Congress Passes Puerto Rico "Oversight" Bill

Just before a $2 billion debt payment was to come due on July 1st,The Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) was passed in the U.S. Congress that creates a powerful elitist oversight board that will undercut fundamental contract law. for bond holders of  Commonwealth of Puerto Rico debt

 The seven-member control board will have the power to overrule stipulated guarantees in certain classes of debt, to oversee negotiations with creditors and the courts over reducing some debt.

The Act also includes a moratorium on litigation by bond holders meant to “empower the commonwealth during negotiations.”

 Logan Beirne, an ISP Fellow & Lecturer in Law at Yale Law School, where he teaches Financial Markets and Corporate Law, wrote earlier this week:

The proposed stay of litigation will set the government up for a Constitutional takings claim and disrupt the broader U.S. municipal market....

Puerto Rico’s constitution guarantees general obligation bondholders explicit priority over other obligations, including the expenses of the Puerto Rican Government. Specifically, Article VI, Section 8 states, “interest on the public debt and amortization thereof shall first be paid and must be serviced by the government prior to any other government obligation.” Congress not only affirmed this priority when it ratified the territory’s constitution, it reaffirmed when it approved the implementation of Puerto Rico’s constitutional debt limit in 1961.

Lured by this guarantee in addition to tax exemptions, investors poured money into the island – with the established hierarchy directly impacting their risk vs. reward calculations. But the House version of the bill seeks to change the terms post hoc. It provides the Puerto Rico Control Board with the sweeping power to place a temporary stay of litigation when it deems it necessary for the island’s financial interests.

Rather than press for Puerto Rico and creditors to negotiate a legal path forward, such action empowers Puerto Rico to walk away from the negotiating table. With investors hobbled by their inability to seek legal recourse, Puerto Rico’s government has little incentive to work with them during the moratorium and is empowered to instead divert its few remaining resources elsewhere. The bill does provide for creditors to seek relief for cause and to prevent irreparable harm, but that neglects the damage caused by such delays. Each day that passes diminishes the value of their investments.

In this way, the government is picking the winners and losers while ignoring long-established debt payment hierarchies. Once investors regain their full rights, their investments will almost inevitably be worth even less.

The solution, of course, should have been for Puerto Rico to outright default. PROMESA,in addition to distorting the bankruptcy system. also requires the territory to create a fiscal plan to bring the island back from it's current financial situation. Among other requirements, the plan would have to provide "adequate" funds for public pensions, which the government has underfunded by more than $40 billion.

Translation of: "create a fiscal plan to bring the island back from it's current financial situation" Squeeze the citizens of Puerto Rico, Greek style.

 -RW