United States: Puerto Rico Supreme Court’s Deference to Legislature’s Determinations: A Double-Edged Sword for Puerto Rico Bondholders?

The Government Development Bank for Puerto Rico (GDB) hosted an unusual public conference call on October 31 to respond to legal questions raised by investors in bonds issued by the Puerto Rico Sales Tax Financing Corporation, better known by its Spanish acronym, COFINA.  During the one-hour call (which is available for replay on the GDB website), bond counsel and underwriters' counsel made presentations explaining the rationales for legal opinions they delivered in connection with COFINA's most recent bond issues, and responded to several written questions submitted by investors in advance of the call.

The legal opinions and the investor questions focused on the validity of the statutory transfer by the Commonwealth of Puerto Rico to COFINA of 2.75% (recently increased to 3.50% by statutory amendment) of Puerto Rico's annual sales and use tax revenues (or, if greater, stated minimum annual amounts), and of the legislature's statutory declaration that such transferred tax revenues do not constitute "available resources" which, under Puerto Rico's constitution, are dedicated on a first priority basis to the payment of Puerto Rico's "public debt", such as Puerto Rico's general obligation bonds.  Puerto Rico is reported to have over $50 billion in tax-supported debt outstanding.

The legal opinions noted, and counsel reasserted in their presentations, the absence of judicial precedent in Puerto Rico construing the validity of the legislature's carve-out of a portion of the sales and use tax revenue to secure COFINA bonds.  Given such circumstances, the opinions and presentations focused on decisions by various state courts upholding similar financing structures in New York and certain other states, as well as on the Puerto Rico judicial system's history of deference to the legislature's determinations as to the necessity and validity of legislation.   One of the lawyers on the conference call, in response to an investor question, stated that he could recall only two instances in recent memory in which the Puerto Rico courts had invalidated legislation, and one of those involved restrictions on Puerto Rico's judicial branch.

Puerto Rico's tradition of judicial deference to its legislature's acts was emphasized on the call as a source of comfort to bondholders vis-à-vis any potential court challenges to the existing statutes establishing COFINA's revenue stream and its pledge to COFINA bondholders.  We note, however, that a case decided earlier this year by the Puerto Rico Supreme Court suggests that such deference may be a double-edged sword in situations where the legislature decides it is in Puerto Rico's interests to impair rights granted by a prior legislature.  The case in question, Hernandez v. Estado Libro Associado, 2013 WL 3586616 (June 24, 2013) upheld legislative reforms to Puerto Rico's public pension system against claims that such reforms violated the U.S. Constitution's "contracts clause" restricting states from impairing contractual rights, as well as the Puerto Rico constitution's analogous provision.  (Courts that have considered the matter have held that though Puerto Rico is not a "state" it is equally subject to the U.S. Constitution's "contracts clause.")

Hernandez was decided on June 24, 2013, and an official translation of the Spanish text is not yet available.  (Official translations into English of Puerto Rico Supreme Court cases generally lag the opinion release date by a substantial period. )   The unattributed "per curiam" majority opinion and the unusually candid attacks and counterattacks on fellow justices in the concurring and dissenting opinions testify to the political heat generated by the legislative cutbacks on public employee pension rights and brought to bear on the Puerto Rico judiciary in reviewing the constitutionality of cutbacks designed to address the island's troubled balance sheet.  Though Hernandez only directly affects Puerto Rico's state employee pensions, the court's approach to the case may have substantial relevance to Puerto Rico's bondholders should the Puerto Rico legislature deem it necessary to revisit bond-related legislation in order to reduce Puerto Rico's liabilities or reprioritize application of revenues.

Puerto Rico is likely to remain dependent on the good will of the bond market in most conceivable scenarios, and therefore is unlikely to resort to a unilateral  legislative restructuring of its bond debt unless it has no other options.  The Hernandez decision was greeted in some quarters as a positive sign for Puerto Rico's bondholders in that it demonstrates the Puerto Rico judiciary's willingness to uphold politically contentious legislation designed to put Puerto Rico's economic house in order. However, the Hernandez decision, summarized below, suggests that, should Puerto Rico feel compelled to effect a unilateral debt restructuring, the Puerto Rico judiciary may be no more protective of Puerto Rico's contractual obligations to mutual funds and other bond investors than it has been to Puerto Rican public employees.

Hernandez Majority Opinion

The short majority opinion in the 5-4 decision summarizes the challenged legislation as freezing benefits under defined benefit plans for employees in the public pension system who have not yet retired; increasing retirement age, with a phase-in for those near retirement; increasing required employee contributions to the system; and moving current plan participants to a defined contribution plan.  The opinion states:

"{W]e are aware of the effect this reform will have on the retirement plans of the plaintiffs and other public employees. All of us in public service have family members, colleagues and friends who will be affected by this legislation.  On the other hand, we know the importance of the resolution of these cases to Puerto Rico's economic situation, particularly to government debt which permits access to funds for development and maintenance of infrastructure and of other programs of singular importance to those of us who live in Puerto Rico.  This Court has the obligation to adjudicate the cases before us and to delicately balance some conflicting interests of extreme importance in our life as a people."

The majority opinion references the U.S. Constitution's contracts clause and its counterpart in Puerto Rico's constitution, but notes that they do not absolutely prohibit contract impairment.  Citing precedents, the opinion states that if there is a substantial or severe impairment, the court must evaluate whether the impairment promotes a legitimate governmental objective and is rationally related to the attainment of that objective.

