Munis

Investors Beware: Bonds and Amending the Constitution

Today, three PPD (Manuel Natal, Luis Vega & Luis Torres) members of the Puerto Rico House of Representatives announced that tomorrow, they will be filing a Joint Resolution to consult the People of the Island whether to amend the Constitution “to permit the renegotiation of the Government’s debt and of the public corporations recognizing the importance that it does not impair or subordinate to it other socioeconomic development priorities of our people. Among these priorities are: the financing of cheaper energy; cheaper drinking water, strategic investment in infrastructure that encourages private investment and job creation; schools with teachers and materials that students need; special education programs; and better and more far reaching health services for the whole island.”

Natal Alvelo reminded us that PC 2003, which he wrote, seeks a 4-year moratorium on debt service, extendable for 3 additional years. In addition, PC 2314, also of Natal Alvelo’s authorship, calls for the creation of a Special Independent Commission to review all debt issues to determine which are legal and which are illegal. The illegal debt would be rejected. Witch hunt anyone?

At this time, we do not know how much support this Constitutional Amendment or the abovementioned measures have. Suffice it to say that if approved, they are tantamount to Puerto Rico rejecting its General Obligation debt, at least temporarily. Fortunately, Article VII of the Puerto Rico Constitution requires that the Joint Resolution be approved by 2/3’s of the legislative assembly in order for it to be put to popular vote, which would need to be held with the general election, unless ¾ of the legislature so approved it, which then could be at any time. Since the PPD has only a 3-vote majority in the House, it is unlikely it will be approved.

Even if this amendment was approved by the electorate, it would be subject to challenge in federal court for impairment of contractual obligations, see, United Auto., Aerospace, Agr. Implement Workers of America Intern. Union v. Fortuño, 633 F.3d 37 (1st Cir. 2011), and Romer v. Evans, 517 U.S. 620 (1996) (state constitution is not free from federal scrutiny).

As to PC 2003 and PC 2314, they were filed in 2014 and have not been moved in the House. This does not mean, as we saw with the Recovery Act, that they could not be approved, if need be, in one day. Investors need to monitor the situation closely.

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Puerto Rico Tries to Save PREPA Once More

After the Federal Judge Besosa held that “[t]he Commonwealth defendants, and their successors in office, are permanently enjoined from enforcing the Recovery Act,” one would think it was over except for the appeals. One would be wrong, however. As was to be expected, PR Justice Secretary César Miranda announced on February 9, that he would appeal the decision. Less expected were the last words of his press release:

Finally, the Secretary declared that he believes that there is no legal impediment to having Puerto Rico implement the processes established by Law No. 71. Therefore, he will take into consideration the legal remedies available so that the statute remains in force. (Underlining and translation ours)

What does this cryptic sentence mean? What are the legal remedies available to the statute remain in force? On Monday, February 9, 2015, PC 2321 was presented by PR House Speaker Jaime Perelló and several legislators of the governing party. On pages 3-5 of the bill, it allows the Governor or the agency he designates, to impose on any property upon which a person has an interest in real property (this includes property, leases, usufructs, and many others) a declaration of public utility (“utilidad pública”). Upon this declaration, which has to be made after a public or judicial hearing, the property can only be used for that specified public use. In other words, if PREPA bondholders request a receiver as it is their right based on the Bondholders agreement of 1974, this law would not allow the operation of the utility for the benefit of the bondholders and hence would limit their property rights.

This would be nothing else but a boldfaced way of running around the consequences of Judge Besosa’s decision prior to the appeal. Once more this administration, instead of working with its creditors in an orderly fashion, has resorted fighting them in every front. Fortunately, I doubt the measure, even if approved, would pass constitutional muster.

PC 2321 is a bill of attainder, i.e., a law tailor made to punish bondholders, prohibited by both the PR and Federal Constitutions if they exercise their rights under the 1974 agreement, see, Nixon v. Administrator of General Services, 433 U.S. 425 (1977) and Colegio de Abogados v. ELA, 181 D.P.R. 135 (2011). Also, as Judge Besosa intimated, the removal of the right to appoint a receiver could be a taking without just compensation, which is exactly what this law seeks, see pages 65-74 of Judge Besosa’s decision. In addition, PC 2321 could be construed as an impairment of contractual obligations, another claim that survived the Government’s motion to dismiss. See, pages 46-65 of Judge Besosa’s decision.

Once more I encourage the Government of Puerto Rico to deal with its creditors, including PREPA bondholders and Doral, in a responsible fashion. Moodys reports that it still believes PREPA will default in its bonds and this would be disastrous for the island’s battered credit. Even if Chapter 9 of the Federal Bankruptcy Code does not apply to PR, the island could take heed of 11 U.S.C. § 109(c) of negotiating with creditors to obtain their agreement to a restructure, specially since there are efforts by the island’s Resident Commissioner to allow its public corporations and municipalities to use the federal law. Either pursuant to federal bankruptcy law or in a Greek style restructure, the Government must understand that it must reduce its size dramatically. Moreover, If PR insists on clashing with its creditors instead of cooperating with them, the island’s future will be grim.

THE PUERTO RICO GOVERNMENT AND THE MARKETS

Puerto Rico for years has been saying that it will pay all its debts. Governor García Padilla told Bloomberg news (quite incorrectly) that Puerto Rico’s Constitution required the payment of all debts. In January, 2013, the Administration was under pressure from members of its own party to repudiate a lease agreement of Luis Muñoz Marín Airport and the Governor refused, saying that Puerto Rico honored its agreements. That was the administration’s mantra until very recently.

Right after the Mach 2014 record setting bond emission of $3.5 billion in General Obligation Bonds, came rumors of debt restructuring, PS 993 by Senator Angel Rosa, a PR bankruptcy law was filed. The contracts of Puerto Rico with Cleary Gottlieb, Proskauer Rose and Millco Advisors, all firms with restructuring and bankruptcy experience, were registered with the Comptroller’s office. All of a sudden, restructuring was the buzz-word for PR bonds. The Administration kept insisting that these firms were hired to prevent restructuring and denied it would happen.

Then in May of 2014, for no apparently valid reason, Treasury Secretary Melba Acosta decided to unilaterally determine that a closing agreement with Doral of 2012 was invalid. Doral had to sue the Treasury department in order to have it declared valid and at this writing the Appellate Court reversed a determination for the controversy to be heard in Hacienda in an Administrative Proceeding. Now it will be heard in a Court and the Government has the burden of proof. We await final decision.

On June 25, 2014, the Governor, through Senator Bhatia, filed the new PR bankruptcy law and got it approved the same day. On June 28, 2014, it was signed into Law 71 and that same night, Franklin and Oppenheimer filed their challenge in Federal Court.

Irrespective of whether the law is constitutional, a good idea, or simply a back stab to investors, the plain truth its that it aims to change the contractual obligations of payment of principal, interest, or both, by the island’s public corporations. No creditor likes the debtor to unilaterally change the payment terms, be it a moratorium on payment or outright haircuts. They hate it so much that crediting agencies and the markets have punished all of PR’s bonds, including GO’s. What is the reason for their wrath? They now believe that PR will restructure its GO’s and give as a reason that now PR has abandoned its mantra of we will pay everything to we will pay something at some time. It seems that the Governor and its team does not understand the basic business idea of TRUST. Right now, the markets don’t TRUST the Puerto Rico government and no amount of press conferences or conference calls will change that. Let’s see if the Government will learn its lesson.