Restructuring and Due Diligence: The Front-End of Puerto Rico Debt

Restructuring and Due Diligence
The Front-End of Puerto Rico Debt
Maria de los Angeles Trigo
August 2015
The front-end of Puerto Rico debt
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 The ability to make back-end changes to debt contracts is one of the main
objections to an international convention on the restructuring of sovereign
debt.
 Creditors do not want the risk of having sovereigns incorporating changes
in the bond documents after they have been issued and traded. Their due
diligence would be very difficult if sovereign issuers could incorporate new
legal doctrines and terms after the debt is issued.
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 These “back-end changes” are the biggest objection of Puerto Rico’s
creditors to the government efforts to deal with its debt.
 In this presentation, I discuss:
 some elements that this international convention could consider,
 the importance of front-end regulations, and
 how this applies to Puerto Rico.
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The Ad Hoc Committee
 The UN Ad Hoc Committee on Sovereign Debt Restructuring was
established pursuant to General Assembly Resolution 69/247 approved on
29 December 2014. It was tasked with elaborating, through
intergovernmental negotiations, a multilateral legal framework for
sovereign debt restructuring processes. “The purpose is to increase the
efficiency, stability and predictability of the international financial system
and to achieve sustained, inclusive and equitable economic growth and
sustainable development.”
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 In 28-30 April 2015 the Committee celebrated its second working session.
Richard A. Conn, Jr. gave the keynote address, where he discussed factors
to be considered in the preparation of the framework. Mr Conn has been a
consultant to the World Bank, World Trade Organization and the US
Congress, and is the Managing Partner of Innovate Partners, LLC and of
Conn International Group LLC.
 This is a very brief summary of his presentation, which merits watching.
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The Multilateral Framework
 The framework would be a UN convention that would facilitate
interactions between private and public parties — although developed
countries don’t seem to agree, since they are not participating in the
works of the Committee.
 Sovereign debt is unsecured, and that creditors are private parties who
bought the debt in public markets. However, the boycott to this process
by developed countries doesn’t help in solving the problem of lack of a
mechanism that brings together all parties to restructure debt when
needed.
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Sovereignty Mine
 It bears consideration how the framework would affect sovereignty. To
some degree national sovereignty will be affected with a project like this,
which is the reason some countries are not participating in these
discussions.
 In addition, why would the US and the UK participate in the preparation of
a multilateral framework for restructuring? The laws and jurisdictions of
these countries are usually the ones chosen in debt contracts, so they will
be the ones most affected if an international convention limits or amends
contract rights.
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 The problem is compounded by the reality that sovereign defaults to
external bondholders are quite common. And now, recent developments
in case law have made even more difficult for creditors to reach
agreements for new terms, and to exchange bonds.
The interpretation of the contract was so strict that it penalized
reasonable creditors [this reference is to the Argentina case and the
pari passu holding of Judge Griesa of the US District Court for the
Southern District of New York].
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Approaches
 There are three approaches to the framework:
Private: let the market rule;
Statutory: an international convention or a set of rules;
Hybrid: a combination of both.
 The most important criteria is that the framework has to be perceived as
fair. Therefore, it is better to start with modest changes, to get countries
and private parties to buy-in the framework. The scope could be expanded
later.
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What to Consider Now
 The framework at the beginning should concentrate on procedural and
consensual changes. What can be addressed? Slowness of resolution, lack of
forum, and the effect that delays have on the cost structures of both debtor
and creditor.
 The task then is to convince developed countries that it benefits them if the
status quo on sovereign debt restructuring changes.
 For example, the status quo provides no defense for systemic contagion.
Developed countries have an interest in avoiding systemic failure because they
don’t want to be continually funding it. In addition, although the IMF is, in
theory, like a fireman, there to just put out a fire, the more the IMF intervenes
increases the chances that it turn into an entrenched participant in the
markets.
 Also, procedures are important: note that most bankruptcy regimes are
procedural.
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 There could be facilitators for negotiations, but they would not be decision
makers, unless the parties agree that a decision is to be made.
 The framework could provide that substantive law for the restructuring
process can be determined by the parties in the forum they choose. It
could be either the law in the debt contract or what they decide at the
time of negotiation.
 Mr Conn recommends not focusing on enforcement, since it implies a loss
of sovereignty and some countries will oppose the framework just because
of this issue.
 It is important to focus on the private market: to get their input and sell
the solution to them, making sure that it works for them. The participation
of the private market is important, since we need both primary and
secondary debt markets.
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What to Consider Later
 The issues of moral hazard, systemic risks, and political risks should be
considered later, since they are the most contentious. Especially since
issues of debt restructuring in geographically or politically important
countries is always political.
Any kind of framework that infringes on the ability of powerful,
developed nations to use the political leverage they want is a non-
starter.
Any substantive provisions in a framework that affect the ability to
make political decisions will not have the support of these
countries: politicians will not have judges limit the decisions they
may make on what they believe are political issues.