The majority opinion acknowledges that when the law under review impairs the government's own obligation, heightened scrutiny is warranted, because the government's self-interest is involved.  But it also states that the court must give deference to legislative findings regarding the necessity and importance of the legislation.

The opinion references a prior case, Bayron Torro v. Serra, as establishing that the state can alter the terms of the public pension system for employees who are not yet retired as long as the alterations are reasonable and promote the retirement system's solvency.  The current opinion then quotes some legislative history from the pension reform legislation in which legislators referenced the dire status of the pension system.

The majority opinion also acknowledges that an impairment of contract will not be upheld if there are less drastic or severe means of addressing the government's objectives than those set forth in the legislation.  It references the plaintiffs' argument that the legislature could have increased the sales and use tax or other contributions to the pension system.  But, in a single sentence, it summarily states that the plaintiffs failed to proffer evidence sufficient to convince the court that the alternatives were viable or less onerous, and reiterates that legislative determinations are entitled to deference.

The majority opinion concludes that the pension reform legislation is constitutional because, though it substantially impairs contract rights, the measures are reasonable and necessary to salvage the actuarial soundness of the pension system and there are no less onerous measures to achieve that objective.

Hernandez Concurrence

There is a short concurrence by two of the justices stating that they agree with the majority opinion "for Puerto Rico and because it is legally correct, not because of blackmail, pressure or unjust, insulting and regrettable public comments by members of the other two branches of government..."  The concurrence asserts that "for better or for worse, the needs and collective well-being of the approximately 3.5 million inhabitants of Puerto Rico prevail over the individual interests of the thousands of public employees affected."  The concurrence ends with a sentence in bold-faced letters stating: "Those who presumed the existence of a hidden agenda on the part of the members of the Court are shown today to be untruthful."  

Hernandez Dissents

The four dissenting justices produced three dissenting opinions, the first of which starts with the following quotation in English:  "Emergency does not create power."  The first dissent goes on to state that "in a stark per curiam opinion – orphaned of any identified author – the majority plays a final dirty trick on thousands of public employees using a judicial methodology that constitutionalizes the rubber stamp."   The dissent accuses the majority of misreading precedent, and states (quoting another case) that the test is that "alterations of employees' pension rights must bear some material relation to the theory of a pension system and its successful operation, and changes in a pension plan which result in disadvantage to employees should be accompanied by comparable new advantages."  Because the pension reform legislation impaired contractual rights without substituting comparable new ones, the dissent's view is that it is unconstitutional.

The first dissent takes to task three members of the majority who apparently flipped their position from a recent prior case; the dissent forecasts that the turnaround by the three justices has created a "new" Supreme Court.  The dissent characterizes the majority as holding that the legislation "is reasonable because ... why because the government says it is."  The dissent ends with the following advice: "Swim, as this inconsistency can only be understood – perhaps – when, from the shore, we observe the ebb and flow of the sea."

The second dissenting opinion continues the nautical theme of the first dissent, stating that "if the ship is taking on water and there is a real threat of sinking, the first thing one throws over is the knick-knacks," not the most precious objects (such as, in the justice's view, workers' pension rights.)  The second dissent focuses on distinctions between the cases relied on by the majority and the applicable facts and law in Hernandez.  It also asserts that Puerto Rico's public pension system has had an actuarial deficit since its inception, and  references case law from  other states holding that if a state is aware of problems when it enters into a contract, it cannot later impair those contracts just because the problems have changed in degree.  Finally it asserts that while it is likely that many of the pension reforms in the challenged legislation could have survived constitutional scrutiny, the reduction in future annuity payments does not pass constitutional muster because of the existence of less drastic options that could achieve the same objective.

The lengthy third dissenting opinion states that "given the pusillanimous posture assumed by 5 members of this court, I have no choice but to dissent."  The dissent argues that the affected pension rights are contract rights; that the pension reform legislation substantially impairs such contract rights, that contract rights can only be impaired if the impairment is necessary and reasonable; that a substantial impairment is not reasonable if it addresses a problem that the state was aware of when the contractual rights were established, that less deference is due to the state when its legislation impairs its own contractual obligations, that the existence of less onerous alternatives must be taken into account in determining reasonableness of legislation, as must whether any new benefits are granted in substitution for the rights taken away, and that under these standards some of the challenged legislation's provisions are unreasonable and presumptively unconstitutional, and that the plaintiffs' challenge should have been allowed to proceed.

Concluding Observations

The Hernandez case showcases the Puerto Rico judiciary's current deference to legislative determinations, particularly on matters relating to addressing Puerto Rico's economic and financial crisis.  The extent to which such deference should be a source of comfort to bondholders may depend on assessments of the likelihood that the Puerto Rico legislature will view it necessary to accord greater respect to its contractual commitments to bondholders than to its public employees in addressing its financial imbalances.  Should Puerto Rico feel compelled at some future point to enact "bond reform" legislation that impairs existing bondholder rights, the Puerto Rico courts may be no more receptive to a constitutional challenge than they were to the pension reform challenge in Hernandez.  In the event of any such hypothetical legislation, therefore, whether bondholders or bond  trustees can establish a right to bring challenges in federal, rather than Puerto Rican, courts may turn out to be outcome-determinative.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions