Congress appears to be hurtling toward passage of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), which would provide potential restructuring for Puerto Rico’s $70 billion debt, while establishing a fiscal control board to oversee virtually every aspect of the island’s fiscal activities, from budget cuts to construction and energy projects. Outside of Bernie Sanders, there appears to be little impetus in Congress to fight PROMESA, despite progressive uneasiness with the inherent colonialism of stripping Puerto Rico of its self-government in favor of unelected minders in Washington, not to mention provisions that would hit workers, by lowering the minimum wage and exempting the island from the administration’s new overtime rule.
Liberals stress that, despite its flaws, PROMESA would give Puerto Rico essential tools it needs to restructure its debt, and it represents the best opportunity for relief for 3.5 million American citizens suffering under vicious austerity. Moreover, they say this needs to happen right now. While Puerto Rico has already defaulted on portions of its debt three times, a $1.9 billion debt payment due July 1 is much larger, and it involves general obligation debt, which carries a constitutional guarantee. Failure to make that payment would trigger legal action and commence a chaotic process that could take years to untangle. To avoid that, both parties demand that Congress pass PROMESA without delay.
But Puerto Rico could obtain significant debt-restructuring authority before the July 1 deadline and without congressional action, if they get a favorable Supreme Court ruling on a case argued in March. This would change the dynamics of the debt fight, enabling Puerto Rico to dictate terms on at least $20 billion of its obligations. But passing PROMESA prematurely would nullify that ruling, and harm the island’s ability to get more favorable terms.
The case, Puerto Rico v. Franklin California Tax-Free Trust, involves the Recovery Act, a local law passed in 2014 that the commonwealth claims enables them to restructure the debt of public corporations. Puerto Rico used over a dozen different vehicles to issue debt over the past decade. In many cases they set up public corporations for this purpose. The Recovery Act would allow debt restructuring backed by the government’s Electric Power Authority (known as PREPA), Aqueduct and Sewer Authority (PRASA), Highways and Transportation Authority (PRHTA), Telephone Authority, Ports Authority, and a few others.
The local law is not part of the federal bankruptcy code. Under a series of amendments passed in 1984, both Puerto Rico and the District of Columbia cannot allow its municipalities and public utilities to enter U.S. bankruptcy. But the Recovery Act creates a parallel process, supervised by local courts, to achieve similar ends, albeit with fewer protections for creditors than the bankruptcy laws.
Bondholders carrying this debt immediately sued, arguing that the 1984 amendments also prevented Puerto Rico from devising its own bankruptcy-like plan. The problem with this argument is that there’s no legislative history spelling that out. So judges interpreting the law have nowhere else to turn but the plain text.
The U.S. Court of Appeals for the Second Circuit agreed with the bondholders, ruling that Puerto Rico could not set up its own debt-restructuring procedure. The Supreme Court decided to hear the case on appeal. Given the 4-4 split on the Court with the vacancy created by Antonin Scalia’s death, a vote along political lines might produce a stalemate, and a reversion to the appeals court ruling. But Justice Samuel Alito recused himself, because like many holders of municipal bond mutual funds, he owns some of Puerto Rico’s debt.
That 4-3 split gave Puerto Rico an opportunity to sway liberals on the Court and win the case. At the March 22 hearing, they appeared to get the better of the argument. Justice Sonia Sotomayor, born to Puerto Rican parents, wondered why only Puerto Rico among U.S. territories would be treated differently in bankruptcy, unable to create their own restructuring law. Justice Ruth Bader Ginsburg agreed: “What explains Congress wanting to put Puerto Rico in this anomalous position of not being able to restructure its debt?” While Justices Elena Kagan and Stephen Breyer didn’t tip their hands completely, Kagan admitted she initially planned to vote against Puerto Rico, but was swayed by the legal argument.
Matthew McGill, the lawyer representing bondholders, countered that “Congress has for a long time micromanaged Puerto Rico’s debt,” something they appear ready to do again. The implicit assumption was that Congress made this distinction on Puerto Rico because of a lack of faith in their fiscal management. But there’s no documentary evidence for that assumption. And if Puerto Rico wins the case, they could use the Recovery Act to force restructuring on public corporation debt.
That still leaves another $50 billion or so without the same protection. But the commonwealth government could build upon the Recovery Act to cover debts beyond public corporations, or to convert debt to make it eligible for debt restructuring. “What would stop Puerto Rico from expanding it to cover much more of the overall capital structure at issue?” asked Stephen Lubben of Seton Hall Law School in a recent blog post.
The answer is that PROMESA would stop them. Section 303 of the bill specifically frees creditors from any “territory law prescribing a method of composition or moratorium of indebtedness of the territory,” effectively pre-empting the Recovery Act.
Bondholders don’t want any court-managed restructuring of their debt; they’d rather be paid off in full. But they’d prefer a process with the protections of PROMESA and the imprimatur of the U.S. government to a local law administered by Puerto Rican judges. Therefore, if the Supreme Court rules for Puerto Rico, you may see the same dark-money groups spending hundreds of thousands of dollars to oppose PROMESA do an about-face, and urge Congress to pass it, to stop the Recovery Act.
Liberals worried about PROMESA but seeing it as the only alternative to chaos in Puerto Rico should think hard about the pending Supreme Court decision, which will come sometime this month. Why rush through a bill re-colonizing Puerto Rico when the Supreme Court might give the island a path to solve the problem themselves? Why agree to all the harsh measures in PROMESA if the leverage changes with a favorable Supreme Court opinion? It’s clear that liberals aren’t enamored with the bill as written. If it’s suddenly the only way to save hedge funds and other investors from deep haircuts on Puerto Rican debt, they could ask to excise the worst parts in exchange for their vote.
It would be madness for Democrats to use PROMESA to extinguish the Supreme Court ruling, without getting something for the people of Puerto Rico in return. They would be expressly intervening on behalf of creditors for no justifiable reason. Hopefully liberals will hold off on passing a flawed bill until they understand the alternatives.