On the Brink of Governmental Bankruptcy

Good Morning! In this a.m.’s eBlog, we consider the unique federalism and fiscal challenges confronting Puerto Rico—a U.S. territory in the Rod Serling Twilight Zone between a state and a municipality. 

Mayday. With a May Day midnight deadline looming under the PROMESA law, the PROMESA Oversight Board, meeting in New York City, officially put on the table the possibility of using the PROMESA Title III judicial bankruptcy mechanism as a chapter 9-like mechanism to initiate the use of judicial proceedings to allow the U.S. territory access to the use of quasi-judicial proceedings to allow Puerto Rico to escape from some $70 billion of debt, adopting a resolution permitting such a fateful decision today in an executive meeting, without the need for a public meeting, using the mechanism contemplated under Title III of PROMESA. At its New York City session, the PROMESA Board resolution adopted this weekend, provides that “[B]etween the closing of this session and the opening of the next public meeting, the Board may consider in executive session any matters that it is authorized to consider under PROMESA,” in the wake of the adoption of the fiscal plans of four Puerto Rican public corporations, three of them with important amendments aimed at revising rates and examining models of privatization. Now, in order to bring the Board’s debt restructuring proposal before a judge, who must be appointed by the presiding Justice of the US Supreme Court, five of the seven Board members have to vote in favor of a restructuring.

At a press conference, PROMESA board Chairman José Carrión III stated: “We reserve the right to deal with any presentation of a resource or certification in an executive session;” however, he avoided commenting on what would happen if May 2nd arrives and the Government of Puerto Rico has not reached an agreement with its creditors—with a critical focus on the U.S. territory’s main investment funds via general obligation bonds, those which have preference under Puerto Rico’s Constitution, and the Corporation of the Appealing Interest Fund (Cofina). Thus, while the Government of Puerto Rico has been hoping to achieve an extrajudicial agreement with its main creditors which would have allowed it to continue debt discussions after today, that option appears to have died. For his part, Chair Carrión, meanwhile, hoped that any decision to go to federal court to ask for the creation of a territorial bankruptcy court. He said he hoped that any restructuring of Puerto Rico’s general obligation debt would gain the support of Gov. Ricardo Rosselló’s administration: “We want to be aligned with the government, and I think they have been able to see that the work has been done together. The government has raised its fiscal plans, we have contemplated changes, made suggestions and the government has welcomed them.”

The Mayday deadline marks the expiration of a moratorium on the judicial litigation for collection of the debt of the Government of Puerto Rico, which has served as a shield for the U.S. territory’s authorities since last June 30th, thus, as in a chapter 9 municipal bankruptcy, serving to prevent claims from jeopardizing essential public services. Unsurprisingly, neither the members of the PROMESA Oversight Board, nor the government of Governor Ricardo Rosselló has wanted to declare how ready they are to bring debt restructuring cases to the courts. Under a unique mechanism, the members of the PROMESA Board will be able to vote today by e-mail, as the authorizing resolution reads: “Between the adjournment of this meeting and the opening of the next public meeting, the Board may consider in an executive meeting any matters that it is authorized to consider under PROMESA,” referencing the resolution, which was the first agreement ratified at this weekend’s PROMESA Board meeting in New York, where the Board adopted the tax plans of four public corporations, three of them with major amendments focused on revising rates and examining privatization models. In order to bring the debt restructuring proposal before a judge, per the unique process described above, five of the seven members of the Board must vote in favor thereof. PROMESA Board Chair José Carrión III noted the Board reserves “the right to deal with any appeal or certification, at an executive meeting.”  At the very least, the Government of Puerto Rico hopes to reach an extra-judicial settlement with its major creditors that enables continuation of talks after today–without being sued—notwithstanding how difficult it would be to adopt any agreement which would prevent judicial actions by other holders of Puerto Rico’s municipal bonds. (Note: the key focus has been with regard to the U.S. territory’s main investment funds which hold general obligation bonds, which have a preferred status according to Puerto Rico’s Constitution, and the Sales Tax Financing Corporation (COFINA)).

