« Congratulations to Pamela Foohey! | Main | It makes a fine Halloween gift! »

Aurelius v. Puerto Rican Control Board (or "Do Activist Hedgies Add Value?")

posted by Mitu Gulati

This post draws considerably from research on Puerto Rico and its current constitutional status with Joseph Blocher (see here).

Tuesday was oral argument day at the Supreme Court in the battle between the Puerto Rican Control Board and a big bad hedge fund, Aurelius.  Aurelius, zealous defender of the constitution that it is, had brought a challenge to the constitutionality of the Control Board. The claim being that the failure of President Obama and the then Congress to follow the strictures of the Constitution for the appointment of principal officers of the federal government (nomination by the President, followed by Senate confirmation) made the Board and all its actions invalid.

I am not a constitutional scholar and don’t have any desire to be one.  Still, the basic issue here seems fairly simple:  Are the members of the Control Board principal federal officers?

Aurelius claims that they are obviously so.  After all, they are creatures of the federal government that put them in place to supervise the fiscal affairs of Puerto Rico and oversee a debt restructuring for the territory.  Plus, they have enormous power over Puerto Rico's fiscal future, are answerable only to the President, and the Puerto Rican people had no say in their selection.

The Control Board and the DOJ counter saying that the Board members are local territorial officers. Yes, they may have been put in place by the federal government to do a task that Congress and the President didn’t trust the local government to do.  But their task is exclusively Puerto Rico based and therefore they are local, local, local.

Aside: At the earlier stages of this litigation, there had been a lot more drama because the Control Board’s lawyers had been using the infamously racist Insular Cases as support for their argument. (For a discussion, see here). That, in turn, had given Aurelius and Co. a wonderful platform from which to argue that they were the defenders of truth, justice, equality and all that. Indeed, I suspect the "dark cloud of the Insular Cases" (to quote one of the justices on Tuesday) played a role in Aurelius winning hands down at the First Circuit. But, in a brilliant piece of lawyering (well, I guess that depends on whether the Control Board wins), the Control Board and the DOJ tossed out their arguments based on the Insular Cases and took the proverbial air out of the sails of Aurelius and its labor union co litigant. Addition by subtraction.

At the oral argument on Tuesday, without the emotional drama that discussions of the Insular cases would likely have provoked, the justices seemed to tilt toward the Control Board. In other words, taking a view that the Control Board was primarily a local entity.  If that’s where they end up, it means a loss for Aurelius (see here and here for reports from the WSJ and ScotusBlog). But don’t take this to the bank. It is by no means clear that the justices, once they have thought through this question, will end up concluding that the Control Board is an obscure local body that just as easily could have been appointed by the Governor of Puerto Rico and the local legislature.

That’s like thinking that the Troika teams that went into Greece to deal with its crisis in 2011-13 were basically local bureaucrats because their task (which bears some similarities to the Control Board) was Greece focused.  Hell no.  These kinds of teams are necessarily external because they have to be able to get past the inefficiencies and corruption in the local administration so as to be able to cut debt and spending to a manageable amount.  Left to the local administrators, neither fiscal austerity nor debt restructuring would have been the preferred solution. Borrow more, was more likely to have been their strategy – and indeed, that is what local authorities did for far too long in both Greece and Puerto Rico. The result in both Greece and Puerto Rico was an enormous debt crisis that threatened to cause mayhem well beyond local borders.  And that’s why an external team of technocrats had to come in to make sure that the bleeding stopped.  So, in that context does it sound like the Control Board is a local entity that could just as easily have been the creation of local authorities?

But even if Aurelius were to win on the foregoing, will the Court give it what it wants (which is invalidating all of the past actions of the Control Board)?  Justice Breyer seemed to signal that he would not, when he asked whether, even if Court were to decide that the Control Board was unconstitutional, all that would happen is that there would be a delay of a few days where the President would nominate the same Board again and they would then get confirmed.  The lawyers for the Control Board and the DOJ resisted this view, saying that Aurelius would use its fancy lawyers to produce interminable delays.  However, it wasn’t clear how much delay would ensue (and it was big news to me that the President was planning to re nominate the same Control Board if he needed to – although maybe I misunderstood this bit).

Bottom line: No one on the Court seemed to have any appetite for ruling that all of the Control Board’s work over the past three years was invalid. Instead, the justices seemed inclined to uphold the First Circuit’s use of the de facto officer doctrine to legitimize all of the Control Board’s past work.

