In 2017, Puerto Rico and certain of its affiliates filed “bankruptcy” petitions under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”).  These cases are pending in the U.S. District Court for  Puerto Rico; however, under the law Judge Laura Taylor Swain in New York was appointed to preside over the cases.  My new paper – Puerto Rico; Act III – provides an overview of where things stand  and where they might be heading.

PROMESA is a bankruptcy law, with various bells and whistles attached. In addition to its restructuring provisions, the law creates the Financial Oversight and Management Board for Puerto Rico.  The board frequently states (particularly in press releases) that “the purpose of the Oversight Board is to provide a method for Puerto Rico to achieve fiscal responsibility and access to the capital markets.”  In essence the Board operates as a supra-governmental body for fiscal matters.

Title III of PROMESA creates a court-supervised process for the board, the commonwealth and its affiliates, and creditors to reach a consensual reorganization plan – formally called a “plan of adjustment,” in both chapter 9 and PROMESA.  The process has similarities with chapter 9 and chapter 11 of the Bankruptcy Code, but many provisions are unique to PROMESA.  The court shall confirm the plan if, among other requirements, it complies with the applicable provisions of the Bankruptcy Code, is feasible, and is consistent with the fiscal plan certified by the oversight board.

In the years since the Title III cases were commenced, Puerto Rico has been beset by natural disasters and political turmoil.  Key among the former was the turbulence of August 2019, when Puerto Rico had three different governors in short order.  Among the former, during 2020 the island experienced a series of significant earthquakes, as well as the effects of the COVID-19 pandemic.

In the face of the many recent calamities, the oversight board has attempted to push forward with a reorganization under Title III.  The pandemic, however, might substantially delay the process and force a reconsideration of the present reorganization plan.  It thus represents the opening of a third act – of how many, we do not yet know – in Puerto Rico’s debt drama.

Even before recent events, I had argued that the board was far too timid in its efforts to revamp Puerto Rico’s economy, given that the PROMESA process was presumably a one-time opportunity.   In particular, the debt relief the board proposed was comparatively modest, and I worried that it might still leave the commonwealth with too much debt to successfully restart its economy.

The problem is that almost nobody supports the board’s current plan, making even “cramdown” of the plan extremely unlikely.  To achieve such a non-consensual plan, the board will have to find at least one constituency to buy in.

Pensioners might be the most likely ally, although the government of Puerto Rico, and presumably many of the pensioners, object to the current offer.  As Justice Sotomayor recently noted,

The Board’s decisions have affected the island’s entire population, particularly many of its most vulnerable citizens. The Board has ordered pensions to be reduced by as much as 8.5 percent, a measure that threatens the sole source of income for thousands of Puerto Rico’s poor and elderly… Other proposed cuts take aim at already depleted healthcare and educational services. It is under the yoke of such austerity measures that the island’s 3.2 million citizens now chafe.^[1]

Indeed, Justice Sotomayor’s recent opinion also provides a kind of roadmap for a challenge to PROMESA, and the creation of the oversight board, if any party wants to take it.  In short, she explains that she concurred in the Supreme Court’s result only because nobody had argued that Puerto Rico’s commonwealth status was inconsistent with the creation of the oversight board.  As she sees it, Congress made certain commitments to Puerto Rico back in the 1950s when it created the commonwealth, and Congress may not “take back” those commitments.   Any litigation following her approach would presumably involve extensive and time consuming appeals.  But it looms as a threat to the PROMESA process, particularly if the process drags on for a substantial length of time.

At heart, the problem in Puerto Rico is not unlike the problem in many sovereign and municipal workouts.  The bondholders want to recover as much as possible, of course, and are leery of settling claims only to see the debtor rebound shortly thereafter.  The conundrum is that the rebound is unlikely to happen without serious debt reduction.  Debt reduction is often not the only requirement for a rebound, but it is fundamental.  The continuous cycle of bondholders refusing to agree to meaningful debt reduction for fear of “missing out,” but there being nothing to miss out on unless the debt is cut, is the basic problem of all these sorts of workouts.

Either the board needs to lead Puerto Rico out of this feedback loop, or Puerto Rico needs to extract itself from the PROMESA process.  If not, the drama will continue for many more acts.

ENDNOTE

[1] Financial Oversight And Management Bd. For Puerto Rico v. Aurelius Investment, LLC, 590 U. S. ____ (2020), Sotomayor, J., concurring in judgment, slip opinion at page 7.

This post comes to us from Professor Stephen J. Lubben, the Harvey Washington Wiley Chair in Corporate Governance & Business Ethics at Seton Hall University School of Law. It is based on his recent article, “Puerto Rico; Act III,” available here.