July 24, 2018 International Swaps and Derivatives Association, Inc. ( ISDA ) 10 East 53 rd Street, 9 th Floor New York, New York 10022 Attn: Annabel Akintomide, Esq. Re: ISDA Informal Jurisdiction Update Puerto Rico 2018 Ladies and Gentlemen: We have been asked to provide an overview for information purposes only on the general regulatory and legal environment for derivatives transactions conducted under any of the ISDA Master Agreements (as defined in the U.S. Netting Memorandum referenced below) in the Commonwealth of Puerto Rico ( Puerto Rico ). The information that we have provided does not constitute legal advice. We address no law, other than the laws of the Commonwealth of Puerto Rico and, to the extent applicable, the federal laws of the United States. 1 This memorandum is not a comprehensive review of the ISDA Master Agreements or all of the issues that might arise thereunder but is only meant to address generally the issues specified in the questions set out below. As Puerto Rico is part of the United States, we reference and rely upon the U.S. Memoranda (as defined below), which were rendered by another law firm. We accordingly assume the accuracy in all relevant respects of the legal analysis and conclusions contained in the U.S. Netting Memorandum (and, for purposes of Question D.6 below, the U.S. Collateral Memorandum and the English Collateral Memorandum (each as defined below)). A. Introductory. Puerto Rico is a territory of the United States with a constitution and a democratically elected local government that is subject to the plenary authority of the United States Congress (at which Puerto Rico has a resident commissioner without the right to vote). Given Puerto Rico s political status as a Commonwealth of the United States, the federal laws of the United States are applicable in Puerto Rico to the same extent as they are in each of the States, unless otherwise provided by any such laws. However, even in cases where federal law applies in Puerto Rico, there are many instances (such as federal income taxation or, indeed, the eligibility of Puerto Rico and its instrumentalities for relief under the United States Bankruptcy Code discussed below) where federal law 1 Jones Day does not practice law in Puerto Rico and McConnell Valdés is responsible for the Puerto Rican law analysis herein.
provides different or specific rules with respect to certain activities and/or for persons who reside in Puerto Rico. Except as otherwise discussed herein, all of the federal law addressed herein applies identically in Puerto Rico as elsewhere in the United States. Puerto Rico is also part of the federal judiciary system, and there are a United States District Court and United States Bankruptcy Court for the District of Puerto Rico. Many of the matters to be addressed herein are covered in the Memorandum for ISDA dated as of December 1, 2015 from Mayer Brown LLP on the Enforceability of the Termination, Close-Out and Multibranch Netting Provisions of the 1987, 1992 and 2002 Editions of ISDA Master Agreements (the U.S. Netting Memorandum ) and, in relation to Question D.6 below, (i) the Memorandum for ISDA dated as of March 1, 2018 from Mayer Brown LLP on the Validity and Enforceability of Collateral Arrangements under the ISDA Credit Support Documents (the U.S. Collateral Memorandum and, together with the U.S. Netting Memorandum, the U.S. Memoranda ), and (ii) the Memorandum of Law for ISDA dated as of 30 December 2015 from Allen & Overy LLP on the Validity and Enforceability under English Law of Collateral Arrangements under the ISDA Credit Support Documents, as supplemented by the Memorandum of Law for ISDA dated as of 1 September 2016 from Allen & Overy LLP on the WGMR Collateral Provider Supplement: Validity and Enforceability under English Law of Collateral Arrangements under the ISDA Credit Support Documents (collectively, the English Collateral Memorandum ). Capitalized terms and not otherwise defined herein shall have the meanings ascribed thereto in the U.S. Netting Memorandum. Specifically, the U.S. Netting Memorandum addresses derivative transactions of the type described on Appendix A thereto ( Transactions ) and covers, among other entities, entities ( Covered Entities ) that are (i) eligible for relief under the United States Bankruptcy Code, 11 U.S.C. 101 et seq. (the Code ) such as corporations, partnerships and business trusts incorporated or organized under the laws of Puerto Rico; (ii) nationally