That then brings up the question of why Aurelius spent so many resources on this case in the first place and caused Puerto Rico to spend resources as well (with three former solicitor generals involved in this case, legal bills on both sides must be in the millions of dollars).  And, more important, whether it is a good thing for society – or even just the market for Puerto Rican debt – for activist funds to be disrupting and delaying debt restructurings by bringing such cases.

On the first question, no one seems to know (other than Aurelius, and they are unwilling to spill the beans).  Given that Puerto Rico is broke, delay and oodles of legal fees surely mean that the result of this case will necessarily be that there will be fewer resources to pay creditors regardless of who wins.  If the Control Board were incompetent or corrupt or something like that, maybe one could argue efficiency gains by having the rogues kicked out. But no one has claimed any such thing; not even close.

And, in that case, isn’t Aurelius shooting itself in the foot by harming the restructuring process? In theory, it is possible that Aurelius has purchased large amounts of some financial instrument that will pay out higher returns if Puerto Rican bonds do worse (maybe a short sale?). But really?  Yes, there was the recent Windstream case where they allegedly did something like this.  (Stephen Lubben had a nice post on the Windstream/CDS issue here; see also hereand here). But this is just speculation. There is undoubtedly something here that I am not seeing.

On the second question, it might be worth looking at what has happened to the prices and yields of the various Puerto Rican bonds in response to how this current law suit has gone. On Tuesday, the general sentiment after oral argument seemed to be that the Court would rule in favor of the Control Board.  If bond prices rose on that news, that tells us something about the value to other creditors of the Aurelius lawsuit. 

Of course, the foregoing is only part of the equation.  One could argue that Aurelius is adding to social welfare by increasing the cost of a restructuring and thereby giving incentives to governments to avoid defaulting in the first place.  This is the type of moral hazard argument that distressed debt hedge funds often make; and it isn’t implausible. But it is not clear there is any evidence supporting this moral hazard theory, for Puerto Rico or any other sovereign/sub sovereign. Government officials, the evidence suggests, already have too much of an incentive to avoid default and that results in undue delay in restructuring the debt where necessary (this is the “too little too late” problem in sovereign debt; see here). And if this is the case, then Aurelius, by creating more delay, is exacerbating an existing inefficiency rather than ameliorating it.

Hopefully, the decision in this case will come down sooner rather than later.  Puerto Rico’s debt situation is terrible and the restructuring has already taken too long.


I appreciate Professor Gulati making Puerto Rico a sideline to his sovereign work but PR's restructuring is handled within the US judicial system following the specific statutory framework laid out by Congress in Promesa and sections of the US bankruptcy code that were incorporated in the law. Making broad sweeping comparisons to motivations in a sovereign restructuring are generally not useful.

Note that in addition to the First Circuit Court of Appeals ruling that Oversight Board members are federal officials that the Federal Court of Claims also ruled on a prelim basis that OB members are federal officials and that any losses that creditors suffered due to restructuring would expose the Congress to Takings violations. That would be a long road for creditors to battle but there are sufficient constitutional basis to pursue that strategy. Although I have no knowledge of Aurelius' strategy they might believe establishing that OB members are federal officials at SCOTUS opens a similar path.

As for the Insular Cases it seriously aggrieved the people of Puerto Rico that the OB and US govt would use that ancient SCOTUS precedence to make their case in this appointments litigation. In those cases, from the beginning of the 20th century, SCOTUS essentially ruled that Puerto Ricans were "savages" and were not entitled to all the rights of US citizens. I would suggest that OB and USG dropped that argument because 100,000s of protesting on the streets in PR last summer and their anger could easily have been turned to the OB for that insult.

In terms of the orals I think the court was basically split and the most useful comments were those of the Chief Justice (at page 52):

"What if we -- I mean, I think it's very artificial to look at this and say, is this local or is this national? It obviously is some of each, or even the local aspects certainly have national implications.

So, again, I mean, where -- where do we -- I know what your answer is, but you could explain it. What do you do with -- what -- what do I do if I view it as some of each?"

Oral argument transcript here: https://drive.google.com/file/d/1q8Dn81ua9hOguJwMtjv-TADuXTU7_tbh/view?usp=sharing

The comments to this entry are closed.


Current Guests

Follow Us On Twitter

Like Us on Facebook

  • Like Us on Facebook

    By "Liking" us on Facebook, you will receive excerpts of our posts in your Facebook news feed. (If you change your mind, you can undo it later.) Note that this is different than "Liking" our Facebook page, although a "Like" in either place will get you Credit Slips post on your Facebook news feed.



  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless ([email protected]) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.