a roadmap for puerto rico and its creditors

A ROADMAPFOR PUERTO RICO AND ITS CREDITORS

Maria de los Angeles Trigo

August 2015

A ROADMAP FOR PUERTO RICO AND ITS CREDITORS 1

The government of Puerto Rico started conducting meetings with representatives from its creditors to present the Krueger Report. The first meeting publicly announced, celebrated on 13 July 2015, is part of the country’s attempt to negotiate a moratoria on the repayment of its debt. The purpose is to implement new measures to promote economic growth that will enable Puerto Rico issuers to pay their debts in full.

Since Puerto Rico has no recourse to either Chapter 9 of the US Bankruptcy Code or its own law, it must negotiate with its creditors without any pre-established process or framework.


Under the circumstances in which Puerto Rico is forced to conduct its negotiations, it would be helpful to discuss the roadmap prepared by UNCTAD’s ad hoc Working Group on a Debt Workout Mechanism.

This roadmap strives to present four “steps that countries can take before and during debt restructuring” within the context of five principles that should provide guidance in the negotiation process.

The Working Group is an expert consultation that UNCTAD launched in 2013, where more than 20 experts, including leading legal scholars, investors, policymakers and representatives of civil society, participated in the design of the roadmap.


THE OPEN ROAD


“The Roadmap and Guide for Sovereign Debt Workouts includes recommendations to improve the coherence, fairness and efficiency of current sovereign debt restructuring processes.”

In this presentation I’ll consider:

• the principles that should govern sovereign debt workouts,

•what are the steps countries can take before and during debt restructuring,

• how they apply to Puerto Rico.


http://unctad.org/en/PublicationsLibrary/gdsddf2015misc1_en.pdf

THE GUIDING LIGHTS


The Roadmap and Guide identifies five principles to help interpret the legal rules involved in a restructuring process, and to help fill in loopholes in the legal rules. These principles are:

Legitimacy — the legal regime’s properties make it acceptable to the subjects of its rules: “the good reasons why one should follow a specific rule or regime.” Factors now considered as part of this principle of legitimacy are inclusive decision-making, and the respect for human rights and the rule of law.

Transparency — the information about the exercise of public authority is available to the public or, at least, to interested stakeholders. Transparency would be seen in data transparency, and in institutional and process transparency. The Roadmap and Guide notes that any limitations on transparency should follow rules.


Impartiality — the absence of bias. The Roadmap and Guide presents three dimensions of the impartiality principle: institutional, actor, and informational.

Good faith — fairness, honesty, and trustworthiness. “Traditionally, its significance has been larger in continental legal systems. Nevertheless, in recent decades, good faith has gained importance for the interpretation of contractual obligations in common law jurisdictions.” Good faith bears on both the substance and the process of debt restructuring.

Sustainability — the debt “can be serviced without impairing the social and economic development of society.” The Roadmap and Guide presents two dimensions: procedural (debt restructuring starts as soon as debt levels exceed debt service capacity), and substantive (a standard for the outcome of the restructuring).


The principles proposed build on the 2012 UNCTAD Principles on Promoting Responsible Sovereign Lending and Borrowing, with “a growing recognition that debt workouts must safeguard the economic, social, and cultural rights of the affected population.”


http://www.unctad.info/en/Debt-Portal/Project-Promoting-Responsible-Sovereign-Lending-and-Borrowing/About-the-Project/Principles-on-Responsible-Sovereign-Lending-and-Borrowing/

ON THE ROAD …The Roadmap and Guide proposes

four steps for a sovereign debt

workout, to help both creditors

and debtors face and resolve an

unsustainable debt situation.


I. THE DECISION TO RESTRUCTURE

The Working Group believes that one of the main problems with sovereign debt workouts is the short-termism with which politicians make decisions. Winning an election beckons and guides, so the decision that debt is unsustainable is neither easy nor politically expedient. The decision is postponed by accumulating more debt, weakening even more the country’s finances and making a workout more costly.

Sometimes the government delays because it doesn’t have the information to determine whether the problem is one of insolvency or of illiquidity. And this delay is aided by lenders that believe they would be better off with a bailout than with a restructuring, so they lend additional money to keep the debtor country servicing the debt.


Although the debtor could consider pre-emptive restructurings, which are conducted before there is a nonpayment or default, it must have an idea of the restructuring terms that are needed, and of the process that could be followed.

An independent assessment should be made as to the sustainability of the debt, based on indicators that are relevant for the country and the circumstances. Creditors must be given the chance to study and comment on the debt sustainability analysis, which could be at an initial roundtable.