chartered banking institutions located in Puerto Rico that take federallyinsured deposits, which are subject to receivership and conservatorship under the Federal Deposit Insurance Act, 12 U.S.C. 1811 et seq. (the FDIA ); (iii) federally-licensed branches or agencies of banks incorporated or organized outside the United States, whether or not they take federally-insured deposits, located in Puerto Rico ( Federal Branches ); 2 (iv) covered financial companies incorporated or organized under the laws of Puerto Rico that are subject to conservatorship and receivership pursuant to the orderly liquidation authority ( OLA ) under Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 12 U.S.C. 5381 et seq.; and (v) for purposes of the Federal Deposit Insurance Corporation Improvement Act of 1991, Pub. L. No. 102-242, 105 Stat. 2236 (1991) ( FDICIA ), financial institutions incorporated, organized or located in Puerto Rico. As further described in the U.S. Memoranda, each of the Code, the FDIA and the OLA (the Federal Insolvency Regimes ) contains special provisions for the enforceability of 2 As set out in the U.S. Netting Memorandum, Federal Branches that take insured deposits would likely be resolved or liquidated pursuant to the FDIA. 2
termination, close-out netting and collateral realization (and for immunization of certain pre-insolvency transfers from avoidance as preferences or fraudulent conveyances ) under or in connection with Transactions upon the commencement of proceedings under a Federal Insolvency Regime. These provisions, together with the provisions under FDICIA protecting netting of obligations between financial institutions, will herein be referenced as the Safe Harbor Provisions. The U.S. Netting Memorandum pertinently excludes from its coverage insurance companies incorporated, organized or licensed in Puerto Rico (and elsewhere); the Commonwealth of Puerto Rico itself or any of its instrumentalities; Puerto Ricochartered or licensed banks ( Puerto Rico Banks ), whether or not they take federallyinsured deposits ( Insured Puerto Rico Banks and Uninsured Puerto Rico Banks, respectively); and Puerto Rico-licensed branches or agencies of banks incorporated or organized outside Puerto Rico (including within the United States), whether or not they take federally-insured deposits ( Puerto Rico Branches and, together with insurance companies, Puerto Rico and its instrumentalities and Puerto Rico Banks, Excluded Entities ). 3 B. Enforceability. 1. Do OTC derivatives transactions face an enforceability problem (e.g. due to antiwagering provisions etc. under local law)? There is no legislation in Puerto Rico that would impair the enforceability of Transactions on the basis of anti-wagering provisions. Moreover, federal law in the form of the Commodity Exchange Act, 7 U.S.C. 1 et seq. and the Securities Exchange Act of 1934, 15 U.S.C. 78a et seq., confers exclusive jurisdiction on the Commodity Futures Trading Commission over most swaps (7 U.S.C. 2(a)(1)(A)) and preempts the application of any Puerto Rico law that prohibits or regulates gaming or the operation of bucket shops (other than antifraud provisions of general applicability) to most other swaps (7 U.S.C. 16(e)(2)) and to most security-based swaps (15 U.S.C. 78bb(a)(3) and (4)). These federal statutes apply in Puerto Rico as elsewhere within the United States. 2. Are there provisions (of a statutory, customary, common law etc. nature) in local law that provide for the enforceability of close-out netting both pre and post insolvency? Is close-out netting defined in addition to set-off under local law? Does local law allow netting in accordance with the terms of the underlying contract (e.g. the ISDA Master Agreement)? In the absence of close out provisions, are you aware of any current efforts to pass primary legislation in this regard? There are no specific provisions in Puerto Rico law regarding the pre- or post-insolvency enforceability of close-out netting, nor is close-out netting defined under Puerto Rico law. As to contractual rights of set-off, Puerto Rico law provides that they are generally enforceable, subject to compliance with the following conditions: (i) there must be 3 See Question C.3 below relative to Puerto Rico Banks and certain other Excluded Entities. 3
