#DefaultNotDefault

Puerto Rico missed a payment on its bonds yesterday. In other words, a “default”, right? Maybe not, as Mary Williams Walsh reports:

…the bonds that defaulted on Monday were sold with a guarantee, in the form of an irrevocable letter of credit issued by the Government Development Bank.

The letter of credit made the bonds look safer. It said that in the event the Public Finance Corporation failed to make a payment, a trustee for the bondholders would be able to draw the money owed them from the Government Development Bank.

But as investors have prepared for the default, they learned that the bonds’ prospectus does not describe this safety feature the same way the bonds’ indenture does, leaving confusion about what it takes to activate the letter of credit, or whether the guarantee is meaningful at all.

Officials in Puerto Rico have said that the bonds were backed by yearly budget appropriations, and that if an appropriation did not happen, the bonds would not be paid that year and the holders would have no legal recourse — in effect, there would not be any default to cure.

…investors might have to file suit in a Puerto Rico court to get a declaration of default, and there was no guarantee that the court would issue one. Then Puerto Rico might be able to turn around and sue the investors, saying their accusations of default had caused it irreparable legal and financial harm.

In other words, bondholders must rely on the munificence of judges whose salaries come from the Puerto Rican government to rule against said government. Seems unlikely.

Say the Supreme Court of Puerto Rico ruled against the bondholders, or, what’s more, held them responsible for harming territorial interests. The court decision would be reviewable by the US Supreme Court. But this would be a long legal road for bondholders, and loads of uncertainty and expense.

If any of the bondholders were from a country with a US investment agreement, this elongated procedure (if not the default and/or SCPR court excusing of it) would seem ripe for an investor-state complaint. If Puerto Rico were challenged, the US government (that didn’t bail the territory out and whose courts might even side with the bondholders) would be tasked with defending it.

Given US courts’ hardline on Argentina’s default, this would be quite a role reversal!