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Municipal Bond Market Absorbs Puerto Rico Supreme Court’s Decision that Teacher Pension Reform Legislation is Unconstitutional Contract Impairment

Posted in State Law

BY LEN WEISER-VARON and BILL KANNEL

The latest swerve in the rollercoaster that is Puerto Rico public finance occurred on April 11 with the release of the Puerto Rico Supreme Court’s ruling striking down as unconstitutional the bulk of the territory’s teacher pension reform legislation.  The outcome of the case creates some disarray in the executive and legislative branches’ efforts to stabilize Puerto Rico’s finances, as well as in the Puerto Rico Supreme Court’s contracts clause jurisprudence.

We have previously discussed both the teacher pension reform litigation and the Puerto Rico Supreme Court’s prior ruling in the Hernandez case upholding the territory’s public employee pension reform legislation.  In the 5-4 Hernandez case, the dissents included strongly worded accusations that the majority had rubber-stamped the legislature’s conclusion that there were no less onerous alternatives to the  challenged impairments of the employee’s pension rights.   In the 5-3 teacher pension case, the majority went to the other extreme and concluded that the legislature and governor had acted unreasonably in enacting the legislation, because (according to the majority) the legislation failed to take into account the high number of accelerated teacher retirements the legislation would provoke, which (according to the majority) would further strain, rather than improve, the teacher pension system’s finances.

In other words, the court majority concluded that the teacher pension reform legislation did not promote the public purpose to which it was addressed.  As we have previously discussed, the “contracts clause” in the U.S. and Puerto Rico constitutions has been interpreted as permitting state action that impairs contracts if such action promotes a necessary public purpose and there are no less onerous means of achieving that public purpose.  Because the Puerto Rico Supreme Court concluded that the teacher pension reform legislation did not serve its stated public purpose of preserving the viability of the teacher pension system, it did not have to address whether there were less onerous means of achieving that purpose than the legislation’s benefit cutbacks and contribution increases.

In particular, the court referenced certain provisions of the legislation that preserved certain benefits for teachers retiring prior to a near-term cutoff date, economic studies presented by the teachers’ union regarding the impact of the early retirement of 7000 teachers, and an actuarial study forecasting the consequences of the early retirement of 5,000, 7000, 10,000 and 15,000 teachers, respectively.  The court also referenced testimony to the effect that approximately 4,100 teachers had contacted the pension system about early retirement since the legislation was enacted, and that 10,000 or more teachers would be eligible for early retirement.  The court interpreted the actuarial studies as showing that if such large-scale early retirements occurred, the pension fund would be depleted at an earlier date than if no legislation were enacted.  The court noted that the legislation had been enacted during a 6-day period and that the legislature had commissioned no studies about the early retirements the legislation might trigger or the impact of such early retirements on the system’s solvency.  The majority concluded that the teachers’ union had met its burden of proof that the challenged legislation, instead of increasing the system’s solvency, would leave it in a more precarious position.

The court upheld the legislation as applicable to teachers who began or begin service subsequent to its enactment, and also upheld certain cutbacks on system contributions to teachers’ health plans and annual Christmas bonuses to retired teachers, concluding that those benefits were not pension rights or contract rights.

It is unusual for a court, in a situation of fiscal crisis,  to hold that the other branches of government are effectively wrong about the financial effect of legislation being positive rather than negative.  There no doubt are genuine distinctions between the evidence presented in the Hernandez case and in the teachers’ pension case; it is also clear that there was a change in the receptiveness of certain of the court’s members to the government’s arguments regarding the necessity of the applicable pension reform.  To understand the difference in analysis and result, one may need to go no further than the majority opinion’s second paragraph, which states that “Teachers are the ones that mold the knowledge of the members of our society.  They are a fundamental piece of the educational system.”   A majority of the court appears to have credited the teachers’ presentation on this difficult public policy matter over the government’s.

Puerto Rico bondholders have been following this case for its credit implications as well as its legal implications.  The result may be a mixed bag from both perspectives.  From a credit perspective, the decision invalidates teacher pension reform that the Puerto Rico government has touted as an important component of its financial stabilization plan; on the other hand, the court invalidated the legislation on the stated grounds that the reform would make things worse, not better.  From a legal perspective, the court’s closer scrutiny of contract impairment may be somewhat heartening to bondholders concerned that Puerto Rico’s debt may be next on the impairment list.  Whether any comfort is warranted remains to be seen, but it seems less likely that the Puerto Rico Supreme Court would second-guess the financial efficacy of any future attempts to legislate debt restructuring.