mutuality between the debtor and the creditor, as principal debtor and creditor on each debt respectively, and that each debt must (ii) consist of a sum of money, which is (iii) due, (iv) determined and demandable, and that (v) is not subject to any retention or suit instituted by a third person, due notice of which has been given the debtor. 4 Therefore, no Puerto Rico law would restrict the operation of an otherwise enforceable close-out netting clause prior to the commencement of insolvency proceedings. Furthermore, we are aware of no efforts currently underway to advance legislation in Puerto Rico relative to close-out netting. The U.S. Netting Memorandum addresses the enforceability of close-out netting upon the commencement of proceedings under the applicable Federal Insolvency Regime and under FDICIA for Covered Entities. Excluded Entities are covered in Question C.3 below. The Puerto Rico Civil Code also contains certain general provisions in regards to payments made by an insolvent debtor. Among them, Article 1243(3) provides that absent the applicability of any special laws, a contract may be rescinded if it is executed in fraud of creditors, when the latter cannot recover, in any other manner, what is due them. 5 In addition, Article 1244 provides that [p]ayments made, while in a state of insolvency, by a debtor on account of obligations, which at the time of making, the debtor could not be compelled to fulfill may also be rescinded. 6 Nevertheless we understand that, as set forth in the U.S. Netting Memorandum, transfers under or in connection with Transactions would be significantly exempt from challenge under these provisions of the Puerto Rico Civil Code in a proceeding under an applicable Federal Insolvency Regime pursuant to the Safe Harbor Provisions thereunder. C. Scope. 3. If there are netting provisions under local law, do they apply to all types of counterparties, e.g. financial institutions, corporates (commodity trading firms, utilities, manufacturers etc.), SPV, public law entities (municipalities, central bank, development banks etc.)? We primarily address the applicability of the Safe Harbor Provisions to the Excluded Entities. Also, FDICIA is fully applicable in Puerto Rico and applies regardless of whether the dealings between financial institutions represent Transactions. Puerto Rico Banks and Puerto Rico Branches. The business of banking in Puerto Rico is governed by the Banking Act of 1933, as amended (the Banking Act ). The Banking Act covers the organization and operation of banks incorporated under the laws of Puerto Rico (together with their offshore 4 See Article 1150 of the Puerto Rico Civil Code, 31 L.P.R.A. 3222. 5 31 L.P.R.A. 3492 (Contracts subject to rescission: the following contracts may be rescinded: (3) Those executed in fraud of creditors, when the latter cannot recover, in any other manner, what is due them ). 6 31 L.P.R.A. 3493 (Payment by Insolvent Debtor). 4
branches, Domestic Banks ), and also provides the rules and requirements for authorizing banks incorporated outside Puerto Rico (including under federal law and the laws of any State, Foreign Banks ) to maintain Foreign Branches in Puerto Rico. The banking business is supervised and regulated by the Office of the Commissioner (the Commissioner ) of Financial Institutions (the OFCI ), an agency created by law and that is a part of the executive branch of the government. The OCFI has issued Regulation 5793, as amended, to implement and administer various provisions of the Banking Act. All of the commercial Domestic Banks and Foreign Branches doing business in Puerto Rico are Insured Puerto Rico Banks or Foreign Branches that take federally-insured deposits (collectively, Insured Puerto Rico Institutions ), which makes them subject to receivership or conservatorship under the FDIA. Article 33 of the Banking Law provides that if, as a result of an examination performed or a report rendered, the Commissioner has evidence that a Domestic Bank or Foreign Branch is not in sound financial condition or is not correctly managed, the Commissioner shall take over the management and administration of the bank and promptly appoint a receiver that, in the case of an Insured Puerto Rico Institution, may be the Federal Deposit Insurance Corporation 7 for purposes of administering receivership or conservatorship proceedings under the FDIA. There are other insolvency regimes under the Banking Law for Uninsured Puerto Rico Banks and Foreign Branches that do not take federally-insured deposits (for example, the dissolution of an International Financial Entity (off-shore bank)). 