This piece has been updated.
Puerto Rico’s $73 billion debt restructuring may soon come grinding to a halt as a judge weighs legal challenges to the entity Congress created to manage the island’s finances.
Although many Puerto Ricans have criticized the Fiscal Oversight and Management Board as undemocratic and lacking in transparency, the lawsuit isn’t coming from anyone on the island, but from a New York-based hedge fund that could stand to profit if a new board were created under President Donald Trump.
On Jan. 10, Aurelius Capital Management LP asked U.S. Federal Court Judge Laura Taylor Swain to dismiss the restructuring process that the oversight board initiated last May as part of PROMESA, a legislative package designed to rescue Puerto Rico from insolvency by handing its fiscal management to a board of technocrats assembled by Congress in 2016.
Aurelius, which holds nearly half a billion dollars of Puerto Rico’s debt, claims that the board is unconstitutional, arguing that the confirmation process for its members violated the rules on how officers with such responsibilities should be appointed.
If Swain agrees with Aurelius’ argument, Puerto Rico could eventually end up with a new oversight board – one named by Trump. A new board could seek to restructure the island’s debt on terms more favorable to debt-holders like Aurelius, according to Gil Hall, a journalist and analyst who is writing a book on the history of Puerto Rico’s debt crisis.
“Creditors are hoping a board appointed by Trump would be far more sympathetic to their claims for payment,” said Hall. “But that’s a tricky thing in itself. The general consensus when PROMESA passed was that the current board favored investors. It hasn’t turned out that way.”
The 10-year fiscal plan approved by the board in March had budgeted paying off just 24 percent of the debt owed by Puerto Rico’s government and authorities. Investors expect a revision to the plan, due on Jan. 24, to inflict even heavier losses on bondholders in the wake of Hurricane Maria.
Aurelius declined AQ’s request for comment on their intentions in suing the oversight board, but in public court filings the company says they have been “adversely affected by the board’s actions,” and that the question is not whether the debt restructuring should proceed, but who is in charge of the process.
That’s where the members of the board come in. Specifically, the fund’s legal team, led by heavyweight lawyer and former Solicitor General Theodore Olson, is arguing that the selection of the board’s members violated the U.S. appointments clause, which stipulates that federal officers must be appointed by the president and confirmed by the Senate. In this case, then-President Barack Obama simply chose the members from lists of nominees compiled by lawmakers.
The oversight board, on the other hand, holds that Puerto Rico is subject to rules governing territories and that the board members do not qualify as federal officers.
Judge Swain is expected to decide on the case in coming weeks. In the short term, a win for Aurelius would at least put Puerto Rico’s debt restructuring process on hold, as it would nullify all the oversight board’s actions since its creation, according to John Mudd, a Puerto Rican attorney and legal analyst who specializes in bankruptcy, constitutional law and issues of federal jurisdiction. That may be a blessing in disguise for the island’s leaders, Mudd told AQ.
The process of re-establishing the oversight board could take up to two years in the courts and in Congress, said Mudd, and in that time Puerto Rico would be able to use its budget in a way that it currently can’t because of the oversight board’s restrictions on prioritizing public funds. The current financial plan approved by the board called for cuts to education and health services, but is being reassessed given Hurricane Maria’s toll. The devastation has led many to question how much of priority should be placed on paying debts.
“The government of Puerto Rico would be peachy and hunky dory for a year or two,” Mudd told AQ. “They could continue paying retirees and suppliers and receive money from Congress.”
The respite would be short-lived, however, as Puerto Rico would still need to find a path toward reducing its debt. Because Puerto Rico isn’t a state, its municipalities can’t declare Chapter 9 bankruptcy in the way a local government could on the mainland. Barring a change in legislation, this leaves the cash-strapped territory with few viable options beyond the oversight board to pull itself out of insolvency.
In the long term, Aurelius’ success in court threatens to draw out the legal battle between Puerto Rico and bondholders. Although the oversight board was ostensibly created to give Puerto Rico the mechanisms to restructure its debt while avoiding costly and extensive litigation from creditors, both funds and individuals upset with delayed payments have continued to sue Puerto Rico—litigation that the oversight board has argued is an expensive stumbling block to the island as it gets its finances in order.
Aurelius, for its part, has been here before. The hedge fund was one of the chief “holdout” funds that sued Argentina over unpaid sovereign debt related to its default in the early 2000s. That battle ended with Aurelius making hundreds of millions of dollars when the country settled with creditors in 2016. For Argentina, the saga kept the country from attracting foreign investment, and ultimately cost the government billions of dollars. Aurelius may now be looking to do something similar with Puerto Rico.
However Swain decides, the case offers further evidence of the difficulties Puerto Rico faces due to its status as an unincorporated territory.
“Nothing that was discussed in the hearing would have happened to a state,” said Mudd.
Perhaps it’s no coincidence, then, that even as Swain heard arguments on Jan. 10, Puerto Rico’s government was in Washington making what was called the island’s “most ambitious push yet” for statehood, sending seven shadow members to Congress to put pressure on legislators.
Statehood may not quite be on the horizon, but after a year many Puerto Ricans would like to forget, it’s no wonder the island is looking for a new course of action.
This piece has been updated to clarify that if Puerto Rico were a state, its municipalities would be able to declare bankruptcy, not the entire state.
O’Boyle is an editor for AQ.