As The Puerto Rico Lawsuits Begin "A Bankruptcy Is A When, Not An If"

Last July, Puerto Rico defaulted on hundreds of millions in debt, however under the PROMESA federal rescue law put together in the last minute, creditor litigation was put on hold - a kind of deferred debtor protection without the actual bankruptcy. The law was meant to encourage Puerto Rico and its federal financial oversight board to negotiate debt-cutting agreements with creditors. No deals were reached and on midnight of May 1 into Tuesday, the litigation freeze expired, opening the doors for creditors to take Puerto Rico to court, in hopes of blocking the next step in the Puerto Rico restructuring, namely Governor Ricardo Rossello's plan to impose drastic repayment cuts. As a reminder, Puerto Rico defaulted on $1.3 billion of principal owed since the previous governor declared the $70 billion public debt load unpayable in June 2015.

And as expected, on Tuesday Puerto Rico and its federal financial oversight board were flooded with the first lawsuits from stakeholders, with more expected in the coming days, which could ultimately push the insolvent U.S. territory into bankruptcy.  The lawsuits, according to Reuters, include complaints from holders of Puerto Rican sales-tax-backed debt, from general obligation bondholders and from bond insurer Ambac Assurance Corp.

  • The first group, those holding sales-tax backed debt known as the COFINA bondholders, allege that the island's debt-cutting plans violate the U.S. Constitution.
  • The second group, those holding general obligation debt which is guaranteed by the island's constitution, are demanding payment on $242.5 million of debt defaulted upon since July, including damages and interest of more than $102 million.
  • Finally, there is Ambac which insures $2.2 billion of Puerto Rican bonds, and which filed four lawsuits, including two against the island's government and another against U.S. Treasury Secretary Steven Mnuchin, seeking a lien on Puerto Rican rum taxes collected by the U.S. Treasury Department.

"Puerto Rico is no longer shielded from creditors rushing to the courthouse to lay claim to its assets - that includes the beaches, pieces of art, historical furniture and any assets whether they are nailed down or not. The people of Puerto Rico have had enough. The governor and the board have a moral imperative to act immediately" said Rep. Nydia Velazquez, a New York Democrat, who is calling on a federal control board overseeing Puerto Rico's finances to seek a court-supervised debt restructuring similar to Chapter 9.

So with the lawsuits now pouring in, and with $70 billion in debt, a 45% poverty rate and near-insolvent public health and pension systems, the torrent of litigation could force Puerto Rico into a so-called Title III proceeding - an in-court debt-cutting process similar to U.S. bankruptcy. In fact, various experts cited by Reuters, see Title III as inevitable, the only question is when.

"At some point, Puerto Rico might run up against an adverse court ruling it would rather not have," said Keefe Bruyette & Woods analyst Chas Tyson, who follows Puerto Rico.


"I continue to think (bankruptcy) is a when, not an if."

Yet while the creditors can finally pursue their contractual rights, they will hardly win many supporters in the court of public opinion, as most of them are hedge funds, and who may have accumulated PR debt at prices below prevailing. For example, the COFINA plaintiffs include such hedge funds like Aurelius, Cyrus Capital and Tilden Park, best known for its founder Josh Birnbaum who in 2010 defended Goldman in the infamous Carl "Shitty Deal" Levin hearing. In a lawsuit filed in federal court in Puerto Rico, they collectively accuse the U.S. commonwealth, Rossello and other officials of "angling to repurpose the tax revenue earmarked to pay COFINA debt, which they say violates the due process clause of the U.S. Constitution."

Further, they ask the court to block Rossello from implementing a blueprint for fiscal turnaround that was approved by the oversight board in March. According to that plan, the island is forecast to only have $800 million a year to pay debt, or less than a quarter of what it owes, implying draconian haircuts for all bondholders.

Among Ambac's lawsuits, two lodged complaints against the PR government, adding as defendants the island's oversight board and the board's seven members.The bond insurer, which may be on the hook should the island default, also aims to block not only the fiscal blueprint, but the filing of any Title III bankruptcy based on that blueprint. The insurer said in one lawsuit that Puerto Rico's oversight board exacerbated the island's abuses by "giving its imprimatur to an ongoing scheme ... that can only be called theft.”

AP puts things into perspective as follows: Puerto Rico could announce a historic, court-supervised restructuring for a portion of its $70 billion debt. By comparison, the U.S. city of Detroit had $9.3 billion of obligations when it filed for bankruptcy in 2013 in the biggest U.S. municipal bankruptcy ever. In fact, Puerto Rico's situation is more dire than Detroit's because the city, in part, had a firm set of rules in bankruptcy court, an option that the U.S. territory doesn't have, said Greg Clark, head of municipal research at Debtwire.

Ahead of the May 1 deadline, the government on Saturday offered to pay 50 cents on the dollar to holders of general obligation and sales-tax bonds backed by Puerto Rico's constitution. Bondholders rejected the offer.

But the biggest wildcard is what happens not so much to the creditors - who will be fine no matter the outcome - but to the ordinary people of Puerto Rico if the island does go bankrupt.  Puerto Rican officials have already imposed austerity measures, including cuts to worker benefits and pensions, and have said debt cuts are needed to spare the island from even more severe cuts to quality of life.

Two years ago we (and German finmin Wolfgang Schauble) joked that Puerto Rico could be the American Greece. Now with a Puerto Rico bankruptcy "only a question of when", it is unfortunately no longer a joke.