Negligent Disclosure and Imputed Scienter: Recent SEC Enforcement Actions Against Municipal Bond Issuers

Posted in Disclosure

 

The post on our securities litigation and compliance blog titled “SEC Steps Up Scrutiny of Municipal Bonds: Recently Filed Enforcement Actions”  surveys recent SEC enforcement actions against municipal bond issuers.  As discussed in the post, the SEC’s charges in these actions include charges based on issuer negligence (versus the “scienter” standard of knowingly or recklessly misleading disclosure applicable to private securities law claims against municipal bond issuers), and also notes the SEC’s position that an officer’s state of knowledge can be imputed to a municipal bond issuer for purposes of establishing the issuer’s “scienter” in a securities fraud action.

 

Mintz Levin to Conduct Webinar on SEC Enforcement and Self-Reporting Initiatives Relating to Municipal Bond Issuers and Underwriters

Posted in Disclosure

As indicated in the adjacent blog posts, the SEC is increasing its enforcement presence in the municipal bond market, including enforcement and self-reporting initiatives relating to disclosures about an issuer’s historic compliance with Rule 15c2-12 continuing disclosure agreement obligations.  Mintz Levin is hosting a webinar to review these developments and the conundrums the self-reporting initiative may cause for issuers and underwriters.   Registration for the free webinar is available through the link below.

 

A New Era of SEC Muni Enforcement

Tuesday, April 29

1:00 pm ET

 

Over the last few years, the SEC has put its spotlight on the municipal market, increasing its scrutiny of issuers and underwriters alike. This new and aggressive approach has broken unspoken barriers that long defined the SEC’s long-standing policy of minimal regulation and intervention in the municipal market. Most notably, the SEC has increased its enforcement actions and imposed steep sanctions against individuals, issuers, and underwriters.

Join us for a review of the SEC’s recent enforcement actions and a discussion of its priorities and initiatives for 2014, including the new Municipalities Continuing Disclosure Cooperation (MCDC) Initiative.

Register Here: http://w.on24.com/r.htm?e=777668&s=1&k=70279BACFC42C416B572DBE16785E538&partnerref=pfblog

 

 

SEC Enforcement Staff Continues Sweep of Financially Distressed Municipal Bond Issuers

Posted in Disclosure

For an analysis of the SEC Enforcement Staff’s recent announcement that it is one year into a general sweep of financially distressed municipal bond issuers and that it has commenced formal investigations against some of these issuers, please view the post on our securities litigation and compliance blog titled, “SEC Enforcement Staff’s Investigations of Financially Stressed Municipal Issuers.”

That blog post examines several legal issues arising out of this sweep and the resulting investigations, including how this announcement by the Staff could be intended to put further pressure on municipal issuers and underwriters to self-report inaccurate disclosures, how investors may be swept up into these investigations, and the potential collateral legal issues that can arise if the SEC brings more actions in this area.

Legislative Trial Balloon for Puerto Rico Public Corporation Insolvency Process Attracts Bondholder Attention

Posted in Bankruptcy, State Law, Workouts

By LEN WEISER-VARON and BILL KANNEL

Last Tuesday, Puerto Rico sold its much-ballyhooed $3.5 billion in non-investment grade general obligation bonds.  Two days later, two legislators in Puerto Rico’s Senate filed a bill which, if enacted, would permit insolvency filings by Puerto Rico’s public corporations in Puerto Rico’s territorial trial court.  The juxtaposition of the two events has some bond investors crying foul.  But though the timing of the insolvency bill must have Puerto Rico’s investor relations personnel swallowing ibuprofen, Puerto Rico itself is not a “public corporation” and the proposed legislation would not establish a process for an insolvency filing affecting the territory’s general obligation bonds.  (Although the legislation authorizes a bankruptcy-like process, the process is referred to in this post as “insolvency”  to distinguish it from the federal bankruptcy process.)

