Puerto Rico's Debt Dilemma and Pathways Toward Sovereign Solvency

• DOI: http://doi.org/10.1111/ablj.12094
• Author: Tim R Samples,Stephen Kim Park
• Date: 01 March 2017
• Published date: 01 March 2017

Puerto Rico’s Debt Dilemma

and Pathways Toward Sovereign

Solvency

Stephen Kim Park* and Tim R Samples**

INTRODUCTION

The debt crisis currently facing Puerto Rico is geographically small in scope

but enormous in its legal complexity and policy implications. Grappling with

worsening structural problems, economic shocks, and public finances, Puerto

Rico’s unsustainable debt burden has threatened to topple its economy and

destabilize its relationship with the United States.

1

In June 2015, the Gover-

nor of Puerto Rico declared Puerto Rico’s “unpayable” $72 billion debt a

“death spiral.”

2

Weeks after defaulting on a $58 million bond payment,

3

*Assistant Professor of Business Law, University of Connecticut School of Business.

**Assistant Professor of Legal Studies, Terry College of Business, University of Georgia.

The authors wish to thank Anna Gelpern, Mitu Gulati, Mark Weidemaier, Lee Buchheit,

Cate Long, Charles Blitzer, and Chanda DeLong, as well as colleagues, friends, and family,

for their comments and encouragement. This article received the Holmes-Cardozo Award

for Best Submitted Conference Paper at the 2016 Annual Conference of the Academy of

Legal Studies in Business. Prior versions of this article were also presented at the Interdis-

ciplinary Sovereign Debt Research and Management Conference at Georgetown Universi-

ty Law Center in 2016 and the 2015 Annual Conference of the Southeastern Academy of

Legal Studies in Business. All errors and omissions are our own.

1

See ANNE O. KRUEGER ET AL., PUERTO RICO—A WAY FORWARD 3–13 (2015), http://www.bgfpr.

com/documents/FinalUpdatedReport7-13-15.pdf.

2

Michael Corkery & Mary Williams Walsh, Puerto Rico’s Governor Says Island’s Debts Are ‘Not

Payable,’N.Y. TIMES (June 28, 2015), http://www.nytimes.com/2015/06/29/business/dealbook/

puerto-ricos-governor-says-islands-debts-are-not-payable.html.

3

See Aaron Kuriloff, Puerto Rico Defaults on Most of $58 Million Debt Payment,WALL ST.J.

(Aug. 3, 2015, 4:30 PM), http://www.wsj.com/articles/puerto-rico-misses-most-of-58-million-

debt-payment-1438633822.

V

C2017 The Authors

American Business Law Journal V

C2017 Academy of Legal Studies in Business

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American Business Law Journal

Volume 54, Issue 1, 9–60, Spring 2017

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Puerto Rico released a debt restructuring plan in September 2015, calling

for a voluntary bond exchange.

4

Amidst a series of defaults and rapidly

worsening economic conditions in the first half of 2016, Puerto Rico’s crisis

hit a boiling point, with stark ramifications for the island and the municipal

bond market.

5

Following the enactment of the Puerto Rico Oversight, Man-

agement, and Economic Stability Act (PROMESA) in June 2016,

6

Puerto

Rico must now work with its external creditors to obtain debt relief through

restructuring.

7

However, the legal blueprint for this uniquely complex

restructuring is still coming into focus.

Puerto Rico faces a debt dilemma that is shaped by the legal limbo of

its status as a U.S. territory. Puerto Rico is neither a sovereign govern-

ment nor a municipality.

8

Rather, it is a quasi-sovereign, with uncertain

legal powers and obligations.

9

Puerto Rico lacks sovereign prerogatives,

as well as the powers of a state government in the U.S. federal system.

10

As a result, Puerto Rico issues debt as a municipality yet has historically

lacked recourse to municipal bankruptcy under Chapter 9 of the U.S.

4

WORKING GROUP FOR THE FISCAL AND ECON.RECOVERY OF PUERTO RICO,PUERTO RICO FISCAL

AND ECON.GROWTH PLAN 65 (2015), http://bgfpr.com/documents/PuertoRicoFiscalandEcono-

micGrowthPlan9.9.15.pdf.

5

See Heather Gillers & Nick Timiraos, Puerto Rico Defaults on Constitutionally Guaranteed

Debt,W

ALL ST. J. (July 1, 2016, 6:24 PM), http://www.wsj.com/articles/puerto-rico-to-default-

on-constitutionally-guaranteed-debt-1467378242.

6

Puerto Rico Oversight, Management, and Economic Stability Act, H.R. 5278, 114th Cong.

(2016).

