WASHINGTON — A draft bill that would give Puerto Rico and other U.S. territories the right to terminate their public, unsecured debt would be unprecedented, harmful to the municipal market, and likely unconstitutional, market sources and bankruptcy experts said.

According to a one-page summary of The Territorial Relief Act of 2018, which was leaked on Thursday, the bill would also provide federal relief funds to compensate certain unsecured creditors, but not others.

The bill was to be introduced late Thursday or early Friday, one of it's sponsors, Kirsten Gillibrand from New York, told The Bond Buyer Thursday morning, but sources said later that it will be delayed and somewhat revised. The other sponsors are Sens. Elizabeth Warren from Massachusetts, Bernie Sanders from Vermont, and Kamala Harris from California, according to the summary that was being circulated on Capitol Hill to pick up additional co-sponsors.

The summary suggested the impetus for the bill was the utter devastation that Hurricanes Irma and Maria caused to Puerto Rico and the U.S. Virgin Islands, coming on top of their already difficult financial situations. Puerto Rico has more than $70 billion of debt.

The area where a bridge once stood before Hurricane Maria is seen along Highway 152 in Barranquitas, Puerto Rico.  Many rural areas of the U.S. territory remain inaccessible.
The area where a bridge once stood before Hurricane Maria is seen along Highway 152 in Barranquitas, Puerto Rico. Many rural areas of the U.S. territory remain inaccessible. Bloomberg News

“The Territorial Relief Act of 2018 provides territories that have suffered an extraordinary crisis with a route to comprehensive debt relief and a chance to get back on their feet,” said the summary. “If Puerto Rico chooses to terminate its debt load within three years of the Territorial Relief Act being signed into law, this bill contemplates that $15 billion in federal funds will become available to some of the island’s creditors whose holdings were terminated,” it said.

"Few investors are willing to sink money into rebuilding Puerto Rico or the U.S. Virgin Islands if the debt overhang means that the islands have no realistic chance to recover," said the summary. "Congress’s previous attempt to address the Puerto Rican debt crisis — PROMESA — was enacted back in 2016 and was not written to address the devastation of a disaster like Hurricane Maria," the lawmakers said.

PROMESA was enacted to establish an oversight board, a process for restructuring debt and expedited procedures for approving critical infrastructure projects for Puerto Rico, which was in the midst of a debt crisis.

“The whole idea is that we need to get relief for Puerto Rico,” Harris told The Bond Buyer. “I’ve been there both before and after the hurricanes. I’ll tell you they are devastated and whatever we can do would be smart and give them support.”

Matt Fabian
Matt Fabian, managing director of Municipal Market Analytics.

But Matt Fabian, managing director of Municipal Market Analytics said, "The bill is a great way to make sure that no U.S. territory ever borrows in the muni market again. It would be problematic for any potential lender for any U.S. government."

"I think it would create a real cloud over their ability to have access to the capital markets and to borrow at any reasonable cost," agreed Jim Spiotto, a bankruptcy expert who is managing director at Chapman Strategic Advisors.

The legislation "would be unprecedented," he said, adding, "I don't know how you would make it fit constitutionally."

"I think the discrimination against creditors creates real issues -- that would be taking property without just compensation, which is required by our Constitution," he said referring to the Fifth Amendment of the U.S. Constitution.

Prospects for passage of the legislation are dim since it appears to have no Republican sponsors.

Sen. John Kennedy, R-La., was concerned that any federal bailout of Puerto Rico wouldn't help the territory. “The Puerto Rican people are just wonderful people but their political leadership is lacking,” he told The Bond Buyer. “And they need to get out of la-la land and realize the money they are spending is not unlimited. It comes out of people’s pockets and it’s not unlimited. It’s a scarce resource. And you can’t just waste money and keep going back to the well. So put me down as doubtful about the bill but I’m certainly willing to keep an open mind and read it.”

Under the bill, Puerto Rico and other territories would be given the option to terminate their public, unsecured debt if they met two of three criteria: a population decrease of 5% over 10 years; the receipt of major disaster assistance; or per capita debt exceeding $15,000.

The legislation would protect secured creditors to the extent of the value of their perfected security interests and create a judicial process for contesting the extent and perfection of security interests.

"PROMESA already has a judicial process for determining the priorities, the secured status of securities that fits within the basic parameters of the bankruptcy code, which has been found to be fair and just," said Spiotto.

Under this bill, "We'd have a new process for territories that would be in conflict with the one we have in effect for Puerto Rico and municipalities in the U.S.", said Spiotto.

The summary of the draft bill said that debt relief would only be provided if approved by either the territory’s governor as well as a majority of the legislature, or two thirds of the legislature.

The bill would not allow a territory to use this debt relief more than once every seven years.

One of the conditions of PROMESA is that the oversight board would remain in place until Puerto Rico obtained access to the capital markets, said Fabian. This bill, he said, "would guarantee a perpetual oversight board. It would become an eternal board."

The draft legislation would also create a Puerto Rico Debt Restructuring Compensation Fund that would provide federal relief funds to compensate eligible unsecured creditors, which would be allocated by a special master.

Puerto Rican creditors whose debt was terminated would be allocated $7.5 billion. These would include: the territory’s residents and banks; credit unions doing business solely in Puerto Rico; the island’s unions and public pension plans; businesses with a principal place in Puerto Rico; and certain others identified by the special master.

Another $7.5 billion would be allocated to mainland creditors whose debt was terminated. These would include: individuals, trade unions, pension plans, open-end mutual funds that pledge to waive their manager’s fee for any compensation received, and certain others identified by the special master.

Excluded from the federal relief funds would be: hedge funds and their investors; bond insurers; many financial firms with consolidated assets greater than $2 billion; and repo or swaps investors.

"This is probably more about capturing the votes of Puerto Rican sympathizers than undermining the debt negotiations," said Fabian.

Brian Tumulty contributed to this story.

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