The proposed legislation is of greater interest to holders of bonds issued by Puerto Rico’s public corporation bond issuers.  To the extent the legislation responds to requests by one or more public corporations, it is not good news for bondholders, as it suggests that some of those public corporations may be actively considering an insolvency-related process.  However, press reports indicate that Puerto Rico’s Governor opposes enactment of this particular legislation.  Accordingly, the existence of the Senate bill, and its details, may deserve attention not so much because of any likelihood that such an insolvency process will be implemented in the short term, but rather as a case study in the legal complexity of any attempted restructuring of Puerto Rico’s governmental debt.

Whether legislation of the type represented by the Puerto Rico Senate bill, if enacted, would be constitutional would likely involve years of litigation following an attempt by any public corporation to avail itself of such protection as it provides.  As suggested in the bill’s preamble, Puerto Rico’s authority to create its own non-federal process to address insolvent public corporations is uncertain.  Puerto Rico’s instrumentalities are excluded from the definition of “municipality” under Chapter 9, which governs municipal bankruptcies.  Whether under the U.S. Constitution’s supremacy and bankruptcy clauses the existence of Chapter 9 preempts Puerto Rico’s ability to establish its own bankruptcy-like process for its public corporations, or whether Puerto Rico’s exclusion from Chapter 9  suggests that Congress did not intend such preemption, is the main constitutional question.  Further complicating the resolution of that question is Puerto Rico’s status as a federally-approved U.S. territory that has been recognized as akin to a “state” for at least some constitutional purposes by the U.S. Court of Appeals for the First Circuit.

If legislation of the type filed in Puerto Rico’s Senate were enacted, and if the constitutionality of such a non-federal insolvency process in Puerto Rico were ultimately upheld, such legislation by its terms limits a public corporation’s ability to restructure its debts.   The legislation precludes a “significant” impairment of the public corporation’s major contractual obligations unless it is reasonable and necessary to serve an important public purpose.  The legislation defines an “important public purpose” as including (somewhat perplexingly) the obligation to comply with existing contracts, but, perhaps more significantly, as including “the stability and continuity of essential public infrastructure, utilities and services.”   In other words,  the bill would create a “bankruptcy-lite” statute designed to permit approval of restructuring plans only to the extent they satisfy the federal constitutional test for impairment of contracts.  The “contracts clause” of the U.S. constitution has been judicially interpreted not as a prohibition on contract impairment but rather as a balancing test under which contracts may be impaired if there is sufficient public necessity for doing so and there are no less onerous means of addressing such public necessity .

The limits on what can be achieved under the proposed legislation are compelled by the fact that, if it were enacted, in contrast to Chapter 9 it would not be enacted under Congress’s constitutional power to provide a bankruptcy process.  Whereas the constitutionally-sanctioned federal bankruptcy act expressly contemplates certain judicially approved contract impairments to give a debtor a “fresh start”, a Puerto Rican public corporation insolvency statute not enacted pursuant to the constitutional bankruptcy provisions would need to comply with the anti-impairment provisions of the U.S. Constitution.  Accordingly, any plan under a Puerto Rico statute that impairs bondholder rights would be subject to challenge on whether the statute’s definition of “important public purpose”  correctly incorporates the federal constitutional balancing test for permissible contract impairment and, if so, whether that test has been properly applied in the context of any particular impairment by any particular bonding authority of particular bondholder rights.   This is an inefficient process relative to the federal bankruptcy statute, which provides a process for bankruptcy plan approval that obviates the need to address on a case by case basis whether an approved contract impairment is constitutional.

The bill introduced in Puerto Rico’s Senate reinforces a risk already faced by Puerto Rico bondholders that Puerto Rico may seek by direct legislation or by legislatively-established process to impair to the extent constitutionally permissible the contractual rights of bondholders of insolvent bonding authorities.  That risk is already playing itself out for a different class of Puerto Rico’s creditors, its public employees and teachers, in legislation imposing certain pension cuts and in court challenges to such legislation.  If there is good news for Puerto Rico’s public corporation bondholders in the specific legislation filed in the Puerto Rico Senate, it is that the insolvency process outlined in such legislation, unlike the federal bankruptcy statute,  lacks a “cramdown” provision and would require approval of any restructuring plan by 75% in amount of affected creditors.  In other words, any cutbacks in bondholder rights under the proposed legislation would, in most conceivable instances, require the consent of a substantial proportion of the bondholders.

