Assured Guaranty Ltd. and Ambac Financial Group Inc.
"As had been widely predicted and forewarned, the Commonwealth of Puerto Rico has been sued by Wall Street insurers," Governor Alejandro García Padilla said in a statement Friday. "This latest development will force a race to the courthouse and with no legal framework to handle this impending litigation crisis both the Commonwealth and its creditors will soon face the opposite of due process and rule of law. This reality causes great uncertainty for all parties involved."
García Padilla said Congress could have prevented the coming "litigation pandemonium" at no cost to the U.S. taxpayers.
"Congress can still prevent this humanitarian crisis from spinning out of control by immediately enacting the Puerto Rico Emergency Financial Stability Act of 2015," he said, referring to a bill introduced by House and Senate Democrats that would have established a short-term stay on creditor litigation until Congress takes action to allow Puerto Rico to restructure its debts. "Swift action from our congressional leaders is necessary and what the people of Puerto Rico deserve."
Puerto Rico on Jan. 4 failed to pay $35.9 million of interest on rum tax bonds issued by the Puerto Rico Infrastructure Finance Authority and $1.4 million in interest on Puerto Rico Public Finance Corp. bonds. In order to pay about $1 billion in other public sector debt payments, Puerto Rico said it diverted money from the income streams for the rum tax bonds, Puerto Rico Highway and Transportation Authority bonds, Convention Center District Authority bonds, Metropolitan Bus Authority bonds, and the Integrated Transportation Authority bonds.
On Dec. 29, Ambac and Financial Guaranty Insurance Co. delivered letters to Puerto Rico's government saying they considered the diversion of money from the PRIFA bonds to be illegal.
"Litigation is not the quickest route to a resolution," said Jim Spiotto, managing director of Chapman Strategic Advisors. "It's always time-consuming, expensive, and subject to appeal. Certainly Congress has before it various mechanisms to provide oversight to help Puerto Rico help itself to solve its problems."
Howard Cure, director of municipal research at Evercore, said Congress remains politically divided on how to respond to Puerto Rico's crisis.
"If Puerto Rico restricts its defaults to issues that have the ability to have their revenue stream clawed back, I don't think that, in and of itself, would pressure Congress to act," Cure said. "One of the questions facing Congress is not only to allow a Chapter 9 bankruptcy and also if they will expand it to include not only the various Authorities and enterprise systems, but the Commonwealth itself."
Cure added that Puerto Rico is now waiting on the Supreme Court to see if it will validate a local law that would allow the island's public corporations to restructure their debt. Lower courts have found the law to be unconstitutional.
"Congress also needs to decide about some kind of financial control board with real authority to set a budget and tax policy in order for the traditional muni buyers to re-enter the market," Cure said.
Before the year-end recess, House Speaker Paul Ryan (R-Wis.) set a deadline of March 31 for House committees with jurisdiction over Puerto Rico to come up with a workable solution for the commonwealth. García Padilla has said he intends to hold Ryan to that promise.
U.S. Senator Richard Blumenthal (D-Conn.) issued a statement on the lawsuit, saying that this is likely a tipping point in the island's debt debacle.
"Now, instead of using critical, scarce resources to pay its debts, Puerto Rico will be paying attorneys, fighting preventable litigation, and spiraling deeper into completely avoidable economic turmoil," Blumenthal said. "Congress can still - and must - act to stem this crisis, which is affecting 3.5 million American citizens in Puerto Rico, by passing my legislation to allow them to restructure their debts."
Last month, Blumenthal along with other Senators Elizabeth Warren (D-Mass.), Harry Reid (D-Nev.) and Chuck Schumer (D-N.Y.) introduced the Puerto Rico Emergency Financial Stability Act.
Rep. Nydia M. Velázquez, D-N, said that the situation in Puerto Rico continues to deteriorate, affecting the lives of 3.5 million American citizens.
"We are running out of time," she said. "Congress must pass [House Minority] Leader [Nancy] Pelosi's [D-Calif.] legislation to prevent creditors from suing the Commonwealth and enact meaningful legislation to permit a broader restructuring of Puerto Rico's debt."
The suit was filed on Jan. 7 in United States District Court for the District of Puerto Rico, names Garcia Padilla and other Puerto Rico government officials, seeks to have the clawback declared unconstitutional, and asks the Court to issue an injunction against its implementation.
"The Commonwealth has not satisfied the preconditions to the clawback and is disregarding the priorities of its own Constitution and the rule of the law," Dominic Frederico, president and chief executive officer of Assured, said in a statement released late on Jan. 7. "This confiscation of revenues pledged to bondholders is illegal. We encourage the Commonwealth to instead focus on measures that build market credibility and develop specific fiscal plans to address its critical issues, including revenue collection."
Cure said legal turmoil was predictable in the absence of a bankruptcy court and the protections that would come under it, given the differing interests of various creditors.
"The argument that the issuers are making is that you are only supposed to clawback if there is no other money," Cure said. "The whole concept is open to interpretation, and no one knows who will be settling that. It is only a matter of time before there will be other defaults. Normally a bankruptcy judge would make the call but in this situation we don't have that."
Cure also said he was unsure whether the insurers' arguments will hold up and that every dollar that Puerto Rico spends on lawyers and defending itself will reduce money that could go to bondholders.
"It was an inevitable lawsuit, but I am not sure what standing it has or how valid is. Without a judge refereeing, it could take years to be settled," he said.
Ambac president and chief executive officer Nader Tavakoli said that over the last several months, Ambac has attempted to engage the Commonwealth in consensual conversations toward finding amicable solutions for their asserted liquidity issues, only to be rebuffed.
"Instead the Commonwealth has committed itself to a 'scorched earth' strategy of blaming its fiscal and structural problems on lenders, Congress and others, in an effort to deflect responsibility and obtain retroactive application of bankruptcy laws," Tavakoli said. "Serious issues have been raised by the Governor himself as to whether the Commonwealth historically misrepresented its financial condition to fool the very lenders it now seeks to punish."
Tavakoli continued to say that Ambac remains hopeful that the Commonwealth will abandon such tactics, and turn instead toward good faith negotiations instead of confrontation.
"While we are optimistic that the government of Puerto Rico will begin to act responsibly, at this time we have no choice but to protect our stakeholders through judicial recourse," he said.
Mark Palmer, analyst at BTIG said that litigation is likely going forward as Puerto Rico opts to pay for public services before making its debt payments.
"The question is not whether the indentures provide for clawbacks, but the commonwealth's applications for those provisions," Palmer said. "Can Puerto Rico clawback when it has $9 billion in tax revenue on an annual basis? The insurers are arguing that the Commonwealth can't do that."
A spokesperson for Sen. Orrin Hatch, R-Utah , chairman of the Senate Finance Committee, said Hatch recognizes the debt challenges facing Puerto Rico, but based on the limited financial information that the government of Puerto Rico has chosen to provide, he and Senators Lisa Murkowski (R-Alaska) and Chuck Grassley (R-Iowa) have put forward legislation that paired tax and other fiscal relief with a path to credible budgeting and transparency for Puerto Rico's opaque government financing.
"Unfortunately, Puerto Rico's government continues to withhold information, choosing instead to engage in questionable interpretations of what is meant by the rule of law and due process," the spokesperson said. "Chairman Hatch remains committed, as he has been for quite some time now, to finding solutions that work to resolve Puerto Rico's debt and fiscal challenges."
