Puerto Rico may have filed to formally restructure back in 2017, but the lessons that can be learned still apply today. Former oversight board member David Skeel joins Jane Komsky to discuss his new book Promise Land which delves into the creditor battles, political compromises and lessons behind and beyond his experience navigating the restructuring.
Skeel maps the competing claims of roughly $18bn of General Obligation bonds, $18bn of sales tax-backed Cofina bonds, clawback creditors, pension bonds and general unsecured creditors. He also recounts Aurelius’ role and attempt to mastermind the restructuring.
The discussion explains how Promesa created the oversight board and Title III restructuring framework, and why Skeel believes an out-of-court resolution was ultimately unworkable. He recounts some of the unforeseeable obstacles including Hurricane Maria, political upheaval and the pandemic repeatedly disrupted negotiations, as well as divisions within the board complicating its dealings with creditors.
For distressed and municipal bond investors, Skeel’s conclusions extend beyond Puerto Rico. To get the full story, Skeel’s book is available for purchase here.
Have any feedback for us? Send us a note at podcast@9fin.com. Thanks for listening!
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Episode transcript:
This transcript was generated with AI assistance. Report any material inconsistencies or inaccuracies by emailing podcast@9fin.com.
Jane Komsky
Hello, and welcome to Jane's LME Addiction, a Cloud 9fin podcast where we talk about all things liability management. I'm your host Jane Komsky, head of LMEs, here at 9fin and with me today is Professor David Skeel from the University of Pennsylvania Carey Law School. Professor Skeel served on the seven person Puerto Rico oversite board. And recently wrote a book about his experience called Promise Land.
Welcome, Professor Skeel!
Professor Skeel
Thank you so much. It's great to be together, at least virtually.
Jane Komsky
Yes. Fun fact, Professor Skeel was, in fact, my bankruptcy professor. And because of that, even though I think he would have introduced himself as David, I will exclusively refer to him as Professor Skeel.
Professor Skeel
Well, feel free to slip up on that anytime.
Jane Komsky
One day. But today is not that day. And so I think, you had this very interesting experience, which you obviously decided to turn into a book. And after serving on this Puerto Rico board, you named this book Promise Land. And so I think my first question for you is, why is that the name of your book?
Professor Skeel
Well, the three reasons why Promise Land really seemed like it had to be the name of the book. The first is there's a very long history of promises made or thought to have been made to Puerto Rico and usually not fulfilled. Going back to 1898, when America first acquired Puerto Rico in the Spanish-American War. So back then, a lot of people in Puerto Rico thought that Puerto Rico was on its way to becoming a state, like territories had been in the 19th century. That turned out not to happen.
In 1952, Congress allowed Puerto Rico to make its own constitution, subject to some oversight from Congress. When that constitution was put in place, a lot of people in Puerto Rico thought that it had changed Puerto Rico's status, that Puerto Rico was not just a territory anymore. It had a heightened degree of sovereignty, and it's not clear that that happened either. So there are a long series of promises involving Puerto Rico historically.
The second reason I called the book Promise Land is that the legislation that created the Oversight Board in 2016 began with the promise. And the context was in 2015, in June of 2015, the then governor of Puerto Rico said, we cannot pay our debts. Our debts are unpayable, he told the New York Times on the debts at that point were $70bn of financial debt and about $50, $55bn of unfunded pension. Congress started scrambling after that, wasn't able to put together a response.
We got to the end of 2015. Paul Ryan was the new House majority leader. He needed to get an omnibus spending bill passed by the end of 2015. Because of the Freedom Caucus, a group of Republicans that wasn't going to GO along with anything that he put on the table, he needed Democratic votes. Paul Ryan made a deal with Nancy Pelosi, who was the minority leader at the time, that if Nancy Pelosi came up with 100 Democratic votes, Paul Ryan would give some or put some Democratic priorities into the omnibus spending bill. Nancy Pelosi did come up. With the votes. There were some priorities that were put into the spending bill, things like an extension of subsidies for the solar industry. But the one thing that didn't get in was help for Puerto Rico. The Democrats were understandably upset about that. And what Paul Ryan said at that point was, I promise I will craft a quote unquote responsible solution for Puerto Rico by the end of March 2016, by the end of the next quarter. And he ended up more or less making good on that promise. The legislation, it took a little longer than the end of March 2016, but it was in fact enacted in June of 2016.