For his part, Chair Carrión has hoped that any decision to resort to the federal court to request the creation of a territorial federal bankruptcy court would have the support of Gov. Rosselló’s administration, noting: “We’re trying to do our best and trying to do the right thing by all the stakeholders and the people of Puerto Rico.” The Chairman told reporters after the meeting. “It’s a very difficult situation. These folks have lent Puerto Rico money, and we are where we are, and it’s not a situation where we don’t understand…We want to be aligned with the government, and I believe you have seen that these efforts have been made jointly.  The government has proposed its fiscal plans; we have contemplated changes, made suggestions; and the government has accepted them.” The extraordinary federalism here led Elías Sánchez, Gov. Rosselló’s representative before the PROMESA Board, to assert that the PROMESA Board should act on the basis of a debt adjustment requested by the head of a dependency. That is, the PROMESA statute, unsurprisingly, did not specifically specify whether the PROMESA Board is obligated to have Puerto Rico’s support. Chair Carrión, over the weekend, said that the U.S. Treasury Department had discarded the idea that Congress may be entertaining any amendment to postpone the possibility of using the judicial bankruptcy mechanism contemplated in PROMESA—with the statement coming as some conservatives in Congress have been distributing a potential amendment to the next omnibus bill set to be considered before the end of this week, which would allow blocking the territorial bankruptcy mechanism—apparently backed by groups of creditors of the Government of Puerto Rico.

Legal Deadline. The decision comes with tonight’s expiration of a legal stay which has sheltered Puerto Rico from lawsuits filed by its municipal bondholders after a series of escalating defaults, and in the wake of making little meaningful headway in negotiations with creditors, leading, seemingly intractably to the courts—as was the case in Detroit, Stockton, Jefferson County, Central Falls, and San Bernardino—and marks the end of a last gap effort by some of the U.S territory’s general obligation bondholders to achieve a “consensual solution that is based on a credible financial forecast and that avoids the free fall Title III that the Oversight Board seems intent on imposing.” Indeed, as late as Saturday, Gerardo Portela Franco, the Executive Director of Puerto Rico’s Fiscal Agency and Financial Advisory Authority, said Puerto Rico was committed to reaching a consensual resolution with its creditors, noting the territory’s proposal was “intended to maximize returns to its creditors in a manner consistent with Puerto Rico’s goals for economic growth equitably,” and adding: “The government anticipates the discussions to continue over the coming weeks.” He was discussing an offer to repay general-obligation bondholders as much as $10.25 billion of the $13.2 billion they are owed, according to the proposal, and that sales tax bondholders would receive as much as $10.2 billion of $17.6 billion of sales tax bonds. Under said proposal, investors would exchange their existing municipal securities for two different types of debt: tax-exempt senior bonds with a constitutional priority maturing in 30 years, and cash-flow bonds that would be repaid after the senior securities, depending on the commonwealth’s liquidity. That proposal would have meant providing g.o. bondholders a recovery range of as little as 52%. Nonetheless, Puerto Rico bondholders had rejected Governor Rossello’s debt-restructuring proposal days before today’s deadline—effectively triggering the PROMESA provision.  

In a separate but related action, the PROMESA Board approved winding down Puerto Rico’s government development bank, which financed public works on the island until it defaulted during the crisis. Elias Sanchez, Governor Ricardo Rossello’s PROMESA representative stated: This will provide a viable path for an orderly process for the Government Development Bank with the least impact for stakeholders involved.”

Meanwhile in the Nation’s Capital. With Congress in OT after failing to act by last Friday, Congressional negotiations over including healthcare funding for Puerto Rico may have been stymied in the pending Continuing Resolution (CR) in the wake of President Trump’s tweet denouncing the idea; nevertheless, there appear still to be efforts in Washington to negotiate health care assistance in return for Puerto Rico’s agreement to a temporary hold on any use of bankruptcy-like provisions available under PROMESA. In the negotiations, Democrats in the House and Senate had been pushing to get Medicaid funding for Puerto Rico included in the CR, with some indications that Republican leaders have agreed that some type of Medicaid funding is needed for the Commonwealth—which is expected to exhaust its Medicaid funding under the Affordable Care Act by the end of the year, putting a huge strain on its ability to provide healthcare to its citizens—deemed a “Medicaid cliff” by Gov. Ricardo Rosselló, who, over the weekend noted: “This is not a bailout…This is what was allotted to Puerto Rico in the first place and is what is needed for us to have a runway in the next year so we can execute certain changes to our health industry.”

However, in a pair of tweets, President Trump blasted the possibility of Medicaid funding for Puerto Rico in a continuing resolution; he also took the opposite view in a pair of tweets late Wednesday and early Thursday last week which linked Democrats’ calls for funding help in Puerto Rico with insurer subsidies under Obamacare, writing: “Democrats are trying to bail out insurance companies from disastrous #ObamaCare, and Puerto Rico with your tax dollars. Sad!” The next day he tweeted: “The Democrats want to shut government if we don’t bail out Puerto Rico and give billions to their insurance companies for OCare failure. NO!” Thus, with Congress in overtime this week, the extra time could provide Congress more time to debate a potential agreement which would delay the Commonwealth’s ability to seek in-court restructuring of its debts in exchange for the Medicaid funding—albeit, the clock, as noted above, expires today.  

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