Understanding and Solving the Puerto Rican Municipal Bond Crisis

Where Less Light is Shed Than a Piece of Coal on a Moonless Night: Understanding and Solving the Puerto Rican Municipal Bond Crisis

Stanley Carignan*


In the final week of June 2015, the financial world’s attention focused on whether Greece would default on its loan to the International Monetary Fund (IMF). Anna Yukhananov, The International Monetary Fund is on the Hook if Greece Defaults, Bus. Insider (June 29, 2015, 6:37 PM), http://www.businessinsider.com/the-international-monetary-fund-is-on-the-hook-if-greece-defaults-2015-6.  As the tension between Greece and the IMF came to a head, Puerto Rican Governor Alejandro Garcia Padilla quietly announced that the Commonwealth of Puerto Rico would no longer be able to pay the $72 billion in debt it owes to its creditors.  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.  Taken on its face, Puerto Rico and Greece’s debt crises may seem very similar, but in fact, each crisis involves a different set of legal issues and solutions.  John Cochrane, Greece vs Puerto Rico and What’s “Systemic”, Grumpy Economist (July 4, 2015, 10:28 AM), http://johnhcochrane.blogspot.com/2015/07/greece-vs-puerto-rico-and-whats-systemic.html.  To start, Puerto Rico owes significantly less debt than the country of Greece.  Desmond Lachman, Is Puerto Rico America’s Greece?, The Hill (May 29, 2015, 7:00 AM), http://thehill.com/blogs/pundits-blog/economy-budget/243406-is-puerto-rico-americas-greece.  Moreover, Puerto Rico cannot declare bankruptcy to renegotiate its debt with its creditors, increasing the possibility the island will default.  AJ Vicens, Puerto Rico Crisis Goes From Bad to Worse, Mother Jones (Aug. 5, 2015, 6:05 AM), http://www.motherjones.com/politics/2015/08/things-keep-getting-worse-puerto-rico.


            How Puerto Rico reached this crisis point involves a litany of factors, but an initial portion of the blame can be placed on the unique tax status of Puerto Rico.  In 1917, President Woodrow Wilson signed the Jones-Shafroth Act, which provided that, among other things, all bonds issued by the Government of Puerto Rico are exempt from local, state, and federal taxes.  48 U.S.C. § 745 (2012).  Purchasing Puerto Rican debt in the form of municipal bonds quickly became an attractive proposition to many U.S. investors.  Michael A. Fletcher, How Puerto Rico Hopes to Break Its Debt Spiral and Fix Its Broken Economy, Wash. Post: Wonkblog (Sept. 9, 2015), http://www.washingtonpost.com/news/wonkblog/wp/2015/09/09/how-puerto-rico-hopes-to-break-its-debt-spiral-and-fix-its-broken-economy/.  Knowing that any future problems could be solved by taking out more debt from eager creditors, Puerto Rico engaged in a short-sighted and unsustainable development pattern.  Today, Puerto Rico only receives 1% of its energy from renewable resources.  Daniel Gross, Why Is Puerto Rico Burning Oil to Generate Electricity?, Slate: The Juice (May 30, 2014, 11:25 AM), http://www.slate.com/articles/business/the_juice/2014/05/puerto_rico_is_burning_oil_to_generate_electricity_it_s_completely_insane.html.  The remaining 99% of Puerto Rico’s energy comes from petroleum, natural gas, and coal and must be imported from the United States at great expense. Id.  By 2014, this wasteful energy cycle put Puerto Rico’s municipal power authority in over $8 billion of debt.  Hunter, Legal Fault Lines Over Puerto Rico Restructuring Law Come Into Focus, Distressed Debt Investing (July 29, 2014), http://www.distressed-debt-investing.com/2014/07/legal-fault-lines-over-puerto-rico.html.  Faced with crushing debt and more risk-averse investors, the prospect of Puerto Rico gathering enough capital to build new, profitable energy infrastructure is slim.  Gross, supra.

If the tax exemption of Puerto Rican bonds are the starting point of Puerto Rico’s current debt crisis, Puerto Rico’s bankruptcy exemption is the catalyst that pushed the Commonwealth to the brink of fiscal disaster.  Typically, under the United States’ bankruptcy laws, municipalities can file for bankruptcy like a corporation. See, e.g., In re City of Stockton, 526 B.R. 35 (Bankr. E.D. Cal. 2015); In re City of Detroit, 524 B.R. 147 (Bankr. E.D. Mich. 2014).  However, Puerto Rico is exempted from the Bankruptcy Code. See 11 U.S.C. § 101(52) (2012) (“The term ‘State’ includes the District of Columbia and Puerto Rico, except for the purpose of defining who may be a debtor under chapter 9 of this title”).  Without the authority to discharge or restructure its debts, it is unclear how Puerto Rico could legally be released from paying its creditors.  Matthew Yglesias, The Puerto Rico Crisis, Explained, Vox (Aug. 3, 2015, 5:10 PM), http://www.vox.com/2015/7/1/8872553/puerto-rico-crisis.  Financial disaster for Puerto Rico seems inevitable without an immediate solution to the island’s debt crisis.

