Puerto Rico’s debt restructuring is now entering its crucial final stage–one that will determine the Island’s future financial trajectory.

Over the last four years, Puerto Rico’s creditors and the federally formed Financial Oversight and Management Board have engaged in tumultuous, and at times highly contentious, negotiations to address Puerto Rico’s more than $70 billion in financial debt and more than $50 billion in unfunded pension liabilities. Now, as a possible final resolution emerges, the FOMB seeks court approval of a plan of adjustment that will provide for treatment of creditor claims under the terms of a global settlement with nearly every major creditor constituency.

Every constituency that is except for one of Puerto Rico’s most vulnerable populations: public pensioners.

On July 30, 2021, the FOMB filed its current plan of adjustment proposal, which the court will consider for confirmation this November. Through the plan, the board seeks approval of a settlement that would reduce the commonwealth’s overall debt and other claims by 80%–from $35 billion of prepetition claims to $7.4 billion in new debt–and provide bondholder recoveries ranging from 67.8% to 77.6%.

But the plan also places an inordinate financial burden on public pensioners by imposing an across-the-board 8.5% pension cut on those receiving more than $1,500 in monthly benefits ($18,000 annualized) while also freezing benefits for judges and teachers.

The FOMB has argued that these pension cuts and freezes are necessary as a matter of bankruptcy law based on recent cases under chapter 9 of the bankruptcy code–the municipal restructuring process on which Puerto Rico’s restructuring is primarily based. That assertion, however, fails to recognize that, in the context of government-sponsored pensions, benefit freezes and reductions can only be implemented if they satisfy the court’s sense of fairness.

The board justifies its proposed pension cuts and freezes by drawing comparison to what has been done in other municipal financial restructurings. However, the multiple calamities Puerto Rico has withstood in recent years–a fiscal crisis compounded by natural disasters and political upheaval–are unlike anything that any other municipality has endured. Its loyal public servants should not, once again, be asked to pay for this damage, which occurred through no fault of their own.

Unlike residents of U.S. mainland municipalities, the people of Puerto Rico have suffered through a devastating economic recession caused in part by the commonwealth’s colonial insular status. Residents receive unequal treatment under federal funding statutes as compared to the states, pay the highest sales and use tax in the United States, and suffer a poverty rate of 43.1% (more than double that of the highest state poverty rate of 19.7% in Mississippi).

In addition, the impact of two devastating hurricanes in 2017, ongoing earthquakes since 2019, and the persistent COVID-19 pandemic have destroyed the homes and livelihoods of thousands of residents.

In addition to these hardships, Puerto Rico’s public pensioners already experienced significant cuts to their benefits prior to 2017 so that the government could continue making debt service payments to bondholders. For example, in 2013, the government passed three separate laws to reduce pension benefits, increase the amount of employee contributions, and raise the retirement age under the pension plans at each of the government’s three primary retirement systems.

According to the FOMB’s own expert report issued in September 2019, these laws resulted in benefit reductions as high as 82% for some participants. And since 2007, all retirees (other than judges) have not received cost of living adjustments, which will cause retirees to lose 39% of the purchasing power of their already-reduced pensions in the 30 years after retirement.

Now the board seeks to confirm a plan of adjustment that would add to these cuts while the cost of living continues to increase and a majority of Puerto Rico’s pensioners are dangerously close to the federal poverty line.

Although a direct comparison of recoveries under the proposed plan of adjustment appears to show that bondholders will experience much larger losses (up to 32.2%) than government pensioners (8.5%), the raw numbers fail to tell the whole story.

Unlike financial creditors who will receive an interest-bearing instrument that accounts for the time value of money, pensioners are only receiving a promise of future payment without cost of living adjustments. This reduces the real-world value of future pension payouts due to inflation, thus impairing pension recoveries by 39% according to the board’s own estimates.

Financial creditors can also trade the bonds they receive under the plan or diversify their risk through portfolio management. Pensioners do not have that option–they are stuck with the plan’s non-tradable promise subject to Puerto Rico’s future ability to pay.

It is important to note that government pensioners experienced pension reductions over the past two decades, while other creditors were continuously paid through 2016. Furthermore, any pensioner losses directly affect whether a family can retire with dignity after a dedicated life of public service, further straining the government’s social services budget. The government has steadfastly committed itself to ensuring that such service is duly rewarded and that they receive a fair treatment that reflects the historical impairment of their pensions.

Having settled with every major constituency, it is time for the FOMB to do the right thing by abandoning unnecessary pension cuts and freezes. In fact, Puerto Rico Gov. Pedro Pierluisi has already urged it to use the fiscal plan and budgetary processes under Title II of PROMESA, which would align the government’s interests in implementing necessary reforms and fiscal measures with making pension cuts or freezes a last resort.

While other alternatives are possible, the FOMB must first be willing to discuss pensions with the government.

Puerto Rico’s pensioners did not create the island’s fiscal crisis and should not be forced to shoulder its most severe burdens. The FOMB owes all government employees its best efforts to save their retiree benefits before inflicting further pain and suffering upon them. We can only hope they will have the courage to do so.

John J. Rapisardi is a partner at O’Melveny & Myers LLP and legal counsel to the Puerto Rico Fiscal Agency and Financial Advisory Authority (AAFAF).

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