7

Over one-third of Puerto Rico’s debt is owned by U.S.-based and other offshore hedge

funds and mutual funds, which have an outsized role in Puerto Rico’s future. See Heather

Long, Who Owns Puerto Rico’s Debt?, CNNMONEY (July 1, 2015, 7:06 PM), http://money.

cnn.com/2015/07/01/investing/puerto-rico-bond-holders.

8

See Mitu Gulati & Bob Rasmussen, Guest Post: Puerto Rico—Debtor, Heal Thyself,FIN.TIMES,

Jan. 14, 2016, Factiva, Doc. No. FTCOM00020160114ec1e006y1. (“In short, Puerto Rico

is—both tactically and geographically—precisely half way between Detroit and Buenos

Aires.”).

9

See Anna Gelpern, Bankruptcy, Backwards: The Problem of Quasi-Sovereign Debt, 121 YALE L.J.

888, 897 (2012); see also Adam D. Chandler, Comment, Puerto Rico’s Eleventh Amendment

Status Anxiety, 120 YALE L.J. 2183, 2186–87 (2011).

10

See Stephen J. Lubben, Puerto Rico and the Bankruptcy Clause,88AM.BANKR. L.J. 553, 556

(2014) (“Puerto Rico was thus left in a kind of constitutional limbo, whereby Congress

might treat it in ways that would be prohibited with regard to a state or even a continental

territory.”); see also David A. Skeel Jr., States of Bankruptcy,79U.C

HI.L.REV. 677 (2012).

10 Vol. 54 / American Business Law Journal

Bankruptcy Code.

11

Among Puerto Rico’s outstanding bonds, various

levels of priority and legal rights exist, thereby compounding intercredi-

tor complications.

12

Roughly one-third of Puerto Rico’s $72 billion debt

is tied to government-owned enterprises, which also lacked access to the

U.S. federal bankruptcy process prior to PROMESA.

13

Amidst the legal and political uncertainty facing Puerto Rico, this arti-

cle examines the process by which Puerto Rico has engaged in negotia-

tions with its creditors.

14

In the absence of a sovereign bankruptcy

regime, many sovereign debt restructurings have included committees

composed of representative creditors.

15

Creditor committees were par-

ticularly common and influential in the 1980s, when creditors were

almost exclusively commercial banks and debt instruments were primar-

ily syndicated bank loans.

16

Today, sovereign debt instruments are pri-

marily bonds, and creditors are mainly institutional bondholders—

among which include, most notably, distressed debt hedge funds that

acquire government-issued bonds at a discount on the secondary market

(i.e., “vulture funds”).

17

Conflicting incentives among increasingly

11

See Vincent S.J. Buccola, An Ex Ante Approach to Excessive State Debt,64DUKE L.J. 235,

269–80 (2014) (describing the application of Chapter 9 to states).

12

For example, certain bonds have constitutional guarantees for priority of payment. See

P.R. CONST., art. VI, § 8; see also infra Part I.B (discussing debt obligations and specific

pledges in Puerto Rico’s bonds).

13

See Lubben, supra note 10, at 553 n.4 (noting that $24.8 billion of debt owed by Puerto

Rican public companies is not supported by the Puerto Rican central government or the

U.S. federal government). In this article, the term “public company” refers to

government-owned enterprises of Puerto Rico. See MARK D. JOFFE &JESSE MARTINEZ,MER-

CATUS CTR.AT GEO.MASON U., ORIGINS OF THE PUERTO RICO FISCAL CRISIS 7–8 (2016),

https://www.mercatus.org/system/files/Joffe-Puerto-Rico-Fiscal-Crisis-v1.pdf (explaining the

origins of public companies in Puerto Rico).

14

In this article, Puerto Rico, in its capacity as a quasi-sovereign debtor, collectively refers

to the central government, municipalities, and public companies of Puerto Rico, unless

otherwise specified.

15

See Lee C. Buchheit, Use of Creditor Committees in Sovereign Debt Workouts,10BUS.L.INT’L

205, 206–09 (2009).

16

Id. at 207; see also Lee C. Buchheit & Ralph Reisner, The Effect of the Sovereign Debt

Restructuring Process on Inter-Creditor Relationships, 1988 U. ILL.L.REV. 493, 500–04 (1988)

(describing intercreditor issues in syndicated lending structures).

17

See Jill E. Fisch & Caroline M. Gentile, Vultures or Vanguards?: The Role of Litigation in Sov-

ereign Debt Restructuring,53E

MORY L.J. 1043, 1074–79 (2004) (describing creditor

2017 / Puerto Rico’s Debt Dilemma 11