The final reason that I call the book Promise Land is the name of that legislation is Promesa, which means promise in Spanish. The idea was that legislation was a promise to help build a better future for Puerto Rico. What the legislation did is it created the oversight board, the seven-person oversight board that you referred to, and gave the board two main powers. One was the power to restructure Puerto Rico's debt, and the other was the power to certify five-year fiscal plans that would have the effect of restoring balance to Puerto Rico's budget.
So that's kind of a long-winded explanation. But by the time the, even before the book was in the publishing pipeline, I knew the name was going to be Promise Land.
How Skeel joined the oversight board
Jane Komsky
And so I think that's a great lens. So we have these three promises, but let's talk about, I guess, how did you end up on this oversight board in the first place?
Professor Skeel
The short answer is I'm not 100 percent sure, but the slightly longer answer is I wrote an op-ed in The Wall Street Journal in January of 2016 when the legislative process was really just getting going. And I wrote the op-ed intentionally trying to attract a little attention and hopefully be invited to talk to somebody in Washington. I was assuming it would be Republican lawmakers.
Jane Komsky
That's all of my articles, by the way, and nobody has ever called me from Washington.
Professor Skeel
Well, I didn't I didn't get the right people calling me. I thought I thought it would be Republican lawmakers would call me up. And I was hoping because I had talked to a number of Republican lawmakers, some Democratic ones as well during the Great Recession and the discussions about financial reform at that point.
They didn't call me up, but the person somebody did call me up. And the person who called me up was a guy named Kent Hiteshew, who's a municipal bond expert. And he turned out to be the person who was really the point person in many respects for the Obama administration. He was in the Obama Treasury Department. So I was involved in some some a few conversations. I didn't have any impact on the legislation at all.
Whether that's why I got called, I'm not sure. But in June 2016, I think it was the day the legislation was signed into law by President Obama, I got a call from Mitch McConnell's office. And that led to a meeting with him and then ultimately to being nominated by him and picked by President Obama.
Jane Komsky
Interesting. And so when you think about restructurings, obviously, Puerto Rico, when you're restructuring a state is very different than restructuring, you know, your usual corporate entity. And obviously that in and of itself would make for an interesting book.
But as we know, when we're reading books, books are only as interesting as their characters. And so you and your book introduce a number of very interesting characters. And I'd love to give our listeners some sort of overview of who the main, I guess, stakeholders are in this restructuring and how they drove that process.
Meet Puerto Rico's competing creditors
Professor Skeel
Sure. So Yeah.
Jane Komsky
You can start with the bondholders and move on to the board.
Professor Skeel
And there are there are characters at various points. But I'll start out with just the overview to kind of create a sensible lay of the land. So there were five main creditor groups in the restructuring of the central government, the restructuring of the Commonwealth, which was the big restructuring. There were 12 other restructurings, but the big one was the Commonwealth.
So the two biggest groups of bondholders, one was General Obligation bondholders or GO bonds. They were about $18 billion. And those were bonds that were backed by the full faith and credit of Puerto Rico. The other really big group of bondholders was what was called Cofina. Cofina is an acronym, C-O-F-I-N-A, which stands for sales tax entity, basically. What Cofina was, and it was also about $18bn, Cofina was a separate entity that was set up really to evade Puerto Rico's debt limits and to issue bonds that technically wouldn't count as Puerto Rico bonds, as central government bonds. And those bonds were backed by sales tax revenue. So Puerto Rico diverted sales tax revenues to this separate entity. That entity issued bonds, and in the end, there were about $18 billion of them.
So those were the two really big groups. The third of the five groups was a group of creditors that were called clawback creditors. And what they were is they were bonds that were issued not by the central government, but by other entities. And the main entity was the highway authority. And there was another entity as well that issued a fair amount of bonds. So these other entities issued bonds. It was about $6bn in total.
And the Commonwealth promised to pay to make the payments on those bonds. That's why they were creditors of the Commonwealth or the central government. But if the central government couldn't pay its GOs, it could stop paying those clawback bonds. That's why they were called clawback, although that's not really what you think of when you think about clawback. Clawback here, the main thing it meant was the central government would stop. So they were kind of indirect obligations of the central government in a way.
The fourth group of creditors was about $3bn of pension bonds, bonds that were issued by the pension system to plug holes in pension funding.
And then the fifth group of creditors was the general creditors, the Unsecured Creditors Committee. So those were the key groups. And there were key players within a number of those groups with the General Obligation bonds. One of the key players was a hedge fund called Aurelius, which is a hedge fund.
