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Could Bondholders Bring Claims Against Puerto Rico Bond Issuers in Courts Outside Puerto Rico?

As Puerto Rico prepares to access the public markets with a new bond issue, the Wall Street Journal reports that the list of demands from some potential investors include, in addition to a high interest rate and as much security as the issuer can provide, the issuer’s consent to the adjudication in the New York courts of any future disputes involving the applicable bonds.

Hoping for the best but preparing for the worst, holders of existing bonds issued by Puerto Rico and its bond-issuing instrumentalities (such as COFINA) are likewise engaged in prospective forum-scouting.   The desired option to litigate any potential dispute outside Puerto Rico may be driven by the assumption that in times of financial crisis Puerto Rico’s courts are less likely to side with off-island investors than with Puerto Rico’s bond issuers, however meritorious the bondholders’ claims may be.

Questions of court jurisdiction over a sovereign entity or sovereign instrumentality are complex and nuanced, and require individualized analysis regarding the applicable entity, the applicable court and the applicable dispute.  But a few basic general observations may be of interest to those involved with Puerto Rico’s ongoing bond saga:

  • A Puerto Rico bond issuer and its bondholders may contractually agree (in a bond resolution or indenture or, in the case of general obligation bonds issued without a resolution or indenture, in the bonds themselves) on exclusive or non-exclusive jurisdiction in the courts of Puerto Rico or in the courts of another state.  Courts will generally enforce such contractual choice-of-forum clauses.

  • Absent any contractual agreement, Puerto Rico or a Puerto Rico instrumentality may be sued in the courts of Puerto Rico unless such issuer has sovereign immunity and has not waived it.  Puerto Rico itself, and many but not all of its agency issuers, likely qualify for sovereign immunity in Puerto Rico’s courts.  The extent to which such immunity has been waived for particular claims would likely be at issue in any litigation in Puerto Rico’s courts.

  • Under the Eleventh Amendment to the U.S. Constitution, which applies to the states and has also been held applicable to Puerto Rico, Puerto Rico and its instrumentalities generally cannot be sued for money damages in the U.S. federal court system, absent a waiver of such Eleventh Amendment protection by the applicable issuer.   It may be possible to obtain injunctive relief against a Puerto Rico issuer in federal court without an Eleventh Amendment waiver by such issuer.

  • Neither Puerto Rico’s sovereign immunity in its own courts nor its Eleventh Amendment protection from being sued in the U.S. federal courts apply to a suit against Puerto Rico or a Puerto Rico instrumentality in the state courts of New York or of any other state, although individual states may, as a matter of “comity”, opt not to exercise jurisdiction over other states or other sovereigns.  New York’s highest court to date has declined to use “comity” as a basis for protecting other states from defending financial claims brought in New York courts, referencing “New York’s recognized interest in maintaining and fostering its undisputed status as the pre-eminent commercial and financial nerve center of the Nation and the world.” However, as a constitutional due process matter, a Puerto Rico issuer would need to have sufficient “minimum contacts” with the applicable state to warrant the exercise of jurisdiction by that state, and would have to have engaged in acts described in the so-called “long-arm jurisdiction” statute of the applicable state governing jurisdiction by its courts over non-domiciliaries of such state.  Though these are highly fact-specific matters, New York’s status as “financial nerve center” increases the odds that a Puerto Rico bond offering would involve a variety of contacts with New York.

All of which is to say that:

  • If bondholders succeed in obtaining contractual agreement by a Puerto Rico issuer to jurisdiction in New York’s state courts, any future dispute relating to the bonds could be adjudicated in New York’s courts.  A New York litigation forum, in addition to eliminating any perceived home turf advantage a Puerto Rico issuer would have in the courts of Puerto Rico, would also likely benefit bondholders by eliminating the need to establish a sovereign immunity waiver by any such issuer that would otherwise be entitled to assert sovereign immunity before Puerto Rico’s courts.

  • If bondholders purchase or hold bonds under a resolution, bond indenture or other agreement that requires that any dispute be adjudicated in the courts of Puerto Rico, any future dispute relating to the bonds would be adjudicated in Puerto Rico’s courts.

  • If there is no contractual provision governing jurisdiction, bondholders may be able to litigate any contractual dispute against a Puerto Rico issuer in the courts of New York, or of another state that has no statutory or common law preclusion on hosting litigation against another sovereign without that sovereign’s consent, if the Puerto Rico issuer has had sufficient contact with the applicable state to satisfy constitutionally required minimum contacts and the applicable long arm statute.

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About this Author

Leonard Weiser-Varon, Mintz Levin Law Firm, Corporate and Finance Law Attorney

Len is active in both municipal finance and corporate finance, with an emphasis on financings for 501(c)(3) institutions, project finance, secured lending, structured finance transactions, workouts and restructurings, corporate debt, and Section 529 college savings programs.

His practice includes service as bond counsel, issuer’s counsel, underwriters’ counsel, and counsel to institutional purchasers and borrowers in connection with public offerings and private placements of, and defaults and bankruptcies involving, tax-exempt and taxable debt for public, nonprofit, and corporate...

William W. Kannel, Bankruptcy Attorney, Mintz Levin Law Firm

Bill’s practice focuses primarily on commercial law, workouts, and corporate reorganization. He has represented various institutional lenders, indenture trustees, bondholders, and other creditors, debtors, and trustees in all manner of insolvency proceedings in courts throughout the United States.

His industry experience encompasses municipalities, airlines, hospitals and other health care facilities, retail, telecom, energy and clean tech, waste disposal, military housing, hotels, and educational institutions.

He has substantial experience in all phases of bankruptcy litigation, practice, and case management from both the debtor’s and creditor’s perspective, including relief from stay, adequate protection, valuation, preference, fraudulent transfer, subordination, competing plan, and appellate litigation. One of his specialty areas is in negotiating sales of troubled companies and assets, both in and out of bankruptcy. His practice also includes addressing bankruptcy and documentation issues in securitizations, receivable sales, bond transactions, and structured financings generally.

Bill is also experienced in the growing area of municipal bankruptcies, and recently was quoted in stories in the Wall Street JournalThe Deal, BloombergLaw360, and Dow Jones Daily Bankruptcy Review.