When Contractual Rights are Better than Constitutional Rights: Addressing Puerto Rico's Debt Crisis Through Constitutional Amendment

Abstract

Constitutional rights are commonly considered the most fundamental, most protective of rights. Yet, in the context of public debt, there is a critical difference between constitutional provisions and contractual promises: who wields the power to amend. It generally takes mutual consent for parties to amend a contract, but the Constitution of Puerto Rico can be amended by the people of Puerto Rico by referendum, without creditors’ consent. Creditors understand that local law is subject to change. Creditors who do not want to assume that risk negotiate for explicit contractual protections and insist that another jurisdiction’s law govern the debt. For instance, Puerto Rico’s latest bonds, issued in 2014, are protected by explicit priority and remedy provisions in the language of the contract and are governed by New York law (hereinafter “NY law bonds”). The NY law bonds account for only about $3.5 billion of Puerto Rico’s $17 billion in general obligation (“GO”) debt. Accordingly, if Puerto Rico amended its Constitution it could reprioritize public spending over the significant majority of its general obligation bonds, those governed by Puerto Rican law (“PR bonds”). Puerto Rico can wield this power to encourage PR bond creditors to restructure. Right now, Puerto Rico’s pleas to restructure are more likely to fall on deaf ears since creditors can sue for payment from tax revenues. Reasonable investors may understand that a healthy, sustainable Puerto Rico will enhance their likelihood of sustainable payments in the future, but possible holdouts create real fears that those who restructure will bear the brunt of the crisis without fellow creditors carrying their fair share. Indeed, a creditor lawsuit could jeopardize a sustainable recovery even if reasonable creditors agree to haircuts. A constitutional amendment could check the extraordinary priority of creditors to pave the way for a productive refinancing.This paper will briefly examine the danger that holdouts pose to the refinancing process. It will then explain how the vulnerabilities of the PR law bonds’ enforcement mechanisms can be used to encourage restructuring. Finally, it will answer possible critiques of the plan and address potential legal challenges.