Jane Komsky
I think our listeners will be very familiar. But yeah, continue.
Professor Skeel
You know, the guy who started Aurelius, Mark Brodsky, was originally at Elliott Management. So Aurelius is a daughter hedge fund of Elliott Management in a way.
Who gets the sales tax revenues?
Jane Komsky
And so unlike in a normal capital structure, when you're laying things out from the start and you kind of know, OK, here are your secured lenders, here are your unsecured lenders, here are your term lenders. It seemed like in the Puerto Rico structure, it was not necessarily clear who had the most priority at any given moment. And that sort of both made restructuring more complicated and also obviously drove some good drama in the book. Could you speak to that?
Professor Skeel
Absolutely. And that really wasn't the heart of it. There were two key issues in the Commonwealth well, restructuring that you can see as priority issues in a way.
One was the relationship between the GOs and Cofina. Theoretically, the Cofina bonds had nothing to do with the central government. They were funded by sales tax revenues that theoretically never touched the central government. They went straight to Cofina. But the creditors of the central government, particularly the GO bondholders said that was an illegitimate structure. It was just set up to try to evade the debt limit. It's illegal. And we are entitled to that money, to all of those sales tax revenues. So not directly a priority issue, but in a sense it is, or at least it's a gets the money first kind of issue.
The other really big priority issue was the General Obligation bonds. There is a provision in the Puerto Rico Constitution that says the general, or it says, bonds that are backed by the full faith and credit of Puerto Rico have to be paid first in any given year. And the GO bondholders took the position that that made them absolute first priority over all of those other groups of creditors that I referred to.
In my view, that it was quite debatable and we did debate it with the GO bondholders. In my view, all that provision said was that whatever the amount owed on the bonds in a given year, that amount has to be paid first before other amounts. It's not it's not a provision that says you can't restructure the bonds. It's just a provision that says whatever is owed today, either before or after restructuring, needs to be paid before other creditors. But that priority or claimed priority played a very, very big role in the central government restructuring.
Title III and Aurelius's bid to avoid it
Jane Komsky
I think another interesting facet of this is the fact that, I mean, technically, Puerto Rico never actually filed for bankruptcy, right? And could you explain why that is?
Professor Skeel
Promesa creates a different framework or a new framework for restructuring Puerto Rico's debt. Going into when Promesa was enacted in 2016, Puerto Rico didn't have any way to restructure any of its debt, either the central government's debt or the debt of any of the other entities like the electricity company.
Unlike every state, which can let its cities or government corporations file for municipal bankruptcy, Chapter 9, Puerto Rico is excluded from that. So there was no restructuring possibility at all. Promesa created a restructuring opportunity for both the separate corporations and for the central government, which is called Title III.
So in a sense, there never was a bankruptcy. There never was anything that looked like, or there was something that looked like bankruptcy, but there never technically was the bankruptcy. I mean, in another sense, Puerto Rico didn't file for bankruptcy because the way that Puerto Rico got into Title III, I hope I said Title III earlier. I should have said Title III. The way Puerto Rico got into Title III is the board put Puerto Rico into Title III. The governor didn't put Puerto Rico into Title III, although the governor did have some say in that, which created a little bit of drama. And then finally, there was an effort to avoid this altogether, which involved Aurelius. Aurelius tried to make a deal with the governor of Puerto Rico about a year after Promesa was enacted, right when the board was thinking, we need to put the central government into Title III, Aurelius tried to make a quick deal at the last minute to make Title III unnecessary from its perspective. And it was that that really drove the board to file for Title III or I mean, for all intents and purposes, Title III walks like a bankruptcy, talks like a bankruptcy. I think I'm going to call it a bankruptcy.
Jane Komsky
But had Aurelius not made that play to try and prevent the option of Title III ever being on the table? One, do you think you would have filed as quickly as you did? And two, do you think there's any world in which you could have prevented, you might not have had to file at all.
Professor Skeel
Well, taking the second question first, could bankruptcy or could Title III have been avoided altogether? I think at the end of the day, the answer is no. It was just going to be too complicated, and Puerto Rico was in too deep a financial crisis. If the GO bonds were the only big creditors, it might have been possible to restructure them without going into Title III, without going into bankruptcy.
But there was this huge issue of whether Cofina was legitimate or not, which there was $51bn of nominal sales tax revenues on the line with that issue. And you really couldn't resolve anything until you figured out whether the GOs got that money, Cofina got that money, or there was going to be some settlement of it. So that would have made it really hard.
