The fairness of bankruptcy for Puerto Rico
Ever since the Great Depression, our country has provided a lifeline for insolvent municipalities, local public corporations, and their creditors: a last-resort, court-supervised debt restructuring process. This restructuring authority has proven to be an effective, inclusive and fair process to resolve the challenges that all parties face in a municipal insolvency. Its primary purpose, however, is to allow the municipality to recover from its mistakes and factors beyond its control and keep its first and utmost promise – to provide essential services to its residents and businesses.
As we have known since last summer, the Commonwealth of Puerto Rico is on the very brink of breaking that promise. Decades of shortsighted fiscal management, combined with the expiration of key federal programs, have left it with enormous debts that it is unable to pay. The island has slashed services and raised taxes to stave off default, but its leadership has long warned that this path is unsustainable. Puerto Rico recently defaulted on a major payment – leading to the first of likely many more creditor lawsuits.
Unfortunately, for reasons that are clear to nobody, Puerto Rico is currently excluded from accessing authority to restructure its debts. Even former U.S. Sen. Bob Dole (R-Kan.), who served on the Senate Judiciary Committee when the law was updated in 1984, recently acknowledged that the Commonwealth ought to have this legal remedy.
Indeed, restructuring authority was designed for exactly this type of situation. Creditors – who are far from blameless, having ignored the risks of investing in an island whose finances had been shaky for years – want as much a return on their investment as they can recover. Puerto Rican officials, led by Governor Alejandro García Padilla, want to honor their obligations while maintaining enough budget flexibility to protect the Commonwealth’s 3.5 million American citizens. By organizing the process under the auspices of a federal bankruptcy judge, the law as currently constructed allows both parties to do just that.
Every purchaser of Puerto Rican bonds since 1938 has been on notice that Congress has the constitutional power to provide restructuring authority to Puerto Rico, when the Supreme Court upheld this bankruptcy provision. Claims by current Puerto Rico creditors that granting Puerto Rico restructuring authority is unfair are no more valid today than when the Supreme Court rejected those claims in 1938. Indeed, the unfairness is in applying a double standard to Puerto Ricans by denying them restructuring authority that virtually all of their fellow Americans can utilize.
Any alternative to bankruptcy is chaotic, expensive, time-consuming, unpredictable and risky. Absent this framework, no impartial judgement can be made to protect creditors from unfair discrimination or to protect their best interests.
Recent evidence abounds that this process can pay major dividends for municipalities and creditors alike. The City of Detroit’s bankruptcy case, over which I presided as judge in 2013-14, parallels Puerto Rico’s situation closely. Like Detroit, Puerto Rico suffers from inefficient accounting services, dated infrastructure and other major impediments to economic growth – in addition to a crushing debt load from multiple creditors that threatened its ruin.
The recoveries in the Detroit case for the bondholder classes and the pensioner classes were all the outcome of months-long mediated negotiations. Eventually, this process yielded near complete consensus for the plan that called for limited tax general obligation (LTGO) bonds to receive 41 percent of what they were owed and unlimited tax general obligation (UTGO) bonds to receive 74 percent of what they were owed. Both the City and its creditors felt they were treated fairly.
Today, opponents of Puerto Rico’s petition to Congress for restructuring authority have resorted to revisionist history of the treatment of Detroit’s creditors. Some have also attempted to distract observers from the issue by calling for the bankruptcy law itself to be changed. Asking Puerto Rico to undergo a more onerous and taxing bankruptcy process than any municipality who has ever gone bankrupt before, at a time when cuts to schools and hospitals are at hand, is not just counterproductive – it’s punitive. Congress should ignore this red herring.
Detroit’s insolvency required its creditors to accept the shared sacrifice that was necessary for it to revitalize its services and its economy. Thankfully, its creditors did so. As a result, Detroit is now on the road to a proud and secure future.
It is unfair for Congress to deny Puerto Rico the protections that it affords to other Americans. It is time for Congress to remedy this, and facilitate the restructuring of Puerto Rico’s debt.
