“The Debt Is Not Payable”
by James L. Tatum III, MPA ’17, Maxwell School of Citizenship and Public Affairs at Syracuse University
“The debt is not payable,” said Governor Alejandro Garcia Padilla of Puerto Rico to the New York Times on June 28th, 2015. In fact, by most independent analysis, the island’s $117 billion in total liabilities is not payable. Given this fact, the decision by elected officials not to provide Puerto Rico with access to Chapter 9 bankruptcy is cause for confusion.
Puerto Rico has suffered dramatic population loss for a decade, loss of industry, and a decline that has mirrored the City of Detroit. Puerto Rico has borrowed heavily in an effort to maintain the same quality of life, despite a diminished tax base. For decades, it has had uninhibited access to capital markets. In 1955, The Analysts Journal issued a report titled “A New Look at Puerto Rico and Puerto Rican Bonds” that was spurred by findings that the debt marketed by Puerto Rico was, and still is, triple tax exempt. Despite the decline of the island’s economy since the boom period of 1950 to 2000, investors have continually been attracted to its bond issuance. The result of Puerto Rico’s attractive debt and fiscal policies has been an estimated $71 billion in bonded debt, and $46 billion in pension liabilities.
Further discussion of Puerto Rico’s financial distress requires understanding three terms: insolvency, default, and bankruptcy. Insolvency is an inability to pay debts. Default is the failure to pay—either because of insolvency or by choice. Bankruptcy is the process by which defaults are resolved in an orderly manner.
Puerto Rico is insolvent. The island has had problems with cash flow for years, and is expected to run out of money in the near future. Debt service, or the amount of annual appropriations dedicated to interest and principal payments, exceeds 25 percent (far beyond the recommended 10 percent limit). Puerto Rico has already defaulted on a portion of its debt. On January 4th, 2016 the territory declined to make $174 million in debt service payments. Another payment of $1.9 billion scheduled for July 1st was suspended under powers to enact a debt moratorium passed by the Legislature.
Ordinarily, bankruptcy would be the next step for a similarly distressed entity. However, neither Puerto Rico nor municipal units like the deeply indebted Puerto Rico Electric Power Authority (PREPA) are authorized to file for Chapter 9 bankruptcy. This omission appears to be without reason. In the recent Supreme Court case, Puerto Rico v. Franklin Cal. Tax-Free Trust, the justices were perplexed as to why Congress would omit Puerto Rico from Chapter 9 and take away its power to adjust debt unilaterally. A cursory read of the justices’ questions made it apparent that Puerto Rico would lose its case, and it did, but not because Puerto Rico should not be able to adjust its debts or because of constitutional conflict. Rather, as Justice Stephen Breyer joked, he cannot “say that an airplane means a horse,” and the text of Chapter 9 is clear—even if its justification is not.
Here is Puerto Rico’s dilemma. The island cannot bind creditors under any other kind of deal, which is necessary to restructure debt under Chapter 9. Without such a rule, creditors have an incentive to “race to the courthouse,” where the quickest to sue have the best recovery, and the rest are left to pick over the diminished assets of the debtor. There is also an incentive for “vulture” funds to purchase the depreciated bonds and hold out for payment which exceeds the amount the bonds were purchased for. NML Capital, an investment firm, successfully employed this strategy against Argentina. Note that because of Puerto Rico’s territorial status it does not appear to have the sovereign power to default or even attempt to bind creditors to a debt exchange like Argentina did (before those efforts were usurped by creditor holdouts).
The promise of bankruptcy, and the reason it is needed for Puerto Rico, is that bankruptcy determines who will be paid, how much they will be paid, and who will not be paid at all in a far more orderly manner than a “race to the courthouse.” Secondly, bankruptcy binds creditors to whatever deal comes out–and such a deal would be formally titled a plan of adjustment. The Secretary of the Treasury, whose office has been deeply involved with Puerto Rico, has insisted that the island be provided debt relief of the sort that only Chapter 9 can provide.
Instead Congress has offered Puerto Rico a different system through PROMESA (Puerto Rico Oversight, Management, and Economic Stability Act), which creates a bankruptcy-like process for the island. Why has Congress decided to embark on the odd and unchartered course of creating a bankruptcy-like process that is not bankruptcy? The answers are uncertain. In part, the answer could be that bondholders have successfully lobbied lawmakers to prevent bankruptcy. A separate answer is that lawmakers are unsure Chapter 9 or a Bankruptcy Court could resolve Puerto Rico’s debts. But then, there is no reason to doubt that Chapter 9 could resolve Puerto Rico’s debts.
In 1988, Congress amended the Bankruptcy Code, including Chapter 9, to accommodate sizable jurisdictions with heavy debt burdens, in response to New York City’s fiscal crisis in the 1970s, and Cleveland, Ohio’s shortly thereafter. Before New York and Cleveland teetered on the precipice of default, bankruptcy was rare, and when it was filed, it was by small municipal units, such as water and sewer districts, and transportation authorities. Chapter 9 was amended should another major city or county tumble into insolvency and default on its debt.
The most recent cases display how well bankruptcy can work as a last resort for municipal financial distress. Jefferson County, Alabama filed in 2011 with $4.2 billion in total liabilities—many of which were tied to the county’s use of exotic instruments known as interest rate swaps. Detroit filed in 2013 with $18 billion in total liabilities, which also included interest rate swaps and another type of exotic instrument known as certificates of participation. In both cases, the courts were able to unwind those debts (Jefferson County in two years, Detroit in one year) and successfully provide debt relief to those two entities. Puerto Rico’s debt burden far exceeds that of Detroit and Jefferson County, but its liabilities are not any more sophisticated.
