Puerto Rico restructuring war to last decades as PROMESA battlefield shapes up

24 July 2018
Puerto Rico’s restructuring and the presence of the Financial Oversight and Management Board (FOMB) is expected to last decades as the scope of the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA) becomes clear.
 
Three restructuring attorneys, two creditors, a constitutional attorney, and one minority party lawmaker agreed that the commonwealth’s restructuring is poised to last anywhere between 20 to 30 years as courts are just beginning to interpret and define the contours of PROMESA.
 
Puerto Rico’s political status is also expected to play a leading role as the restructuring deepens through time, the sources agreed.
 
Two crucial factors make the operation especially arduous. One is the sheer size of Puerto Rico’s restructuring, which at USD 120bn is by far the largest ever in the US municipal market. The USD 120bn figure includes roughly USD 70bn in bonded debt and an additional USD 50bn in unfunded pension obligations.
 
“It’s an ambitious undertaking and it’s bound to take at least two or three decades,” said a restructuring attorney involved in Puerto Rico’s Title III litigation. “We’re talking about a complex scheme of issuers, government agencies, and a debt spiral that has been years in the making.”
 
But perhaps more importantly, it is the fact that PROMESA is a novel and unique law that makes the commonwealth’s restructuring timeline so lengthy.
 
“Puerto Rico has attracted the best attorneys, financial advisors, policy makers, you name it. But even for the most seasoned professionals, PROMESA represents a whole new ball game because it establishes a unique set of ground rules,” said a second restructuring attorney, also involved in the commonwealth’s Title III litigation.
 
“Title VI, for instance, and the exclusion of certain Chapter 9 provisions, make PROMESA a unique tool in the municipal bankruptcy world,” the second restructuring attorney added.
 
“PROMESA tinkers and tests the limits of the bankruptcy language in Chapter 9, and that in itself will require clarification from the courts,” said a third restructuring attorney.
 
“Indeed, it’s going to be a long process, and it’s a pity because Puerto Rican taxpayers are footing the bill for the litigation,” said the third restructuring attorney.
 
FOMB fumble
 
The singularity of PROMESA is extensive to its own creature, the FOMB, which for all intents and purposes acts as the physical manifestation of the federal law. Much like PROMESA, the FOMB is an untested body attempting to find its place and form within Puerto Rico’s restructuring.
 
“To a large extent, the FOMB’s identity will be shaped through its dialectical relationship to Puerto Rico’s government,” said the first restructuring attorney.
 
“The FOMB has to brush up against the bounds of PROMESA to understand its powers and limitations over Puerto Rico, and that takes time, especially when those interpretations are delegated to the judicial branch,” the first restructuring attorney said.
 
Nowhere did those inherent struggles become more apparent than in Governor Ricardo Rossello’s and the Legislative Assembly’s lawsuits against the FOMB over Puerto Rico’s FY19 budget.
 
Fired off this month, both lawsuits allege the FOMB has overstepped the boundaries of PROMESA by certifying and enforcing an itemized budget for the commonwealth that includes specific policy prescriptions.
 
Both entities had also tangoed earlier this year over control of the Puerto Rico Electric Power Authority (PREPA) – a battle that Puerto Rico’s government ultimately won after federal Judge Laura Taylor Swain ruled that the FOMB’s request to install Noel Zamot as PREPA’s head was out of line.
 
To be or not to be
 
For the FOMB to understand its powers, it must also wrestle with a much more profound, existential question: is it a territorial or federal entity?

At first glance, PROMESA seems to be quite explicit about the territorial nature of the FOMB, describing the board as an “entity within the territorial government” that is “not to be considered… a part of the federal government.”
 
Yet contradictory court rulings on the matter have cast the FOMB’s very essence into question, and that in turn brings Puerto Rico’s entire political status quandary to a head, said a constitutional attorney and Representative Rafael “Tatito” Hernandez, a member of Puerto Rico’s minority Popular Democratic Party.
 
To define PROMESA’s scope you must define the commonwealth’s political relationship to the US, mainly because PROMESA’s power emanates from the insular cases, said Hernandez and the constitutional attorney.
 
