Don't Buy the Denials, Puerto Rico Is Being Bailed Out

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Despite Congressional leadership's ardent denial that the latest version of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) will not pump taxpayer dollars into debt-ridden Puerto Rico, we are creeping towards precisely such a bailout.

Updated last week, PROMESA seeks to redirect the indebted island territory "from a path of destitution towards a path of prosperity." Republican House and Committee leadership, including the bill's sponsor Rep. Sean Duffy, Natural Resources Committee Chairman Rob Bishop, and House Speaker Paul Ryan, have vowed to do so without pouring taxpayer funds into the island. But that is not how the law would necessarily play out.

Puerto Rico's Constitution gives the U.S. territory's general obligation bondholders explicit and absolute priority over all other obligations and expenses of the Puerto Rican Government. The U.S. Congress affirmed this priority when it ratified the Puerto Rican Constitution, and reaffirmed it in 1961 when it approved the implementation of Puerto Rico's constitutional debt limit.

With these protections and priorities in place, investors purchased Puerto Rico's bonds. But PROMESA's unprecedented stay on litigation and the Oversight Board's excessive power have the potential to completely remove all protections and priorities attached to these bonds.

Not only has Congress never before established a stay on creditor litigation, but Speaker Ryan's desire to strip bondholders' legal rights gives the Oversight Board the ability to extend the stay past the February 2017 deadline at its own discretion. By allowing the Oversight Board to implement a cramdown and extend the stay, the bill would enable Puerto Rico to pay other expenses, such as government pensions, ahead of general obligation bonds and for that matter, any bonds, without any legal recourse to protect their investments.

To retroactively change the rules in the middle of the game is akin to forcing bondholders to bail out the territory at the expense of their investments. It doesn't necessarily stop there, however.

There is a - so far, largely overlooked - scenario whereby PROMESA would, in turn, trigger a genuine taxpayer bailout.

Because investors will inevitably argue that Congress has retroactively changed the rules in such a way that interfered with their reasonable investment-backed expectations and infringed on their private property rights, it may lead to a successful takings claim.

Under this scenario, taxpayers may ultimately be required to foot the bill since the Fifth Amendment guarantees that no "private property be taken for public use, without just compensation." If a court rules that, in enacting PROMESA, Congress infringed upon bondholders' private property rights and thus implemented a federal taking of their private property for public use then the taxpayers will wind up back on the hook for providing just compensation.

In essence, the bondholders will front the money for the bailout while taxpayers would have to pay them back for this cash advance.

This is something that Speaker Ryan and his allies, including the Obama Administration, don't want you to know. We must recall that the United States has been held liable in the past when Congress changed the rules on investors in such a way that destroyed their property rights. For example, in U.S. v. Winstar, a contracts - rather than takings - case in which the Supreme Court upheld the theory of liability established during the Savings and Loan Crisis and ultimately required the United States to pay more than $2 billion dollars in compensation to these investors.

The possibility of this taxpayer bailout scenario is strengthened by the fact that not only has Congress twice affirmed Puerto Rico's constitutional debt hierarchy, and that there is precedent for successful claims when Congress changes rules in a manner that significantly disrupts investors reasonable investment-backed expectations, but also the Tucker Act also waives sovereign immunity with respect to takings claims.

For taxpayers, it matters little whether they are asked to foot the bill immediately for Puerto Rico's crisis, or if they are forced to pay for such dangerous oversights in drafting the bill. A bailout by any other name is still a bailout.

Congress should take great care, therefore, to respect and clearly define the priority assigned to Puerto Rico's general obligation bonds in any legislation it may enact.

Logan Beirne is an ISP Fellow & Lecturer in law at Yale Law School, where he teaches Financial Markets & Corporate Law. He is the author of "Blood Tyrants: George Washington & the Forging of the Presidency." 

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