II. PREPARING FOR NEGOTIATIONS

Once the debtor country has decided to restructure its debt, it must find, with its creditors, a framework for the negotiations and workout. The Roadmap and Guide presents different settings for each of the six different types of debt:

1. bilateral (between governments),2. multilateral (with international organizations),3. bank loans,4. external (foreign law) bonds,5. domestic bonds,6. and other credits (usually trade)

Puerto Rico doesn’t have bilateral nor multilateral debt; the vast majority of its debt is in domestic (Puerto Rico law) bonds. The external bonds outstanding have all been issued under and subject to NY law.


THE ROUNDTABLE

The debtor should convene an initial roundtable to initiate the workout process, discuss the sustainability analysis, and decide on procedures for the workout. Mediation or arbitration could be considered. The roundtable should be open to representatives of all stakeholders. The debtor should propose a negotiating framework, including a procedure for creditors representation (which could be through investors associations).

The Working Group recommends that debtors “carefully document their efforts to set up a comprehensive, inclusive, and transparent initial roundtable. If uncooperative creditors try to enforce their claims through litigation, the documentation might help the debtor to prove their good faith attempts to reach a consensual workout.”


Although the process should start as an informal negotiation, it is recommended that the parties agree from the beginning on formal processes if the workout doesn’t move forward, or if they prefer that a consensus reached informally be supported by a decision that is legally binding.

Two options could be mediation and arbitration, applying the law governing the debt documents.


THE ADJUSTMENT PROGRAM

As part of a workout, debtors implement a structural adjustment program, which usually stipulates macroeconomic benchmarks and structural reforms. For the program to be successful, it must be in the debtor’s best interest, since these programs tend to require changes on very sensitive social and governmental policies, such as the provision of public services and privatization programs.

Another risk in the creation of structural programs is how realistic the expectations of economic growth are and how negative the expenditure costs can be (consider the devastating result of the overly optimistic projections the IMF made in 2010 on the Greek economy).


The Roadmap and Guide recommends that the programs:

respect the country’s sovereignty and the domestic decision-making process;

be linked to growth;

protect the poor and vulnerable groups;

not be geared solely towards short-term financing needs nor to the creditor’s commercial interests;

and respect human rights, especially socio-economic rights.


III. NEGOTIATIONS

A major complication of the restructuring of bonds is the high number of bondholders with different interests and legal constraints. In order to facilitate the restructuring of these bonds many issuers are either amending the debt documents to include new collective actions clauses (CACs), or including CACs in the bond documents for new debt.


CACs authorize the amendment of payment terms if a majority (or super-majority) of bondholders agree. There are three major types of CACs:

• In a majority by series, there must be a vote by bond series, and the restructuring for each series can proceed if a majority in each series agrees.

• In a two-tier aggregated majority, there must be a majority by series and a majority of all bonds outstanding in the aggregate.

•A single-tier aggregated majority binds all bondholders if a majority of all bonds outstanding in the aggregate are in favor of the restructuring.


Act 71-2014 had included a two-tier aggregated majority. Act 71-2014 is the law enacted by Puerto Rico to provide for a bankruptcy-like restructuring of some of its debt. It was based on Chapter 9 of the US Bankruptcy Code.

The Roadmap and Guide muses that a single-tier aggregated majority may avoid disparity among creditors. When all creditors have the opportunity to oppose a restructuring under the same terms, and no one can hold-out, all creditors will receive the same restructuring outcome. Not so when series can exclude themselves from the restructuring (just consider what has happened with Argentinian debt under a ruling from the US District Court in New York, affirmed by the US Circuit Court for the Second Circuit).


http://www.oslpr.org/2013-2016/leyes/pdf/ley-71-28-Jun-2014.pdf

As part of the restructuring, the debtor must take care that the terms agreed with the creditors do not endanger systematically important economic or fiscal institutions. Also, trade debt should be exempt from the debt restructuring process: relationships with vendors should not be affected so that the government can keep operating while the negotiation is taking place.


IV. RESTRUCTURING TERMSAND POST-RESTRUCTURING ISSUES

The restructuring terms need to “allow[] [the debtor], with high probability, to roll over or reduce its debt in the foreseeable future without a major correction in the balance of income and expenditure.” This can be difficult to accomplish, since many negotiations take a long time because the creditors join throughout the process, which also increases the cost of the debt restructuring for everyone.

If there are hold-out creditors, it’s even worse, since there is really no conclusion to the restructuring process. This makes it almost impossible to monitor the debtor’s compliance with the structural adjustment program in place.

Debt workouts should not be sequential as they create many opportunities for abuse.


