By LEN WEISER-VARON and BILL KANNEL
We previously discussed the Puerto Rico Supreme Court’s decision in the Hernandez case, in which by a 5-4 vote the court upheld the constitutionality under federal and Puerto Rico law of pension reform legislation affecting public sector employees, holding that though such legislation substantially impairs contract rights, the measures are reasonable and necessary to salvage the actuarial soundness of the pension system and that less onerous measures are unavailable. Holders of bonds issued by Puerto Rico and its instrumentalities have now shifted their attention to the Puerto Rico Supreme Court’s handling of a constitutional challenge to recently enacted legislation reforming the teacher pension system. The legislation currently under court review requires additional teacher contributions while deferring retirement age for current teachers with at least 30 years’ service from 50 to 55.
On January 14, 2014, the Puerto Rico Supreme Court issued an order taking over jurisdiction of the case from the trial court, and staying the effectiveness of the legislation pending further court action. The court also appointed a special master to conduct an evidentiary hearing and present findings of fact to the court no later than today, February 7. The court’s action, particularly the stay, is being evaluated by bond market participants as a potential sign that the constitutional challenge to this legislation may have more traction in the court than the Hernandez challenge mustered.
Bondholders have a mixed rooting interest in the outcome of the current pension reform litigation. On the one hand, the cutbacks on future pension benefits effected by such legislation are viewed as a positive step by Puerto Rico’s legislative and executive branches to manage the liability side of Puerto Rico’s balance sheet, and therefore as a positive credit development. On the other hand, such legislation impairs the contractual expectations of Puerto Rico’s teachers, much like the statute upheld in Hernandez impaired the pension rights of other public employees. To the extent such impairments continue to survive constitutional challenges in Puerto Rico’s courts, questions are raised about how Puerto Rico’s courts would react should Puerto Rico feel compelled to adopt future measures that defer or reduce debt service payments or that otherwise impair its contracts with bondholders.
The tea-leaf reading in the teacher pension case includes review of brief statements delivered by some of the Puerto Rico Supreme Court justices in connection with the court’s stay order. The Chief Justice indicated that he would have postponed the decision on the stay request until after the evidentiary hearing and findings of fact. He indicated that such postponement would be consistent with court precedent to the effect that injunctive relief is not granted without a prior hearing. One of the associate justices stated that she would not have granted direct Supreme Court review or the stay, but would have ordered the trial court to process the case on an expedited basis. Three associate justices filed a concurring opinion citing precedent that the Puerto Rico Supreme Court can intervene in cases pending in lower courts that raise new questions of law or questions of high public interest that include any substantial constitutional question. The concurring opinion states that the court order is appropriate given the high public interest for review of the changes to the teachers’ pension system and the urgent need to address the constitutionality of the challenged statute. The concurring opinion asserts the need for a speedy resolution not only for the State of Puerto Rico and the teachers, but for the peace of mind of thousands of parents and children that the applicable justices assert are being deprived of education. It also notes that the uncertainty over the teachers retirement system could force over 40,-000 teachers to decide in the coming days whether to resign, causing irreparable harm to the education system.
It is clear from the Chief Justice’s statement that the stay prior to a hearing is a departure from precedent. Whether that indicates that there is a majority of the court that favors a finding of unconstitutionality, or simply reflects the enormous public and political pressure associated with this case and the desire to temporarily mitigate the unrest sparked by the legislation remains to be seen. What seems notable is the emphasis on fact-finding, which may include fact-finding on the key question of the existence of less onerous means of addressing the system’s solvency. As described in our analysis of the Hernandez decision, the dissenters in that case castigated the majority for rubber-stamping the legislature’s findings of crisis and lack of alternative. The Puerto Rico Supreme Court has given the plaintiff teachers, as well as the government, the ability to make presentations in a Supreme Court sponsored fact-finding that was not present in the Hernandez case. Given the emphasis placed by the court on a speedy resolution of the challenge, whether that fact-finding results in a different outcome should be known fairly soon.