Puerto Rico Board Upheld by Supreme Court in Defeat for Bondholders

(Bloomberg) -- The U.S. Supreme Court upheld the oversight board responsible for resolving Puerto Rico’s debt crisis, rejecting a bondholder challenge and bolstering the panel’s efforts to pull the island out of its record bankruptcy.

In a unanimous decision Monday, the Supreme Court said the board was appointed constitutionally, dismissing contentions that members needed to be nominated by the president and confirmed by the Senate.

A ruling against the board would have meant more upheaval for a U.S. territory that has been pounded by a hurricane in 2017 and earthquakes and the coronavirus outbreak this year. The bondholders, led by Aurelius Investment LLC, were seeking to unravel much of the board’s work and eventually get more for their stakes than the oversight panel is offering.

Resolving the commonwealth’s bankruptcy and debt load could eventually help clear the way for more investment and economic growth.

“If they would have thrown out the board, it would have added significant uncertainty to a process that is already in some disarray due to the pandemic,” said John Ceffalio, municipal credit research analyst at AllianceBernstein, which manages $50 billion of munis, including Puerto Rico bonds. “There are so many uncertainties and at least this takes one of those uncertainties off the table.”

Aurelius said the board violated the Constitution’s appointments clause, which requires Senate confirmation for “officers of the United States.”

Local Power

Writing for the court, Justice Stephen Breyer said the board wasn’t subject to the appointments clause because the panel handles primarily local affairs.

“The board possesses considerable power -- including the authority to substitute its own judgment for the considered judgment of the governor and other elected officials,” Breyer wrote. “But this power primarily concerns local matters.”

Congress created the board in 2016. President Barack Obama selected the members, three Democrats and four Republicans, from a list provided by congressional leaders of both parties.

The oversight board said in a statement it welcomes the ruling and is looking forward to continuing its work in the interest of the people of Puerto Rico.

“Promesa’s appointment process has established a bipartisan oversight board, ensuring balanced decisions to help Puerto Rico recover and prosper,” the panel said, referring to the 2016 legislation that created the board. “It is paramount that we turn the corner from this crisis as soon as we can.”

The ruling is also a victory for President Donald Trump’s administration, which backed the board at the Supreme Court.

Reluctant Sotomayor

In a concurring opinion, Justice Sonia Sotomayor questioned whether Congress had any power to create the board at all, pointing to a 1950 agreement between the federal government and Puerto Rico.

The “long-awaited promise” of that accord “seemed to be that the people of Puerto Rico may choose their own territorial officers, rather than have such officers foisted on the territory by the federal government,” wrote Sotomayor, whose parents were born in Puerto Rico.

Sotomayor said she “reluctantly” joined the court’s judgment because those issues weren’t before the justices.

Aurelius had asked the Supreme Court to order dismissal of two of the bankruptcy cases, including the one centering on debt directly owned by the commonwealth.

Although it’s good to have the debate resolved, the ruling shouldn’t affect bond prices, said Daniel Solender, head of municipals at Lord Abbett & Co., which manages $27 billion in state and local debt, including Puerto Rico securities.

The more pressing issue for investors is whether the board will ask them to take bigger losses than those proposed in February with a group of bondholders, Solender said. The board last week said the island will have an estimated $15 billion less to pay investors during the next 12 years because of the coronavirus pandemic.

“Right now the focus is on whether the commonwealth will stick with the previous plans or whether they will use the current economic situation to try to renegotiate,” Solender said.

The case is Financial Oversight and Management Board v. Aurelius, 18-1334.

©2020 Bloomberg L.P.