The Roadmap and Guide recommends that a procedure for the negotiation’s conclusion be determined at the very beginning, at the initial roundtable. It could include a deadline by which negotiation must be concluded. If the deadline is not reached, then mediation or arbitration could be the next step.

To aid in reaching a conclusion to the restructuring, no party should be permitted to raise an objection to the proposal at voting time that could have been raised before but wasn’t.


As to litigation by hold-outs, the Working Group recommends that good faith in the purchase of debt and in the negotiation of a debt restructuring be considered in the concession of remedies for uncooperative and abusive creditors.

To aid in future restructurings, the Working Group recommends to make public “a complete record of the financial and legal terms of the restructuring, a reasoned explanation of the treatment accorded to all creditor groups, a description of the economic reform program undertaken in conjunction with the restructuring, and the economic, financial, and other assumptions supporting the restructuring.”


… TO PUERTO RICO


Puerto Rico hired an undisputed expert to analyze its economic and fiscal situation, and the sustainability of its debt, and will meet with representatives of its creditors to present the Krueger Report and the structural adjustment program.

Undoubtedly Puerto Rico has delayed in recognizing the burden of its debt service and starting this negotiation. This is explained in part because the government and most economists believed that the crisis was cyclical and not structural. If you add the ever-present electoral considerations, this explains the increase in debt issuance in the last electoral cycles: if it was a cyclical liquidity problem, with more liquidity the economy would start moving again, government revenues would increase, and the country would be back on the road.


http://www.bgfpr.com/documents/PuertoRicoAWayForward.pdf

The structural adjustment program (referred to as a long-term fiscal and economic development plan) is in charge of the Working Group for the Economic Recovery of Puerto Rico created by Executive Order OE-2015-022. The Group must submit the plan by 30 August (although it has been announced that it is now expected by mid-September) and it must include the administrative and legislative proposals necessary to comply with the plan’s purposes. The legislative bills must be introduced by 1 October.


http://estado.pr.gov/es/ordenes-ejecutivas/

Whether or not all government issuers will try to restructure their debt, Puerto Rico could start an informal negotiation process and negotiate with creditors a deadline by which, if no agreement has been reached, an arbitration process could start.

An arbitration could be faster that a judicial process considering the jurisdiction issues that will be raised if creditors attempt to file in a US Court a claim based on the debt documents that are subject to and must be interpreted under Puerto Rico law.

Although the debt documents do not have CACs, the obligation to conduct negotiations in good faith required by Puerto Rico legal doctrine could also help in reaching an agreement, whether informally or through a formal process of mediation or arbitration.


As to monitoring the compliance with the fiscal and economic development plan, the Executive Order provides for the creation of a “Fiscal Oversight Board.” This Board will “guarantee the continuity and honor of the commitments agreed upon by the Commonwealth during the restructuring process.” Although the Working Group is responsible for designing and creating the Fiscal Oversight Board, no doubt the result will consider the input provided by creditors; especially because the Board’s purpose is at the heart of the creditors’ reasons to agree to a restructuring.

The process initiated by Puerto Rico is just starting, but the Roadmap and Guide provide an idea of the process that could be followed in negotiating with creditors.


http://www.bgfpr.com/documents/InvestorMeetingPressRelease7.9.15.pdf

EXTRAS

The Krueger Report can be found here.

Two articles discussing Puerto Rico’s lack of a restructuring framework are here and here.

A description of the UNCTAD’s ad hoc Working Group on a Debt Workout Mechanism is here.


http://www.bgfpr.com/documents/PuertoRicoAWayForward.pdf

https://www.linkedin.com/pulse/devil-details-congress-restructuring-maria-de-los-angeles-trigo?trk=mp-reader-card

https://www.linkedin.com/pulse/congress-said-well-do-nothing-maria-de-los-angeles-trigo?trk=mp-reader-card

http://unctad.org/en/pages/newsdetails.aspx?OriginalVersionID=987&Sitemap_x0020_Taxonomy=UNCTAD Home;

ORIGINALLY PUBLISHED IN LINKEDIN

A Roadmap for Puerto Rico and its Creditors

13 July 2015This presentation has been revised from the original post.

Maria de los Angeles Trigo, an attorney and certified public accountant, helps clients understand Puerto Rico’s public finance market. She advises financial institutions, investors, law firms, and government institutions on Puerto Rico debt’s legal and regulatory framework. Maria de los Angeles worked for 16 years in the Government Development Bank for Puerto Rico and was the highest-ranking career legal officer as Director of the Compliance Department and Acting Deputy Director of the Legal Division.

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a roadmap for puerto rico and its creditors

Law

puerto rico issuers

government of puerto

creditors maria

legal rules

process transparency

sovereign debt workouts

debt workout mechanism

data transparency