Rhodes, a retired U.S. bankruptcy judge, handled the Detroit bankruptcy case and is now advising Puerto Rico.
By Steven Rhodes
The fairness of bankruptcy for Puerto Rico
As we have known since last summer, the Commonwealth of Puerto Rico is on the very brink of breaking that promise. Decades of shortsighted fiscal management, combined with the expiration of key federal programs, have left it with enormous debts that it is unable to pay. The island has slashed services and raised taxes to stave off default, but its leadership has long warned that this path is unsustainable. Puerto Rico recently defaulted on a major payment – leading to the first of likely many more creditor lawsuits.
Unfortunately, for reasons that are clear to nobody, Puerto Rico is currently excluded from accessing authority to restructure its debts. Even former U.S. Sen. Bob Dole (R-Kan.), who served on the Senate Judiciary Committee when the law was updated in 1984, recently acknowledged that the Commonwealth ought to have this legal remedy.
Indeed, restructuring authority was designed for exactly this type of situation. Creditors – who are far from blameless, having ignored the risks of investing in an island whose finances had been shaky for years – want as much a return on their investment as they can recover. Puerto Rican officials, led by Governor Alejandro García Padilla, want to honor their obligations while maintaining enough budget flexibility to protect the Commonwealth’s 3.5 million American citizens. By organizing the process under the auspices of a federal bankruptcy judge, the law as currently constructed allows both parties to do just that.
Every purchaser of Puerto Rican bonds since 1938 has been on notice that Congress has the constitutional power to provide restructuring authority to Puerto Rico, when the Supreme Court upheld this bankruptcy provision. Claims by current Puerto Rico creditors that granting Puerto Rico restructuring authority is unfair are no more valid today than when the Supreme Court rejected those claims in 1938. Indeed, the unfairness is in applying a double standard to Puerto Ricans by denying them restructuring authority that virtually all of their fellow Americans can utilize.
Any alternative to bankruptcy is chaotic, expensive, time-consuming, unpredictable and risky. Absent this framework, no impartial judgement can be made to protect creditors from unfair discrimination or to protect their best interests.
Recent evidence abounds that this process can pay major dividends for municipalities and creditors alike. The City of Detroit’s bankruptcy case, over which I presided as judge in 2013-14, parallels Puerto Rico’s situation closely. Like Detroit, Puerto Rico suffers from inefficient accounting services, dated infrastructure and other major impediments to economic growth – in addition to a crushing debt load from multiple creditors that threatened its ruin.
The recoveries in the Detroit case for the bondholder classes and the pensioner classes were all the outcome of months-long mediated negotiations. Eventually, this process yielded near complete consensus for the plan that called for limited tax general obligation (LTGO) bonds to receive 41 percent of what they were owed and unlimited tax general obligation (UTGO) bonds to receive 74 percent of what they were owed. Both the City and its creditors felt they were treated fairly.
Today, opponents of Puerto Rico’s petition to Congress for restructuring authority have resorted to revisionist history of the treatment of Detroit’s creditors. Some have also attempted to distract observers from the issue by calling for the bankruptcy law itself to be changed. Asking Puerto Rico to undergo a more onerous and taxing bankruptcy process than any municipality who has ever gone bankrupt before, at a time when cuts to schools and hospitals are at hand, is not just counterproductive – it’s punitive. Congress should ignore this red herring.
Detroit’s insolvency required its creditors to accept the shared sacrifice that was necessary for it to revitalize its services and its economy. Thankfully, its creditors did so. As a result, Detroit is now on the road to a proud and secure future.
It is unfair for Congress to deny Puerto Rico the protections that it affords to other Americans. It is time for Congress to remedy this, and facilitate the restructuring of Puerto Rico’s debt.
Rhodes, a retired U.S. bankruptcy judge, handled the Detroit bankruptcy case and is now advising Puerto Rico.
By Steven Rhodes
The fairness of bankruptcy for Puerto Rico
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