Rather than create a bankruptcy-like structure, Congress would be better advised to use the architecture that already exists. To provide Puerto Rico with bankruptcy authority would not preclude the other measures insisted on by members of Congress or the Treasury Department. Senator Orrin Hatch of Utah has been said to be infuriated by the island’s inability to provide timely and accurate financial statements. A bankruptcy by Puerto Rico would answer this frustration. Bankruptcy requires that debtors detail their assets and liabilities in a disclosure statement, which would provide absolute clarity to the island’s financial condition. There would finally be a detailed list of what is owed to whom, and under what terms.
The United States Treasury Department should also be authorized to loan money directly to Puerto Rico, and to underwrite a possible “super bond” or new debt to replace the old bonds the island has defaulted on. A loan from the Treasury Department would provide money to fund public services while the island restructures. The Treasury Department extended this kind of aid to New York City at the time of its fiscal crisis, and to General Motors and Chrysler LLC when the two automakers were in bankruptcy. The new “super bond” would further entice bondholders to turn in their old debt for new debt that would carry a later maturity date, or a lower interest rate and reduced principal amount.
Treasury Department assistance is needed for bondholders who have either factually or perceptually better claims and security interests (i.e. claims on specific revenues) than others, who will need enhanced security in order to be incentivized to accept the new “super bond.” Bondholders will need security that only the Treasury Department can provide. In tandem, bankruptcy and a loan or debt guarantee provided by the Treasury Department can mend Puerto Rico’s balance sheet.
The island is short on cash, debt service has crowded out other necessary expenditures, and it has been unable to normally fund its operations. Puerto Rico must be provided with the ability to adjust debts in Bankruptcy Court, because the island is past the point of more politically palatable options. The Federal Government’s policies toward Puerto Rico helped created this mess, and the island is owed forceful action, not a haphazard and untested process.
 Michael Corkery & Mary Williams Walsh, Puerto Rico’s Governor Says Island’s Debts Are ‘Not Payable,’ N.Y. Times: DealBook, (June 28, 2015), http://www.nytimes.com/2015/06/29/business/dealbook/puerto-ricos-governor-says-islands-debts-are-not-payable.html?_r=0 [https://perma.cc/8YZX-QLFZ].
 Clayton Gillette & David Skeel, How Congress Can Help Puerto Rico, N.Y. Times: DealBook (Sept. 14, 2015), http://www.nytimes.com/2015/09/14/opinion/how-congress-can-help-puerto-rico.html [https://perma.cc/5BK9-6CG5].
 Puerto Rico Oversight, Management, and Economic Stability Act, H.R. 4900, 114th Cong. (2016).
 See generally Puerto Rico’s Economic and Fiscal Crisis, U.S. Dep’t of the Treasury (2016), https://www.treasury.gov/connect/blog/Documents/Puerto_Ricos_fiscal_challenges.pdf [https://perma.cc/VS9F-7JTB].
 John P. Broderick, A New Look at Puerto Rico and Puerto Rican Bonds, 11 Analysts J. 107, 107–09 (1955).
 U.S. Dep’t of the Treasury, supra note 4 at 3.
 Id. at 4.
 Mary Williams Walsh, Puerto Rico Defaults on Debt Payments, N.Y. Times: DealBook (Jan. 4, 2016), http://www.nytimes.com/2016/01/05/business/dealbook/puerto-rico-defaults-on-debt-payments.html [https://perma.cc/Y8JV-WQYQ].
 Mary Williams Walsh, Puerto Rico Passes Bill Allowing Halt to Debt Payments, N.Y. Times: DealBook (Apr. 6, 2016), http://www.nytimes.com/2016/04/07/business/dealbook/puerto-rico-passes-bill-allowing-halt-to-debt-payments.html [https://perma.cc/V55B-QPAE0].
 11 U.S.C. § 903 (2012).
 Puerto Rico v. Franklin Cal. Tax-Free Trust, Oyez (Mar. 22, 2016), https://www.oyez.org/cases/2015/15-233 (click the “Oral Argument” button; relevant portion begins at around 5:00).
 Id. (Relevant portion begins at around 18:50).
 Jonathan Gilbert & Alexandra Stevenson, Argentina Reaches Deal with Hedge Funds Over Debt, N.Y. Times: DealBook (Feb. 29, 2016), http://www.nytimes.com/2016/03/01/business/dealbook/argentina-reaches-deal-with-hedge-funds-over-debt.html [https://perma.cc/C5TN-FVAA].
 Letter from Jacob Lew, U.S. Sec’y of the Treasury, to Congress (Jan. 15, 2016), https://www.treasury.gov/connect/blog/Pages/Secretary-Lew-Sends-Letter-to-Congress-on-Puerto-Rico.aspx [https://perma.cc/4LU6-V5YZ].
 Id. at 3.
 Robert S. Amdursky, The 1988 Municipal Bankruptcy Amendments: History, Purposes and Effects, 22 Urb. Law. 1, 1–21 (1990).
 Kelly Nolan, Largest Municipal Bankruptcy Filed, Wall St. J. (Nov. 11, 2011), http://www.wsj.com/articles/SB10001424052970204224604577028491526654090 [https://perma.cc/3A6G-6RWV].
 Matthew Dolan, Record Bankruptcy for Detroit, Wall St. J. (July 19, 2013), http://www.wsj.com/articles/SB10001424127887323993804578614144173709204 [https://perma.cc/TA94-YTDD].
 Mary Williams Walsh, Senate Republicans Introduce Bill for Puerto Rico Relief, N.Y. Times: DealBook (Dec. 9, 2015), http://www.nytimes.com/2015/12/10/business/senate-republicans-introduce-bill-for-puerto-rico-relief.html [https://perma.cc/EWJ4-KDCP].
 David A. Skeel, From Chrysler and General Motors to Detroit, 24 Widener L. J. 121, 124–25 (2015).