Puerto Rico is in something of a jam at the moment.
On Tuesday, Standard & Poor’s downgraded Puerto Rico’s debt to junk status.
The move intensified Puerto Rico’s cash squeeze. How it deals with the issue is complicated by the fact that in 1922, not long after the United States acquired Puerto Rico in the Spanish-American War, the United States Supreme Court ruled that the Constitution did not apply in Puerto Rico because the island was a territory and not part of the union. The ruling left the island in a kind of legal limbo.
And there Puerto Rico has remained. It is not a state. So you might think it could file for Chapter 9 bankruptcy, just as Detroit and Jefferson County, Ala., have done. But no. Puerto Rico is also not a municipality, which is defined in the federal Bankruptcy Code as a “political subdivision or public agency or instrumentality of a State.â€
Without bankruptcy to help it solve its debt problems, maybe Puerto Rico could rely on sovereign immunity. Argentina, a far less sympathetic debtor, has used that to great ends.
But Puerto Rico is not a sovereign nation either. The First Circuit Court of Appeals in Boston has suggested that Puerto Rico has sovereign immunity under the 11th Amendment to the Constitution. But that seems odd, given that the island is clearly not a state or a foreign state, and the amendment uses those terms.
Puerto Rico might have some sort of “common law†sovereign immunity, but that’s mostly just guessing at this point, because there is little case law on the point.
And then there is the fact that Puerto Rico’s own constitution contains something that kind of looks like a waiver of its sovereign immunity when it comes to bond debt.
Why does it all matter? Without bankruptcy, Puerto Rico has no way to bind creditors to any sort of debt exchange offer that might address its problems. And without sovereign immunity, it may be that any creditors holding out for a better deal could run around bringing suits against the island, and obtaining judgments that might enable them to take pieces of property that should rightly belong to the Puerto Rican people.
Consider what the hedge fund Elliott Capital Management did after the Argentine government balked at paying the $370 million Elliott said it was owed after the country defaulted on its debt in 2001 and 2002. An Elliott subsidiary, NML Capital, persuaded a Ghanian court in 2012 to prevent an Argentinian Navy ship from leaving port unless Argentina paid NML $20 million. The ship was released only after a United Nations court stepped in.
In an earlier era, when Congress regularly reached compromises, Puerto Rico might have been able to work out a deal with Washington. But bailouts are political poison right now and for the foreseeable future.
Thus, Puerto Rico is left in a no man’s land: no bankruptcy and a tepid version of sovereign immunity, if anything.
In short, it won’t be easy. But it might be interesting, at least for those of us who are on the outside looking in. For the residents of Puerto Rico, though, it will probably just be painful.
Stephen J. Lubben is the Harvey Washington Wiley Chair in corporate governance and business ethics at Seton Hall Law School and an expert on bankruptcy.