The fact that there was $55bn of unfunded pensions that wouldn't be dealt with if you stayed outside of bankruptcy, that would have made it hard.
But Aurelius did really make a play to keep Puerto Rico out. And the governor of Puerto Rico, at least initially, agreed that bankruptcy wasn't necessary. I think it would have been in the end. It might have been a little bit later, although the other variable that came into play during that period, which was April 2017, was there was a standstill. There was a stay that had been put in place by Promesa and it was about to run out. It was going to run out in early May. It wouldn't have meant that Puerto Rico had to file for bankruptcy immediately. It might've been end of May, even June or a little bit later. But I think in the end, Puerto Rico was going to end up with bankruptcy.
Disasters derail the restructuring
Jane Komsky
And so what happened after Puerto Rico filed, right? I mean, almost like reads like a Grey's Anatomy episode. There are hurricanes. There was an earthquake. Like there was a pandemic. You just couldn't catch a break there. But all of that drama aside, or I guess force majeures aside, I'd love for you to just sort of give an overview of what happened once you filed and how you ended up figuring out a way, even if longer than expected, to get out of bankruptcy.
Professor Skeel
Well, it really was an up and down, forward and back process...
Jane Komsky
And I can't recommend enough reading the book and seeing this process because it really it's it's a fantastic read. And I really enjoyed meeting the various characters, which we won't have time to dive into each one here. But yeah, at the 30,000 foot overview. Yeah, it would be great to hear just sort of the story.
Professor Skeel
Absolutely. Thanks for the kind words about the book. As I look back on it, I think. All of the human and natural disaster obstacles we dealt with were no fun at the time and really complicated things a lot. But they did make, I think, for an interesting book because there was there was a lot going on. So we started in 2016, 31 August 2016. The seven members of the board were appointed. We had no idea what Puerto Rico's revenues and expenses were. So we spent about six months trying to figure that out because we couldn't figure out what Puerto Rico would afford to pay to its creditors if we didn't know what the revenues and expenses were. Spring 2017, we were starting to get our arms around that a bit. We had some skirmishes with the governor, Ricardo Rosselló. And then in September 2017, Hurricane Maria just wiped everything out. Basically forced us to start over. And so we started over. We put together a proposed plan, which I was really enthusiastic about it. The then governor, Rosselló, pushed back against it. There was a big scandal involving him and his administration. So that slowed things down again. And then finally ...
Jane Komsky
Just to also add in, I mean, you say scandal, he was ultimately ousted. There were protests in the street. There's there's a lot. There's a lot here. But continue.
Professor Skeel
It was incredible. I mean, it was. And all we could do is the board is just step back. I mean, we couldn't do anything. So it was summer of 2019. There was a quote unquote chat among the governor and his main advisors, all men, that was politically incorrect, to put it very mildly, led to enormous protests. The final protest was, I think, about a million people in Old San Juan. He was forced to resign. So that really just put everything at a standstill.
By early 2020, we had in place a proposed reorganization plan. I wasn't thrilled about it, but it was probably a confirmable plan. But then the pandemic hit, and so we had to put that on hold for three or four months. And then the final push began in fall of 2020. And we proposed a plan in 2021. It was there were confirmation hearings at the end of 2021. And it was confirmed in January ‘21. Lots of drama throughout that, including drama within the board. We had a board member who considered himself to be a protege of President Trump. And he considered his ...
Jane Komsky
He was almost a de facto bondholder himself, though he held no bonds.
Bondholder tensions inside the board
Professor Skeel
He really was. He had represented, he runs a, or he's one of the folks who run a Washington, D.C. Communications firm. He had represented Aurelius and other bondholders before Promesa, had tried to derail Promesa, managed to get himself appointed to the board. And he quite explicitly and publicly said, my job, as I see it, is to get as much as reasonably possible for the bondholders.
And so I felt during that time, which was started in the fall of 2020, I felt, and I think my fellow board members felt the same way. It was as if it with the reorganization, we were in a football game against the bondholders and the bondholders had somebody in our huddle at all relevant times. We really felt like the bondholders knew everything that we were doing. And so we had to assume nothing was secret. It really was not the way I imagined the negotiations would be, but somehow we ended up with the restructuring in the end.
