Review of Aden et al. (part 3 of 3)

In our previous two posts, we reviewed the main details of a proposed private law solution to Puerto Rico’s public debt crisis. (This proposed solution would not require any new legislation, and it appears in this working paper by Aden, et al., 2016.) Here, we will evaluate the feasibility and merits of this solution.

For starters, we really admire the simplicity and elegance of the private law solution in the Aden et al. paper. After all, since a municipal bond is, legally speaking, nothing more than an investment contract, the relevant provisions of the Puerto Rico Civil Code should, in principle, apply to bonds emitted by the government of Puerto Rico. That said, what if the parties to the underlying bond contracts opted out of Puerto Rico law? We would not be surprised if the underlying contracts relating to Puerto Rico’s municipal bonds contained either a choice of law clause or a forum selection clause (or both). But even if Puerto Rico law did apply to these bonds, there are three additional legal barriers the government of Puerto Rico would have to overcome in order to implement the solution in Aden et al.: (1) can a government agency or instrumentality be a debtor under the provisions of the Puerto Rico civil code, (2) are bonds really a “joint obligation” under civil law, and (3) does federal bankruptcy law preempt the provisions of the Civil Code discussed in Aden, et al.? The third issue is currently awaiting resolution by the U.S. Supreme Court, so let’s focus on the first two issues in the remainder of this post.

To begin with, we see no good reason why the relevant debtor/creditor provisions of the P.R. Civil Code shouldn’t apply to a government agency or instrumentality. If anything, the same laws that apply to private persons and business entities should also apply to the government. Nevertheless, Aden et al. might be on shakier ground regarding step two of their proposed solution. We are under the impression that “joint obligations” (oligaciones solidarias) under the civil code refers to joint ownership of an indivisible thing (like a painting or a boat). In the case of bonds, by contrast, each individual bondholder’s ownership interest or credit rights can be easily and separately ascertained, so a strong argument can be made that bonds (or stocks, for that matter) should never be classified a “joint obligation.” Lastly, even if bonds (i.e. investment contracts) could be classified as a “joint obligation” under civil law (thus solving the critical holdout problem identified in Aden et al.), the government of Puerto Rico would still need to offer a restructuring deal that would be attractive enough to obtain the support of a simple majority of the relevant class of bondholders. How likely is that?

In the alternative, then, we would offer a procedural solution to the P.R. debt crisis: what if the Puerto Rico government and its major creditors (see below) were to agree to some form of binding arbitration to settle their differences?

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