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Aurelius v. Puerto Rico's Control Board: What's the Game?

posted by Mitu Gulati

While most of the sovereign debt world is focused on Mr. Maduro’s shenanigans in Venezuela, a fascinating litigation is playing out in federal district court in Puerto Rico.  Aurelius, a hedge fund known to many of us because of the role it played in the legendary pari passu litigation against Argentina, is challenging the constitutionality of the Control Board that was put in place to run Puerto Rico’s debt restructuring (and, essentially, key aspects of its fiscal affairs). 

Elsewhere, Joseph Blocher and I have written about why this suit is exciting for us in the context of our other work on Puerto Rico’s problematic (okay, shameful) second-class status.  Specifically, this Aurelius case, has the potential to get the federal courts to confront the question of what the legal validity today is of a set of infamous cases from the early 1900s (the Insular Cases). We hope that the courts, when faced with arguments that derive their authority from these cases, will clearly say – and there is enough of a basis for them to do so – that the actions and developments of the past 100 years have effectively overruled these cases. These cases, for anyone unfamiliar, are a set of stunningly racist cases produced by many of the same judges who ruled in favor of “separate but equal” in Plessy v. Ferguson.  Oversimplifying, these cases ruled that Puerto Rico and its people, partly because they were not deemed to be civilized enough in the early 1900s, constituted an “unincorporated” territory (that is, so very foreign that they were not on their way to eventual statehood).

So, in a sense, I find myself in the bizarre position that while I am not rooting for Aurelius to win, I hope that their lawsuit ends up getting the Insular Cases condemned, once and for all, as an awful relic of an ugly past.  That said, what puzzles me about this case though is its economics, particularly from the perspective of Aurelius.  What do they get by undermining the Control Board? My assumption here is that a ruling that the Control Board is unconstitutional and that all of the actions it has taken so far are void will be hugely expensive for Puerto Rico’s debt restructuring effort.  After all, one of the key aspects of the Control Board is that it has been given the power to solve the traditional collective action problem that bedevils every sovereign or quasi-sovereign debt restructuring.  Remove the Control Board, and we go back to square one where the creditors are fighting with each other about who has what level of priority and how to avoid giving the holdouts a disproportionate share of the pie. End result: Lawyers get paid a lot, but both the people of Puerto Rico and the creditors (including Aurelius) have a much smaller pie to divide up.

The folks at Aurelius, best I can tell, are highly sophisticated and really good at making oodles of money in crisis situations (remember Argentina and pari passu). But I cannot figure out what their game is.  How do they win by turning over the applecart? My initial thought was that perhaps they were hoping that Puerto Rico would pay them to drop the lawsuit. But this is the type of lawsuit that can be easily copied. If Aurelius gets a hefty settlement, won’t every other hedge fund holding Puerto Rican bonds file copycat suits? After all, they can all assert the exact same constitutional injury blah blah (and they won’t even have to pay for Ted Olson’s fancy legal team – they can just copy the briefs for this lawsuit that are public).

I have no doubt that there is some clever strategy here that I’m missing. Hopefully, one of the slipsters or sophisticated readers of this blog can help me.


Combination of the fact that 1) they think their GO bond priority (including over essential services, pension etc) is more clear outside bankruptcy (inside bankruptcy the Oversight Board is arguing federal bankruptcy law priority scheme trumps state law priorities and they don’t have a lien so they are just general unsecured creditors behind those other claims) and 2) even if winning doesn’t lead to the end of the Title III it would allow President Trump to replace the existing members of the Oversight Board with more creditor friendly appointees.

Unrelated to Puerto Rico, but Aurelius was excoriated by Judge Lane in Chapter 15 case for Oi Brasil on account of its litigation strategy earlier this week: https://www.bloomberg.com/news/articles/2017-12-05/aurelius-s-disturbing-moves-in-oi-bankruptcy-blocked-by-judge

Rarely do you see a judge outline a fund's litigation strategy in such detail.

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