Jane Komsky
Yeah. And so after, I mean, it sounds like an incredible experience. And I know that you definitely were vying to be on this board in the first place. But I guess my final two questions for you are, one, is this something that you would want to do again? Would you want to join a board? Because I mean, eventually, right, some there will be something similar to this again. You have the right experience. Would you join another board?
Professor Skeel
Well, I do talk about this a little bit in the book. So a little bit of a spoiler alert, I suppose. But the short answer would be yes. The longer answer would be I … and I don't think any of the other original board members I never dreamed it would be an eight year process for me.
Jane Komsky
An unpaid one at that.
Professor Skeel
An unpaid one. The board is still in place after 10 years. If you had asked me in 2016 how long we would be there, I would would have said three or four years. We were racing to try to get the restructuring done before our original three-year period, our term was over. And I thought it'd take a little longer than that, but I would have assumed the board would be done in four years. I had no idea that I would be on it for almost eight and it would still be going at 10. So I would do it.
Jane Komsky
And that prediction actually, as you say in the book, kind of came back to haunt you because you told another board member, aforementioned board member, I should say, that it's probably only another year.
Professor Skeel
Yes that's right. Yeah, I had I had my chance to shorten my time with with Justin because Justin was ready to to leave the board and get back to full time doing doing the business he wanted to do. And he asked me with PREPA, the electricity company, did I think it could be done in the year, in 2022, the year that the central government restructuring was completed. And I said, yeah, I think it could be done this year.
Unfortunately, that kept Justin on the board or may have contributed to keeping Justin on the board. And four years after that, the electricity company is still in bankruptcy, unfortunately, as anybody who watched Bad Bunny's Superbowl halftime show is aware.
Jane Komsky
Yeah. And so I guess if you could leave our listeners with one takeaway, what would that be?
Lessons for the next government debt crisis
Professor Skeel
Well, my one takeaway is actually a couple. I mean, one, if I had to do one, the one would be something that you said at the very outset of this conversation. And that is when we have another governmental crisis, we are going to have the same option set. So if If Chicago ends up in bankruptcy, if Illinois ends up in trouble, if the U.S. Debt reaches a crisis point, we're going to have the same option set. So we're going to be thinking about things like oversight boards and restructuring. And so I guess the one takeaway would be, please read the book and it will give you a sense of how that might play out and some of some of the upsides and downsides.
Jane Komsky
I won't cut you off if you want to add additional takeaways.
Professor Skeel
I'll add a couple more that really is kind of playing that out a little bit more specifically. One is that with an oversight board, one of the things that we really learned, somewhat to our chagrin, is that there's a real tradeoff between democracy and the power of the board. So that if you give the board an enormous amount of power, you're completely undermining democracy. You're putting in place unelected board members, but you can get the job done potentially very quickly. That's what happened in Detroit. The emergency manager had absolute control of the city government and he got the job done in a year and a half.
We didn't have that same kind of control because of concerns about colonialism. Our powers were weakened a little bit. We didn't completely take over. We didn't have the power to pass legislation. And one effect of that is that we couldn't do as much as we would have wanted to do as quickly as we could.
So there's a real trade-off there. If you want to protect democracy and you don't want a complete taking over of the government, you have to weaken the board and the board may not be able to act quite as quickly as you might want.
The second takeaway is that pensions appear to be off limits. Even though Puerto Rico's pensions were $55 billion underfunded, they were essentially unfunded, they were not cut. There were adjustments made and the pension system was shored up, but the nominal amount of the pensions was not cut. And I think at this point, that is going to be the takeaway for future governmental bankruptcies. I don't think we're going to see pension cuts in bankruptcies.
And then finally, what I would say about personal takeaway for me is I'm used to talking about these things in class where you can be a purist and talk about what the rules are and assume the rules are just going to be applied the way they're written. What I learned and what the reality of this kind of situation is, is you can't be a purist. You're going to have to make compromises. Priority rules are probably going to be fudged at various times. But this kind of an approach, an oversight board and a restructuring option can make a big difference. And although there still are issues in Puerto Rico now, I really do think it has put Puerto Rico in a position to grow significantly in the future.
Jane Komsky
I think those are all really interesting takeaways. And I really, I appreciate you coming on the podcast to talk about it. I loved reading your book. And like I said, I can't recommend it enough. Thank you so much for joining me.
Professor Skeel
Oh, thank you, Jane. It's always a pleasure to talk to you.
Jane Komsky
You too. And thank you so much to our listeners. If you have any questions, please email podcast@9fin.com. Thank you again for listening.