Creditor Groups Mull Challenge to P.R. Default
By Philipe Schoene Roura & Luis J. Valentín
The Alejandro García Padilla administration’s default on some $800 million in general-obligation bonds (GOs) due July 1 has several creditor groups contemplating legal action against the Puerto Rico government despite the stay on litigation contained in Promesa’s Title IV.
“Just as GDB [Government Development Bank] creditors filed for an extension of their suit outside the Promesa stay, you could see creditors suing, not on the invalidity of the action, but the fact that it doesn’t follow Promesa,” explained one creditor source with knowledge of the matter during an exclusive interview with Caribbean Business.
“Promesa requires that interest be paid as feasible and to respect the priority of the [Puerto Rico] Constitution. It’s a shame that the first act by the commonwealth was to violate Promesa itself,” added the source, who chose to remain nameless.
He was making reference to the provision under Section 405 of Promesa pertaining to interest payments: “To the extent the Oversight Board, in its sole discretion, determines it is feasible, the government of Puerto Rico shall make interest payments on outstanding indebtedness when such payments become due during the length of the stay.”
However, it is unclear who makes that call in the time before the board is constituted. On July 1, roughly $353 million in interests were not paid as part of the $780 million defaulted GO payment.
When asked by Caribbean Business whether he had the authority under Promesa to make the decisions he made on July 1, the governor said, “Absolutely; if not, I wouldn’t have done it.”
The administration left roughly $146 million sitting in a “clawback account” held in a private bank—monies taken since late last year from some of the island’s public entities originally pledged to pay for their debt. An additional $143 million in clawed back revenues are deposited at the GDB, which brings the total to $269 million, according to the government’s recently published audited statements.
Under its Constitution, Puerto Rico can take control of previously pledged revenue streams, but only to service its constitutionally guaranteed debt if no other resources are available. Although it first triggered the clawback measure to cover a $400 million payment due Jan. 2 on commonwealth-guaranteed debt, the administration did not tap into these funds on July 1, and has yet to announce their use.
Moreover, GO holders point to the fact that the most senior constitutionally protected priority obligations of the commonwealth were not covered, whereas other less-secured credits were paid.
“The idea that the stay is somehow a fair-play notion to create a timeout for the commonwealth is just not true,” one source said. “The most important vehicle for commerce—the GO bond, which provides funding for infrastructure and for essential services—was just pushed aside. When people borrow, they expect to be paid back. We knew there was going to be a default, what is amazing is how much they went out of their way to pay everyone else but the GOs.”
Officials said payments made on July 1 corresponded to entities that already prefunded their payments or their trustees had enough reserves to cover for them.
Territorial in a domestic sense?
The concerns over legal action against Promesa itself were present during the process of drafting and lobbying the measure. For instance, constitutionality issues came to the forefront in debate during the markup of the measure in the House Natural Resources Committee.
“So Promesa can be challenged in a number of ways—on its constitutionality,” said one Capitol source tied to the Democratic Party with knowledge of negotiations. “There was a lot discussion on that front. Even the U.S. Treasury Department had some questions; they were laboring to make it as ‘suit proof’ as possible because of their concerns over the constitutionality of the measure.”
The source said that because there were concerns over the uniformity clause—that bankruptcy is uniform throughout the U.S.—the federal government wanted to make the point that Puerto Rico was a territory when the U.S. Supreme Court was hearing Puerto Rico v. Sánchez Valle. “If you look at Justice’s filing [in that case], one of the reasons was that we may need to do something about Puerto Rico’s debt,” the Capitol source told Caribbean Business.
“And Promesa, which is really directed by the U.S. Treasury and the Obama administration, makes very clear that Puerto Rico being a territory is having this law enacted under the territorial clause because of the concerns they had about the constitutionality—whether you could have another bankruptcy process.”
For his part, Gov. García Padilla believes creditors could take any legal action they deem necessary, but stressed that Promesa protects Puerto Rico the same way U.S. bankruptcy laws protect an individual. “Since [Congress] didn’t give us the protection under U.S. bankruptcy law, it created a special law,” he said.
Promesa provides for a temporary legal shield that could run until the beginning of next year.
Winds of litigation
The possibility that legal action could be coming down the pike was echoed on June 27, during a panel discussion titled “Promesa: Perspectives From the Creditor Camp,” moderated by Caribbean Business during an all-day conclave by Bonistas del Patio, an advocacy group representing local creditors.
When the question arose on whether the stay in Promesa would be challenged, Co-CEO of Fundamental Advisors, Héctor Negroni, answered: “The stay on Promesa is a fairy tale. The stay stops you from pursuing your rights….”
Negroni is behind the suit filed last month by Jacana Holdings LLC, Lex Claims LLC, MPR Investors LLC and RRW I LLC against the commonwealth of Puerto Rico. The group of GDB bondholders is challenging the legality of the local Emergency Moratorium & Financial Rehabilitation Act, enacted in April amid the government’s struggles to restructure part of its $70 billion public debt or achieve relief ahead of its summer debt obligations.
Within hours of the government’s announcement that it would default on about half of its $2 billion in payments due July 1, plaintiffs filed a motion to ensure they may continue to pursue their challenges to the local moratorium law despite Promesa.
Jacana gets its name from Barrio Jacana, in Yauco, where Negroni’s Puerto Rican grandparents were raised. The Jacana suit could be more than a warning shot against Promesa; the group of creditors in that lawsuit includes Aurelius, one of the hedge funds that dragged Argentina through more than a decade of litigation.