Puerto Rico And (Very) Soft Executive Power

Melissa's post asked what the executive branch could do to facilitate restructuring of Puerto Rico's debt. I'll get to that, but I first want to talk about Puerto Rico itself. At first glance, the Commonwealth seems to be in a uniquely terrible position. It has the disadvantages of a sovereign (e.g., no bankruptcy) but lacks the advantages (e.g., legal and/or practical immunity from legal enforcement). In fact, it lacks only most of the advantages. One advantage of sovereignty it does enjoy--and that many "true" sovereign borrowers are obliged to forego when they borrow--is that much of its debt is governed by its own law. That law can be changed (subject to constraints in the U.S. constitution) or interpreted in ways that give the Commonwealth needed restructuring flexibility. 

To begin, there are questions about whether the Commonwealth incurred much of its debt (COFINA in particular) in violation of its constitutional debt limits; if so, whether creditors can enforce claims to the unauthorized debt; and, if not, the scope of any right to restitution. These are questions of Puerto Rico law. Moreover, because the vast majority of the debt issued by the Commonwealth and its instrumentalities is subject to Puerto Rico law, the Commonwealth can amend that law in ways that enable restructuring--think of Greece's retro-fit CAC. The U.S. constitution limits the Commonwealth's ability to make such changes, of course, but it is far from clear that the Constitution would prohibit such a move. (Changes affecting debt issued by the Commonwealth itself, as opposed to its municipalities, would not raise bankruptcy preemption issues.)

Reader reactions to such proposals will vary; some will no doubt view them as lawless. From my perspective, that reaction is misplaced, as an important function of a local law bond is to allow the issuer discretion to change its law in reaction to new circumstances. Certainly every informed institutional investor knows this.

So, what does this have to do with the executive branch? A successful restructuring demands incentives for participation (i.e., new bonds with attractive features) and disincentives for holding out. Doubt about the enforceability of debt, and fears of bankruptcy-type "cram down," are potent disincentives. Just how potent, however, depends on a number of uncertain questions. At a minimum, these include: (i) the facts underlying the issuance of COFINA bonds, (ii) once the facts are known, the legal question of whether that debt was authorized, and (iii) the legal question of the extent to which the U.S. constitution limits Puerto Rico's ability to change and interpret its law in ways that facilitate restructuring. Executive branch officials have at least some indirect influence over such questions. Federal "technical assistance" can be conditioned on a searching inquiry into the facts underlying the COFINA debt. Officials can communicate to potential holdouts that the U.S. government will submit amicus briefs in support of Puerto Rico. I'm sure readers can think of other possibilities. These are not major interventions, and they will not radically change any party's leverage. On the margin, however, they can make holding out a less attractive proposition.