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 An international bankruptcy court or tribunal could be created after the
framework is in place and has been shown to work. This is a complicated
endeavor: it may be a problem to figure out the location of the court, who
the judges will be, and the court’s jurisdiction. The judges also need to
know what are the goals of the court, and what are the tasks given to it by
the legislation. What would be the goals: protect the debtor nation? The
liquidity of the bonds? Protect the economy of the country?
 Another issue is the applicable law. The tribunal will be brand new, so
there will be no precedent to guide the parties. That is an important factor
to consider, since in these circumstances it is difficult for lawyers to advise
their clients.
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 The more substantive criteria are included in a framework, the more
difficult it will be for parties to agree that it is fair. Conversely, the less
substantive provisions included in a framework, the better, since you leave
it to the participants to determine what they want. This would take care of
one of the objections of the private sector, which is that a substantive
framework would not let them contract freely.
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Front-End Regulations
 Restructuring debt is back-ended, and it would be better if there was some
sort of front-end process. This could be done with regulation, especially in
sovereign debt, where a contractual deal has significant effects outside of the
parties. The regulation will recognize that the private contract between
creditor and sovereign has a systemic risk.
 The developed nations have a common interest with developing nations in the
front-end: narrow consensual regulations at the start of a transaction. For
example, collective action clauses could be included in the regulation, with a
provision that all sovereign debt contracts will include them. With these
regulations in place before the transaction is entered into, creditors know what
the conditions are when they decide to do business. A small number of these
front-end regulations could have a chance of being included in the regulation.
 One of the biggest worries of developed countries is that a court will change
contract provisions after they have been signed.
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Puerto Rico Debt and the Front-End
 How do Mr Conn’s remarks apply to Puerto Rico?
 The main objection presented by Puerto Rico’s biggest creditors to its
attempts to deal with its debt is the back-end argument. They argue that
Puerto Rico is changing the rules of the game after they bought their debt.
The objection is, especially as to Act 71-2014 (the Recovery Act) and the
H.R. 870 (the Puerto Rico Chapter 9 Uniformity Act of 2015), that creditors
bought the debt believing no bankruptcy or debt restructuring was
available for Puerto Rico.
 There is not much strength to this argument of a back-end change to the
contractual provisions. In this case, the argument shows lack of due
diligence on the applicable law (Puerto Rico) and how the law has been
interpreted for decades.
Even the US Constitution permits the renegotiation of contractual
terms and obligations under extraordinary circumstances.
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 The majority (over 95%) of Puerto Rico’s debt was issued under Puerto
Rico law. Claims can be brought in a court of competent jurisdiction. This
is the applicable law and jurisdiction, as established in the debt
documents.
Some claims must be presented exclusively in the Puerto Rico
Superior Court in San Juan, such as those related to debt issued by
the Government Development Bank for Puerto Rico.
 Before buying any debt, you would expect buyers to study the law
applicable to the transaction, and decide if they are willing and able to live
with its provisions.
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The Need for Due Diligence
 With adequate due diligence, buyers would have known that:
Puerto Rico has not renounced its sovereign immunity;
its property is not available to be attached for the payment of debt,
since it is needed for the provision of public services;
it has no property outside of its borders;
the rebus sic stantibus doctrine which, if proven to a court’s
satisfaction, would imply the modification of a contract because of
extraordinary circumstances (and which courts apply in compliance
with the Contract Clause of the US Constitution).
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some creditors are contractually bound to bring their claims in the
Puerto Rico Superior Court in San Juan;
the rest of the creditors must bring their claims in a court of
competent jurisdiction;
there are strong arguments for the abstention of the federal court
in a claim brought under the debt documents — wherever the
federal court may be located;
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 These provisions are not back-ended: they are established legal doctrines
in Puerto Rico. They are known to those familiar with Puerto Rico law, and
are identified as a risk by buyers.
 The Recovery Act was actually an alternative to the application of the
rebus sic stantibus doctrine. Act 71-2014 established a process that limited
the judge’s discretion, and tried to create an alternative that was familiar
to the recent buyers of Puerto Rico debt.
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 Act 71-2014 is no longer available, but the transactions are still ruled by
and interpreted under Puerto Rico law. Creditors should make sure they
have identified all public policy and contract arguments and defenses.
 Also, Puerto Rico government structure is unlike any in the US (or the
sovereign debt market, for that matter), so it behooves creditors to
understand it well.
 Ignoring the intricacies of applicable law doesn't mean the debtor is
making back-end changes.
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Extras
 The video for Mr Conn’s keynote speech can be found here.
 Mr Conn’s presentation can be downloaded here.
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Originally published in LinkedIn
The front-end of Puerto Rico debt
2 June 2015
 This presentation has been edited 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.
 To receive future posts, just click the follow button in SlideShare and LinkedIn.
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Restructuring and Due Diligence: The Front-End of Puerto Rico Debt

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