Legal Highlights in Puerto Rico’s “Draft POS” for Upcoming General Obligation Bond Issue

Posted in State Law

By LEN WEISER-VARON and BILL KANNEL

Although Puerto Rico’s much-discussed sub-investment grade general obligation bond issue is not yet being marketed via an official preliminary official statement, it appears that a draft POS has been making the rounds.  The draft POS, dated February 28, 2014, has been posted on at least one website and has been referenced in Bloomberg news reports.

From a legal perspective, an initial review of the draft POS includes the following items of interest:

  • The bonds as offered will not be subject to acceleration upon default.  Accelerability is one of the items that had been mentioned on the buy-side wish list, as otherwise a payment default on a particular coupon or maturity would only entitle bondholders to institute remedial action for the payment of that particular coupon or maturity.
  • Unsurprisingly, there is a lengthy “Risk Factors” section, atypical for general obligation bonds but not for sub-investment grade bonds.
  • The draft POS indicates that Puerto Rico’s Secretary of the Treasury has exercised his new statutory authority to provide for application of New York law and to expressly agree to the jurisdiction of New York’s state and federal courts (as well as Puerto Rico’s) in any action relating to this issue of general obligation bonds. As we have previously discussed, this item was higb up on the buy-side wish list.  However, the draft POS indicates that “no assurance can be given that any such litigation will be accepted by or, once accepted, be continued in a New York court or federal court in New York if the particular court determines by law that it does not have jurisdiction over the Commonwealth or that it should be removed to a court in Puerto Rico, as being more suitable on grounds of judicial fairness to the parties involved.” Furthermore, the draft POS states that “[a]lthough a judgment from a New York court should be given effect in Puerto Rico pursuant to the full faith and credit clause of the U.S. Constitution, such a judgment must meet certain minimum requirements before a Puerto Rico court will give it effect” and that “[t]here is no assurance that any judgment from a New York court would be given effect by a Puerto Rico court.”
  • The draft POS acknowledges the priority status of debt service payments on Puerto Rico’s “public debt” under Puerto Rico’s constitution, but indicates that “public policy considerations relating to the safety and well-being of the residents of the Commonwealth, as well as procedural matters, could result in delays in the judicial enforcement of this remedy, and in limitations on the effectiveness of such remedy” and that “the remedies available to bondholders are dependent on judicial actions, which are often subject to substantial discretion and delay.”
  • The draft POS notes the “clawback” provisions relating to Puerto Rico revenues assigned to Puerto Rico Highways and Transportation Authority (“Highways Authority”), Puerto Rico Infrastructure Financing Authority (“PRIFA”) and Puerto Rico Convention Center District Authority (“PRCCDA”), but states that the availability of such assigned revenues for debt service on the general obligation bonds “is subject to there being no other ‘available Commonwealth resources’” and that “[i]t is not certain what steps a general obligation bondholder would be required to take or what proof such bondholder would be required to produce to compel the diversion of such funds from any such instrumentality to the payment of public debt, or how the necessary available Commonwealth resources would be allocated between each such instrumentality.”
  • As required under SEC Rule 15c2-12, the draft POS discloses that “the Commonwealth has failed to file the Commonwealth’s Annual Financial Report before the May 1 deadline in three of the past five years.”  The draft POS states that “[a]lthough the Commonwealth has implemented certain mechanisms to ensure timely compliance with its continuing disclosure obligations, there is no assurance that the mechanisms put in place will be effective in ensuring timely compliance.”
  • There is no reference in the draft POS to the designation of purchasers’ counsel to represent prospective purchasers of the bonds in assessing the legal risks, legal opinions, continuing disclosure rights and other legal matters relating to this unusual offering. The funding of purchasers’ counsel by Puerto Rico or the underwriters has been requested by some prospective bondholders.

Puerto Rico Senate Not in a New York State of Mind?

Posted in State Law

By LEN WEISER-VARON and BILL KANNEL

As reported by the Wall Street Journal today and by other sources, the authorizing legislation for Puerto Rico’s much anticipated $3.5 billion non investment grade general obligation issue has become hung up in Puerto Rico’s Senate over language included in the bill passed by the territory’s House of Representatives that would authorize Puerto Rico’s Treasury secretary to agree that disputes over such bonds would be governed by the laws of, and could be brought in, a jurisdiction other than Puerto Rico. New York is the jurisdiction and law bondholders are presumed to prefer.

