Puerto Rico's Fate Will Come Down to Decisions of a Single Judge

  • Debt-cut case to dictate public services for years to come
  • Detroit’s bankruptcy fight points to long struggle ahead

U.S. District Judge Laura Taylor Swain, picked to oversee Puerto Rico’s historic restructuring, will do more than set recoveries on $74 billion of debt. She’ll also be deciding how much government the island’s 3.5 million people can afford to live with -- and without.

That’s what happened in Detroit, which in 2013 filed what was then the biggest ever U.S. municipal bankruptcy, listing $18 billion in debt. Federal law gives judges broad discretion over debt-cutting plans, and in Detroit’s case U.S. Bankruptcy Judge Steven Rhodes came down firmly on the side of the city’s residents, ruling against bondholders who had opposed efforts to replace aging police cars and broken streetlights.

While Puerto Rico is barred from seeking creditor protection under the bankruptcy law Detroit used, the system devised by Congress to help the island address its staggering debt still puts plenty of power in the hands of Swain, who spent four years presiding over a bankruptcy cases before President Bill Clinton named her to Manhattan federal district court. Friday, U.S. Supreme Court Chief Justice John Roberts picked her to helm the Puerto Rico case.

The job now “for every junior associate for every constituent that’s involved in this case is to scramble over every ruling she’s ever made to try and predict how she’s going to rule,” said David Tawil, president and co-founder of Maglan Capital LP and a former bankruptcy attorney.

Questions include how she’ll treat groups including the people of the island, pensioners and investors, and how fast she’ll move the case along, he added.

“There are judges who may move more quickly,” said former Assistant U.S. Attorney Randall Jackson, who helped prosecute five former Bernard Madoff employees in Swain’s court. “She lets parties take the amount of time that is appropriate for the case.”

Puerto Rico’s government workforce has dropped by more than 7,000 to 227,000 in the past three years, but the commonwealth still employs about one in four non-farm workers on the island. In Connecticut, with a similar population, about 14 percent of workers are on government payrolls, while the average for a U.S. state is about 17 percent, according to the U.S. Bureau of Labor Statistics.

In its May 3 court filing, the commonwealth outlined a fiscal plan that calls for freezing pay raises for government workers, privatizing some services, and cutting subsidies to cities and the University of Puerto Rico. The plan would shift the cost of “premium” health-care services to patients and try to fix a $48 billion public pension shortfall. It doesn’t say exactly how it will accomplish those goals.

Legendary Bureaucracy

Ricardo Rossello, the island’s 38-year-old governor, has sworn to tame its legendary bureaucracy. As of April, his government had over 80 agencies, a number he has promised to cull. The public university has 11 campuses, more than the University of California, which serves a state population 10 times bigger. Puerto Rico also has 78 towns and cities, complete with their own governments.

A congressionally mandated federal oversight board is in charge of submitting Puerto Rico’s debt-adjustment plan to Swain, much as Detroit’s workout was presented by an emergency financial manager. After creditors and other interested groups weigh in, Swain will decide whether to approve the proposal, balancing the demands of politicians, public workers and private citizens against those of mutual funds and distressed-debt investors.

Puerto Rico’s creditors are likely to ask for more than what the oversight board is offering, if Detroit’s case is any guide, according to James Spiotto, an attorney who writes about the history of municipal bankruptcy. But they should be careful not pull so much money out of the commonwealth that the economy goes over a cliff, he said.

‘Death Spiral’

“If you give them everything they want, that’s not necessarily in their best interest,” Spiotto said. Bondholders “need to get paid in a way that is sustainable,” he added. Cutting too much “would begin a death spiral.”

The fiscal plan, which the oversight board approved in March, also lays out how much cash would be available to pay Puerto Rico’s debts after seeing to essential services. Annual expenses, including those essential services and other spending, will total $17.9 billion this year and reach $22.3 billion in 2026, according to the plan. Creditors have balked at the projections and demanded a breakdown of which services are deemed essential.

The commonwealth planned to spend $676 million between March 17 and June 30 to cover payroll, pay for health insurance, fund the university and pay suppliers. 

So far it hasn’t sought the court’s blessing for the plan. Under Chapter 9 of the U.S. Bankruptcy Code, which will be a guide for this case, governments aren’t required to seek court approval to spend money. Detroit’s emergency manager, Kevyn Orr, nevertheless asked the judge to bless some of the city’s spending plans.

Swain won’t be easy to peg as either a pro-debtor or pro-creditor, said Bruce Markell, a professor at Northwestern University School of Law and a retired bankruptcy judge. He worked with Swain in 2003 and 2004 when she was on a committee that helped rewrite the Bankruptcy Code in 2005.

“She has no natural predilections one way or the other,” he said.

Proposals, Counter-Proposals

In Detroit, Rhodes spent a year and a half fielding proposals and counter-proposals from hedge funds, Wall Street banks, labor unions and Orr before approving a plan for the city that cut 30 percent to 40 percent off what bondholders were owed. Swain will have to address a debt load many billions greater than Detroit’s, while considering the needs of a population five times larger.

“This is going to take several years,” said Richard Cooper, a restructuring lawyer with Cleary Gottlieb Steen & Hamilton LLP, which until earlier this year had been advising Puerto Rico on its debt troubles. “This is far more complicated than Detroit.”

The case is Financial Oversight and Management Board for Puerto Rico, 17-cv-01578, U.S. District Court, District of Puerto Rico (San Juan).

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