link below mentions that many of the bondholders are individual US investors with http://www.nytimes.com/2016/02/25/business/dealbook/treasury-plan-for-puerto-rico-prioritizes-pensions-over-bondholders.html?ref=topics&_r=1

The influence the Executive Branch can exert to make the old bond less attractive appears to be very limited. The threats of an amicus brief in support of Puerto Rico probably would not have a huge impact on holdout creditor's litigation postures. On the other hand, wouldn't the Executive Branch have a better shot at the other side of the balance, i.e. making the new bond more attractive? Could they make forms of guarantee minimum payments of the new bonds conditioned on some fiscal reform of Puerto Rico?

Also, if Puerto Rico amend certain legislation in ways to affect restructuring, how would they be able to avoid violation of the Contract Clause of U.S. Constitution?

Had some posting issues on the previous post. Here is the complete post.

There seems to be hope that the US govt can help PR without the executive branch resorting to executive orders.

The article linked in my previous post mentions that many of the PR bondholders are US individual investors with <100k income and there seems to be support on both sides of the aisle to help their constituents recover on the bonds. The Treasury had a draft of a proposal that suggested prioritizing pension payments over bondholder payments that could be a non-executive order path to help PR.

Regarding to the financial oversight committee mentioned above, there appears to be some interest in a something similar to that. A recent draft of a bill proposed a five member committee to provide fiscal reform assistance for PR. This also seems like an appropriate situation for a more specific committee to be developed. There was recently a House Committee on Natural Resource hearing that focused on the PR debt situation and I would image a more targeted committee could be more effective on this issue.

Of note, Paul Ryan has placed a March 30th deadline for a House bill on how to handle the PR debt situation and it will be interesting to see the ideas that are put forth.

Based on the assumption that the issuance of the COFINA bonds did exceed the constitutional debt limits, we could say that the bondholders issued debt to the Puerto Rico government with knowledge of the violation of the restrictions on debt in Puerto Rico's Constitution while simultaneously relying on Article VI, Section 8 of the very same Constitution for priority of payment of their bonds.

On this assumption, we conclude that the bondholders can't have their cake and eat it too. The bondholders can't simultaneously rely on a favorable provision of the Constitution while ignoring an unfavorable provision of the same Constitution. Therefore, the bondholders can't claim priority under this Constitutional provision. If they were to claim priority under this provision, then Puerto Rico could similarly rely on the constitutional debt limit to render the debt unenforceable.

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