There are three possible outcomes.  If the legislation is enacted in the House form and the Treasury secretary so agrees, Puerto Rico could eliminate any doubt over the ability of bondholders to litigate disputes over the new general obligation bonds in New York federal or state court.  If the legislation as enacted is stripped of the House language, there may be no choice of law or forum provision in the documentation governing the general obligation bonds, in which case, as we have previously discussed, it would remain open to bondholders to bring suit in New York state court (or for injunctive relief in New York federal court), although Puerto Rico could seek to contest New York’s jurisdiction.  If the legislature or the Treasury secretary insist on affirmative language in the general obligation bond documentation requiring suit on the bonds to be brought in Puerto Rico, bondholders, if they accepted such terms, would be bound to litigate in Puerto Rico.

Today’s Wall Street Journal article asserts that “the vast majority of Puerto Rico’s existing bonds are subject to the island’s local law and jurisdiction.”  We believe that may overstate the case as to the jurisdiction element.  A sample of offering documents for Puerto Rico’s outstanding general obligation bonds contains no mention of a Puerto Rico jurisdiction requirement, and the bond resolution for COFINA bonds, while specifying that Puerto Rico law governs, does not reference Puerto Rico jurisdiction.  Although express agreement on New York jurisdiction would be preferable from the perspective of bondholders, it is not a given that silence on the topic in the documentation for the upcoming general obligation bonds would concede exclusive Puerto Rico jurisdiction.

SEC Approves Revised Semi-Annual Data Reporting Requirements for Section 529 Plan Underwriters

Posted in Section 529 plans

By LEN WEISER-VARON

After initially putting the brakes on the MSRB’s attempt to use underwriters of Section 529 college savings plans as its data-gathering team, the SEC has pressed the accelerator and approved an amended MSRB Rule G-45  requiring such underwriters to submit periodic electronic reports to the MSRB providing specified data regarding the applicable Section 529 plan.

The final rule requires semi-annual reporting on new Form G-45 regarding the plan’s assets, asset allocations for each plan investment option, plan contributions, plan withdrawals, plan fees and costs and certain other information, and annual reporting on such form of performance data for each plan investment option.  The “accelerated” rule will become effective on February 24, 2015, with the first semi-annual report due by August 30, 2015.

Much of the data to be submitted under Rule G-45 is already available in the periodically updated offering documents from Section 529 plans, on the issuer’s or program manager’s websites and/or on the College Savings Plan Network’s website, albeit not for consistent periods across Section 529 plans as Rule G-45 requires.  Other required data, such as aggregate contribution and withdrawal levels, is not generally available from plan disclosure.

By approving the new rule, the SEC has endorsed the MSRB’s use of its jurisdiction over brokers of municipal securities to obtain information about municipal fund securities that it lacks statutory authority to obtain directly from the municipal issuers of such securities, just as the SEC, in promulgating SEC Rule 15c2-12, leveraged its authority over brokers to  prompt enhanced initial and continuing disclosure by municipal bond issuers.

Unlike information required under SEC Rule 15c2-12, the Section 529 plan data to be submitted by underwriters to the MSRB will not be disclosed to Section 529 plan investors, at least initially, but rather used by the MSRB to monitor Section 529 plans and evaluate the need for and type of further regulation affecting that niche of municipal securities.  The MSRB has telegraphed, however, that at a future date it may engage in further rulemaking to share its trove of Section 529 plan-related information with investors.  And having established the precedent of requiring Section 529 plan underwriters to serve as data conduits for plans they distribute, the MSRB may also over time expand the categories of such data from those specified in the freshly minted Rule G-45, as the SEC has done with its Rule 15c2-12.

