Getting debt prioritization right is vital to Puerto Rico’s recovery
It has taken three long years, filled with court filings, corruption charges and deadly hurricanes, but there appears to be progress in Puerto Rico as the island looks to come out from under its massive debt. In late September, Puerto Rico officially filed its roadmap out of bankruptcy with a federal court.
If approved, the long-awaited new plan of adjustment would reduce a major portion of the island’s debt by more than 60 percent and cut Puerto Rico’s tax-supported debt from $50 billion to $25 billion. It’s a huge step forward, even if critical aspects of the plan are not yet finalized.
One of the more contentious issues is that of bondholder prioritization. This latest plan seems to buy into the idea that “general obligation” (GO) bondholders should be favored over others. These bondholders claim that they deserve priority, which requires GO bonds to be paid ahead of all other obligations, no matter the scenario. They claim that they enjoy a debt priority under the Puerto Rico constitution that trumps all else, at all times, or, alternatively, that their bonds are secured by a so-called “constitutional lien.”
But there are several reasons these claims are inaccurate.
First, the Constitution of the Commonwealth of Puerto Rico does not create a general debt priority in favor of GO bonds. Rather, it creates a limited budget priority, which requires available resources to be applied first to GO debt in the event of an unanticipated budgetary shortfall within a given fiscal year. Taking funds belonging to other instrumentalities over a period of many years to pay GO bonds, as the fiscal plan envisions, is very different.
Second, even if the Puerto Rican constitution did create a debt priority in favor of GO bonds, that priority is preempted by the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). Previously, Puerto Rico had no established process for bankruptcy. PROMESA was unique in that it superseded the Puerto Rico constitution and established the rules of the road. In passing PROMESA, Congress deliberately adopted only one of the many priorities set forth in the Bankruptcy Code — the administrative expense priority. The result is that GO bondholders are to be treated no better than any other unsecured creditors in the commonwealth’s bankruptcy proceedings.
Finally, it is unlawful for the oversight board to pick and choose which priorities it wishes to enforce. Revenue bonds issued by commonwealth instrumentalities also enjoy priorities under Puerto Rico law — they are to be paid second only to GO bonds in the event of a fiscal-year budgetary shortfall, and any amounts “clawed back” from them in a given fiscal year must be reimbursed. It certainly would be arbitrary, at best, for the oversight board to respect only a purported GO priority while ignoring those afforded to revenue bonds.
The oversight board has decided to pick favorites in the restructuring process, a decision with questionable legal justification. In addition, the practical effect will be to hinder the island’s ability to regain entry to capital markets, because spurning other groups of creditors will alarm future investors who otherwise might play a key role in creating much-needed economic growth on the island.
With Puerto Rico so close to moving forward with its restructuring, it is important that the process remains fair and legal to ensure the economic future of the island. Handling the issue of debt prioritization correctly is vital if the island and its people are going to move toward a more prosperous future.
Mario H. Lopez is president of the Hispanic Leadership Fund, a public policy advocacy organization that promotes liberty, opportunity and prosperity for all Americans. Follow him on Twitter @MarioHLopez.
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