The insular cases refer to a series of opinions by the US Supreme Court in 1901 about the status of US territories acquired in the Spanish-American War. These cases are contemporaneous with the US Supreme Court’s 1896 ruling upholding racial segregation in Plessy v Ferguson and as such should be revisited, said Hernandez and the constitutional attorney.
 
Almost fatefully, the contradictory rulings on the FOMB’s essence arrived on the very same day (13 July).
 
In a lawsuit brought by Aurelius Investment, Judge Swain ruled against the famed Puerto Rico creditor and asserted the FOMB was constitutionally appointed. Judge Swain reasoned that the FOMB members need not go through congressional confirmation as mandated by the US Constitution’s Appointments Clause because they are territorial, not federal officials.
 
Just a few hours later, in a separate matter brought by Puerto Rico Employees’ Retirement System (ERS) bondholders, federal claims Judge Susan Braden ruled the opposite.
 
Judge Braden opined that that the FOMB is a federal entity and, as such, the ERS bondholders led by Altair Credit Opportunities can proceed with a USD 3bn claim on pension obligation bonds (POBs) against the federal government. The ERS bondholders argue the FOMB unconstitutionally allowed the commonwealth to stop making employer contributions backing those POBs.
 
Braden allowed some wiggle room by staying her case until courts resolve the Aurelius case as well as another case brought by electric worker employees that also argues FOMB member appointments violate the US Constitution’s appointments clause.
 
SCOTUS is the limit
 
If the FOMB is tasked with righting Puerto Rico’s economy, and the commonwealth’s economy is inextricably tied to its political status, then the status quandary must be brought to bear.
 
This year marks the 120th anniversary since Spain surrendered Puerto Rico and other territories to the US after swiftly losing the Spanish-American War.
 
Puerto Rico achieved a higher degree of sovereignty in 1952 when it was granted a new status as a commonwealth of the US. Puerto Rico also adopted its own Constitution that year, modeled closely after that of the United States and subject to the Territorial Clause.
 
A part of Article 4 of the US Constitution, the Territorial Clause grants Congress constitutional authority to control and manage all territories or other US-owned property.
 
Litigating Puerto Rico’s status would likely serve as a vehicle to understand the FOMB’s power, and is a question that will likely reach the Supreme Court of the United States (SCOTUS), according to all the sources.
 
“The contradictory rulings by Judge Swain and Judge Braden most likely will push the issue of PROMESA’s scope and, subsequently, Puerto Rico’s status all the way up to the US Supreme Court, said Hernandez and the constitutional attorney.
 
Last week, Aurelius elevated its constitutional challenge to FOMB appointments to the US Court of Appeals. And just yesterday (23 July), monoline insurer Assured Guaranty filed a lawsuit of its own echoing Aurelius’ arguments, and further arguing that the FOMB unconstitutionally lowered the priority of Puerto Rico’s general obligation debt.
 
“The FOMB doesn’t seem to understand its own mandates in PROMESA and has done everything backwards,” said a Puerto Rico creditor.
 
“It’s been two years now [since the FOMB was appointed] and we’re still on square one,” said another Puerto Rico creditor.
 
“The lack of a clear political status for Puerto Rico is directly related to its underperforming economy and that needs to be resolved,” said the third restructuring attorney.
 
“PROMESA mixes the politics of status with public finance, which creates political instability, and that’s why everyone is fighting with the board,” said Hernandez.
 
It’s unclear whether SCOTUS or any of the other courts will decide to tackle Puerto Rico’s political status. Courts usually avoid overarching rulings, meaning they will try to resolve Puerto Rico’s restructuring without taking up the status question if they can avoid it, the restructuring attorneys agreed.
 
However, repeated collisions between Puerto Rico’s government and the FOMB and contradictory rulings such as those issued by Judge Swain and Judge Braden might force SCOTUS’ hand.
 
“If the restructuring is completed rapidly, the status issue will lose relevance, but if the clashes between the board and the commonwealth continue this will bring Puerto Rico’s status issue to a head,” the constitutional attorney said. “We are definitely living in historic times.”