The procedural history of the MSRB’s new rule is peculiar.  The proposed rule was filed by the MSRB with the SEC on June 10, 2013.  Following a comment period, on September 26, 2013 the SEC took the unusual step of instituting proceedings to determine whether it should disapprove the proposed rule, suggesting, among other reasons, that substantial questions had been raised about the cost-benefit aspects of the proposed regulation.  The MSRB then filed a response to the comments submitted on the proposed rule, as well as an amended version of the proposed rule with some clarifications.  On February 21, 2014, the SEC approved the amended rule on an accelerated basis, stating that the MSRB’s response and rule clarifications had satisfied the SEC on the concerns raised by commenters.  The SEC invited further comment on the amended rule, even though the rule is now approved.  The MSRB, in a February 24, 2014 notice, stated that the rule would become effective on February 24, 2015.   The SEC’s initial lack of support for the MSRB’s proposal, and its subsequent accelerated approval of the slightly revised proposal, has generated a modicum of regulatory whiplash among followers of the rule’s progress.

In addition to jurisdictional and cost-benefit objections, comments on the proposed rule focused on its definition of “underwriter” and on an underwriter’s access to the data the rule requires underwriters to submit.  Most Section 529 plans involve retention by the governmental issuer/plan sponsor of a broker-dealer to distribute the plan securities, with other non-broker-dealer entities providing investment advice, recordkeeping and administrative services.  The entities providing the non-distribution services may or may not be affiliated with the broker-dealer and may provide such services pursuant to a contract with the plan sponsor or pursuant to a subcontract with the broker-dealer.   The MSRB’s rulemaking notice included language suggesting that the plan sponsor and other entities that are not registered broker-dealers might, under certain circumstances, be deemed “underwriters” subject to the Rule.  Commenters protested that the MSRB can only regulate broker-dealers.

The MSRB’s letter accompanying its amended version of Rule G-45 retracted the suggestion that the governmental issue/plan sponsor might be an “underwriter” but, as to other entities involved in Section 529 plan program management, doubled down on the proposition that, depending on the facts and circumstances, entities that are not registered brokers might, in performing services as a Section 529 plan contractor or subcontractor, perform functions that are “broker” functions and therefore “underwriter” functions.   The SEC approved the MSRB’s slightly revised position on “underwriter” status.

Commenters also raised concerns about Rule G-45’s apparent assumption that a Section 529 plan’s underwriter has access to and the right to provide to the MSRB plan data that may be maintained on behalf of the plans by affiliated or unaffiliated entities with which the underwriter may or may not have contractual privity.  (Unlike SEC Rule 15c2-12, which requires underwriters to enter into contracts with governmental issuers under which issuers agrees to provide the specified disclosure items, Rule G-45 directly requires Section  529 plan underwriters to provide the specified data to the MSRB.)   The MSRB and SEC have indicated that Rule G-45 requires an underwriter “to submit only information it possesses or has a legal right to obtain.”  The SEC’s rule approval noted that “the MSRB [has] stated its belief that an underwriter has a legal right to obtain all information that is related to its activities in connection with the underwriting, even when it has designated an affiliate or contractor to perform such activities.”

As to concerns that confidentiality or other constraints on the underwriter’s obtaining or sharing of plan-related information should be taken into account, the SEC endorsed the MSRB’s statement that “the legal right to obtain information for purposes of Rule G-45 is not affected by a ‘voluntary relinquishment, by contract or otherwise, of such a right.’’”

To the extent the MSRB continues to use its authority over broker-dealers as a point of access to Section 529 plan data it seeks or wants disclosed to investors, further skirmishing over  the MSRB’s view of information that a Section 529 plan underwriter “has a legal right to obtain” may lie ahead.

Puerto Rico Bondholders Await Contract Impairment Ruling in Teacher Pension Reform Litigation

Posted in Uncategorized

By LEN WEISER-VARON and BILL KANNEL

We previously discussed the Puerto Rico Supreme Court’s decision in the Hernandez case, in which by a 5-4 vote the court upheld the constitutionality under federal and Puerto Rico law of pension reform legislation affecting public sector employees, holding that though such legislation substantially impairs contract rights, the measures are reasonable and necessary to salvage the actuarial soundness of the pension system and that less onerous measures are unavailable.  Holders of bonds issued by Puerto Rico and its instrumentalities have now shifted their attention to the Puerto Rico Supreme Court’s handling of a constitutional challenge to recently enacted legislation reforming the teacher pension system.  The legislation currently under court review requires additional teacher contributions while deferring retirement age for current teachers with at least 30 years’ service from 50 to 55.

