Will the U.S. government be held liable for Puerto Rico’s debt?
Editor’s note: This story first appeared in the May 3-9, 2018, issue of Caribbean Business.
When the territory of Washington, D.C., was taken over by a financial control board in the 1990s, the federal government, unlike it did in Puerto Rico, paid the region’s pension liability and allowed D.C. to borrow from the U.S. Treasury to finance $500 million of debt.
The federal government agreed to assume the District’s $5 billion pension liability—a debt as large as its entire budget at the time—for all active and retired employees. The federal government also agreed to provide D.C. $129 million in the first year of its debt crisis and $685 million over five years to fund the city’s courts and alleviate that drain on the capital’s budget.
It also increased Medicaid funding and gave the nation’s capital the authority under a revitalization plan to take from the federal government a 15-year loan to pay up to $500 million in debt.
Flash forward to 2016, when Congress enacted the Puerto Rico Oversight, Management & Economic Stability Act (Promesa) with the stipulation that says the full faith and credit of the U.S. will not be extended to Puerto Rico’s debt and the federal government will not be held liable for the island’s massive $70 billion debt or any obligation.
Is that legal?
Some individuals and lawyers believe this provision in Promesa may be unconstitutional. Last week, several unions, civic groups and individuals sued in U.S. District Court to challenge the constitutionality of the Financial Oversight & Management Board. As part of the lawsuit, they sought to include the U.S. government in the legal action not only to assume a position on their claims but also to “assume any and all constitutional and legal liabilities it should be compelled to assume over the public debt of the government of Puerto Rico.”
In the lawsuit, filed by René Pinto Lugo and others against the Oversight Board and U.S. government, the plaintiffs noted the U.S. created conditions that led to Puerto Rico’s bankruptcy. They noted that Congress eliminated Section 936 tax incentives, which had helped attract industries to the island, and thus hindered its economic development and government revenues.
In the context of history, the lawsuit states the U.S. government has used the so-called Insular cases, a series of early 20th-century Supreme Court rulings that have served to justify discrimination against the territories, to give Puerto Rico less federal funding than what the federal government provides mainland states for services.
Lawyers argue that recent U.S. Supreme Court rulings that state Puerto Rico does not have sovereignty separate from that of the United States makes the U.S. government liable for the island’s debt.
Yasmín Colón, an attorney who wrote a book on Promesa with Rolando Emmanuelli, said the Sánchez Valle case decided that the ultimate source of power for Puerto Rico lies in Congress. This ruling, which was made shortly before Promesa’s approval, says a person convicted of a crime in federal court cannot be tried for the same crime in local courts because there are no separate sovereignties.
As an analogy, Colón compared it to an adult being held liable for the damages done by a minor child in civil court. “The adult is the one who answers for the child and pays for the damages,” she said.
Colón said she does not know of any ruling that may support the argument that Puerto Rico should be held solely responsible for its debt.
The Pinto Lugo suit also calls for the court to order an audit of the debt to determine its legality. Why is that important? A U.S. Supreme Court ruling in the 1885 Litchfield v. Ballou case held that bonds created in violation of a municipal debt limit do not have to be repaid. Puerto Rico also has constitutional limitations on its debt.
In 2016, a debt commission released what it called a “Pre-audit Survey” of the $3.5 billion general-obligation bond sale of 2014, which took place after Puerto Rico’s bonds were downgraded to junk status and one issued in 2015. The report contained several findings that suggest possible illegalities, including the fact that the government borrowed to cover deficits. The report contended that Puerto Rico had borrowed over $30 billion to cover deficits and may have been doing so since 1979. But the report pointed out that the island’s Constitution explicitly prohibits budget deficits.
The audit commission also found Puerto Rico was spending somewhere between 14 percent and 25 percent of government revenues on debt repayment—which is significant because the Constitution prohibits spending more than 15 percent. It also prohibits most bond sales that would mature more than 30 years after their issue, yet the commission found that because of the terms of the 2014 sale, debt issued in 1987 will not be paid off until 2035, 48 years later.
The problem with this is that Puerto Rico cannot use this argument in court because it has not completed recent financial audits nor formally audited its debt.
While there is no doubt that Puerto Rico’s debt is unpayable, most economists argue the island must not only restructure its debt to pay some of it, but also if it ever wants to regain creditors’ trust in the market—the only source of borrowing. “Not paying debt is not an option regardless of court rulings because who will trust us again,” said a source who works in the Title III proceedings.
The source also believes that asking the United States to pay the debt is “wishful thinking.” President Trump talked about the possibility of erasing the island’s debt, only to have the White House clarify that he did not mean it.
The matter will be decided in the courts.