A Roadmap for Puerto Rico and its Creditors

A ROADMAP
FOR 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.

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.”

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).

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 TERMS
AND 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.

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.

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.

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.

ORIGINALLY PUBLISHED IN LINKEDIN
A Roadmap for Puerto Rico and its Creditors
13 July 2015
This 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.
If you would like to receive future posts, just click the follow button in SlideShare and LinkedIn.

A Roadmap for Puerto Rico and its Creditors

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