 

On January 14, 2014, the Puerto Rico Supreme Court issued an order taking over jurisdiction of the case from the trial court, and staying the effectiveness of the legislation pending further court action.  The court also appointed a special master to conduct an evidentiary hearing and present findings of fact to the court no later than today, February 7.  The court’s action, particularly the stay, is being evaluated by bond market participants as a potential sign that the constitutional challenge to this legislation may have more traction in the court than the Hernandez challenge mustered.

 

Bondholders have a mixed rooting interest in the outcome of the current pension reform litigation.  On the one hand, the cutbacks on future pension benefits effected by such legislation are viewed as a positive step by Puerto Rico’s legislative and executive branches to manage the liability side of Puerto Rico’s balance sheet, and therefore as a positive credit development.  On the other hand, such legislation impairs the contractual expectations of Puerto Rico’s teachers, much like the statute upheld in Hernandez impaired the pension rights of other public employees.  To the extent such impairments continue to survive constitutional challenges in Puerto Rico’s courts, questions are raised about how Puerto Rico’s courts would react should Puerto Rico feel compelled to adopt future measures that defer or reduce debt service payments or that otherwise impair its contracts with bondholders.

 

The tea-leaf reading in the teacher pension case includes review of brief statements delivered by some of the Puerto Rico Supreme Court justices in connection with the court’s stay order.  The Chief Justice indicated that he would have postponed the decision on the stay request until after the evidentiary hearing and findings of fact.  He indicated that such postponement would be consistent with court precedent to the effect that injunctive relief is not granted without a prior hearing.  One of the associate justices stated that she would not have granted direct Supreme Court review or the stay, but would have ordered the trial court to process the case on an expedited basis.  Three associate justices filed a concurring opinion citing precedent that the Puerto Rico Supreme Court can intervene in cases pending in lower courts that raise new questions of law or questions of high public interest that include any substantial constitutional question.  The concurring opinion states that the court order is appropriate given the high public interest for review of the changes to the teachers’ pension system and the urgent need to address the constitutionality of the challenged statute.  The concurring opinion asserts the need for a speedy resolution not only for the State of Puerto Rico and the teachers, but for the peace of mind of thousands of parents and children that the applicable justices assert are being deprived of education.  It also notes that the uncertainty over the teachers retirement system could force over 40,-000 teachers to decide in the coming days whether to resign, causing irreparable harm to the education system.

 

It is clear from the Chief Justice’s statement that the stay prior to a hearing is a departure from precedent. Whether that indicates that there is a majority of the court that favors a finding of unconstitutionality, or simply reflects the enormous public and political pressure associated with this case and the desire to temporarily mitigate the unrest sparked by the legislation remains to be seen.  What seems notable is the emphasis on fact-finding, which may include fact-finding on the key question of the existence of less onerous means of addressing the system’s solvency.  As described in our analysis of the Hernandez decision, the dissenters in that case castigated the majority for rubber-stamping the legislature’s findings of crisis and lack of alternative.  The Puerto Rico Supreme Court has given the plaintiff teachers, as well as the government, the ability to make presentations in a Supreme Court sponsored fact-finding that was not present in the Hernandez case.  Given the emphasis placed by the court on a speedy resolution of the challenge, whether that fact-finding results in a different outcome should be known fairly soon.

 

 

Could Bondholders Bring Claims Against Puerto Rico Bond Issuers in Courts Outside Puerto Rico?

Posted in Uncategorized

By Len Weiser-Varon and Bill Kannel

As Puerto Rico prepares to access the public markets with a new bond issue, the Wall Street Journal reports that the list of demands from some potential investors include, in addition to a high interest rate and as much security as the issuer can provide, the issuer’s consent to the adjudication in the New York courts of any future disputes involving the applicable bonds.

Hoping for the best but preparing for the worst, holders of existing bonds issued by Puerto Rico and its bond-issuing instrumentalities (such as COFINA) are likewise engaged in prospective forum-scouting.   The desired option to litigate any potential dispute outside Puerto Rico may be driven by the assumption that in times of financial crisis Puerto Rico’s courts are less likely to side with off-island investors than with Puerto Rico’s bond issuers, however meritorious the bondholders’ claims may be. Continue Reading