Recovery Act

Despite its role in the creation of the debt crisis, the Puerto Rican government has made an effort to address the financial problems facing the island. In June 2014, the Commonwealth passed the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (Recovery Act). Franklin Cal. Tax-Free Trust v. Puerto Rico, Nos. 15-1218, 15-1221, 15-1271, 15-1272, 2015 WL 4079422, at *1 (1st Cir. 2015), cert. granted, 84 U.S.L.W. 3100 (U.S. Dec. 4, 2015) (No. 15-255).  In a direct affront to the federal bankruptcy code which prohibits Puerto Rico from declaring bankruptcy, the Recovery Act gave the Puerto Rican government the ability to restructure its debts. Id.  Puerto Rico’s creditors quickly filed suit to enjoin the law from taking effect, fearing the loss of any outstanding obligations owed by the Commonwealth. Id. at *2.  The trial court ruled for the creditors and permanently enjoined the enforcement of the Recovery Act. Id. at *1.  On appeal, Puerto Rico argued that, among other things, the legislative history of the federal bankruptcy code indicated that Congress did not intend to interfere with the ability of states to organize their fiscal affairs. Id. at *9.  The First Circuit disagreed, affirming the trial court’s decision and concluding that the 1984 amendment explicitly excludes Puerto Rico from the federal bankruptcy code. Id. at *15.  Because the plain language of the statute indicates that Congress intended to exclude Puerto Rico from the bankruptcy code, Puerto Rico’s Recovery Act was preempted by federal law. Id. at *6.  In his concurrence, Circuit Judge Torruella criticized the majority for crafting a legal fiction to explain why Congress exempted Puerto Rico from the bankruptcy code. Id. at *15 (Torruella, C.J., concurring).  He explained that a “tracing of [the 1984 amendment’s] travels through the halls of Congress sheds less light than a piece of coal on a moonless night regarding the reason for its enactment.” Id.  Nonetheless, the Court concluded that Puerto Rico must seek relief from Congress, and not from the courts. Id. (majority opinion).


Theoretically, the simplest way to solve Puerto Rico’s debt crisis is to amend the bankruptcy code to include Puerto Rico under the definition of state. Already, legislation has been introduced in the Senate to amend the bankruptcy code to include Puerto Rico. See Puerto Rico Chapter 9 Uniformity Act of 2015, H.R. 870, 114th Cong. (2015).  However, this legislation faces steep opposition from elected officials who view this bill as a form of “bailout” for Puerto Rico.  Corkery, supra.  Political gridlock aside, part of the underlying problem is that Puerto Rico does not have a representative in Congress who can fully advocate for it.  Pedro Pierluisi is the Commonwealth’s only representative in Congress, and despite being able to introduce bills, he is unable to vote on the floor of the House of Representatives. Id.  Without a representative that can use his or her political leverage to negotiate with other members, the political future of the Senate Bill 1174 seems grim.


            Without the ability to see judicial or legislative relief, a viable option for Puerto Rico could be to seek independence from the United States.  Independence would bring Puerto Rico all of the privileges and powers that come with being an independent country. See Yglesias, supra (“an independent Puerto Rico would have its own currency and could set monetary policy that is appropriate to Puerto Rican conditions.”).  But most importantly, independence would give Puerto Rico the ability to devise its own bankruptcy code. Id.  Unfortunately, Puerto Ricans overwhelming rejected this option in the 2012 election, when 61.16% voted for statehood, 33.34% voted for the status quo, and 5.49% voted for independence.  Mariano Castillo, Puerto Ricans Favor Statehood for First Time, CNN (Nov. 8, 2012, 10:32 AM), http://www.cnn.com/2012/11/07/politics/election-puerto-rico/.


            The financial outlook for Puerto Rico’s future may seem bleak, but numerous independent reports have indicated that the crisis may not be as dire as the Commonwealth’s government suggests. See, e.g., Jose Fajgenbaum et al., Centennial Grp. Int’l, For Puerto Rico, There is a Better Way (2015), http://www.centennial-group.com/downloads/For%20Puerto%20Rico%20There%20is%20a%20Better%20Way.pdf; Anne O. Krueger et al., Puerto Rico – A Way Forward (June 29, 2015), http://www.bgfpr.com/documents/puertoricoawayforward.pdf.  The greater concern is that Puerto Rico does not possess the internal political will-power to make the necessary reforms to begin substantive payments on its debt.  Fajgenbaum, supra, at 4.  While the Puerto Rican debt crisis does not threaten the global economy like the ongoing Greek crisis arguably does, the Commonwealth’s financial conundrum remains an issue to watch as bankruptcy lawyers are forced to find increasingly unique ways for Puerto Rico to restructure and minimize its debt without declaring bankruptcy.


*Stanley Carignan is a second year law student at the University of Baltimore School of Law. He is a member of the National Taxation Law Moot Court Team and this summer he will be a SLIP intern for the Department of Justice, Tax Division. He was recently name Executive Articles Editor for the University of Baltimore Law Review Volume 46.

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