8 However, these insolvency regimes take no special account of Transactions or close-out netting in connection therewith. Puerto Rico Insurance Companies. Insurance companies are licensed and regulated pursuant to the Insurance Code of Puerto Rico, 26 L.P.R.A. 101 et seq. (the Insurance Code ), which provides the process to follow in the case of insolvency. 9 However, this insolvency process takes no special account of Transactions or close-out netting in connection therewith. Puerto Rico and Its Instrumentalities. Neither Puerto Rico nor its instrumentalities are eligible for relief under Chapter 9 ( Adjustment of Debts of a Municipality ) of the Code. P.R. v. Franklin Cal. Tax-Free Tr., 136 S. Ct. 1938 (2016). However, Title III of the Puerto Rico Oversight, Management, and Economic Stability Act, Pub. L. 114-187, 130 Stat. 5491 (2016) ( PROMESA ), codified at 48 U.S.C. 2101 et seq., creates a special insolvency regime for Puerto Rico and its instrumentalities that incorporates several provisions of 7 7 L.P.R.A. 201. 8 7 L.P.R.A. 232o. 9 26 L.P.R.A. 4001. 5
Chapter 9 of the Code, along with the Safe Harbor Provisions. 10 Accordingly, while untested, close-out netting should be available in a Title III proceeding under PROMESA to the same or similar extent as for Code-eligible entities. 4. Is the scope of eligible transactions restricted in any way, e.g. to certain products (rates, currencies, equities, credit etc.). What about commodity products (gas, coal, oil, metals, agricultural etc.) and new products (emissions allowances, freight rates, weather variables etc.)? Is there a different treatment for financially settled transactions as opposed to physically settled ones (i.e. where the underlying product is delivered)? The scope of eligible transactions and any limitations thereon under the Federal Insolvency Regimes are contained in the U.S. Netting Memorandum and Appendix A thereto. Also, FDICIA is fully applicable in Puerto Rico and applies regardless of whether the dealings between financial institutions represent Transactions. D. Foreign law. 5. Are there any issues with foreign law governed contracts (mainly English and New York law) when used for cross-border transactions into your jurisdiction? For example, some countries may restrict the use of foreign law and language documents when it comes to contracting with local public law or state entities. There are no special issues with foreign law governed contracts (mainly English and New York law) in Puerto Rico. The general principle under Puerto Rico law is to allow the contracting parties to establish the clauses, conditions, and contract terms they desire, so long as these are not in contravention of the law, moral and public policy. 11 6. Are financial collateral arrangements governed by foreign law recognized under local law? In particular, would title transfer and security interest arrangements (under English and New York law) be enforceable (e.g. ISDA credit support documentation)? Please also note any issues in relation to the collection of collateral and permissibility of such an arrangement in respect of derivative transactions under a standard form of ISDA credit support annex. Would this apply to both local collateral and to offshore collateral? Are there any transfer restrictions of local currency or foreign (like USD) or other forms of collateral (like securities, bonds or shares) out of the country; may the counterparty hold these in an account outside of the country? Section 9 of the Puerto Rico Commercial Transactions Act of 1995 (the PRUCC ) governs the creation and attachment of security interests subject to Puerto Rico law. Nevertheless, as noted above, a Puerto Rican court will grant the parties significant 10 See 48 U.S.C. 2161(a). 11 See Article 1207 of the Puerto Rico Civil Code, 31 L.P.R.A. 3372. 6
autonomy to select the law of a particular jurisdiction such as the laws of the State of New York or English law to govern a Credit Support Document if the court finds that (i) there are dominant contacts between the agreement and the law of the jurisdiction selected, and (ii) with respect to specific issues, application of the law of such jurisdiction to such issues would not be contrary to a fundamental public policy of Puerto Rico. Assuming that the dominant contacts requirement is met and that the application of the laws of the State of New York or English law does not contravene fundamental public policy of Puerto Rico (and we are aware of no reason why such application, in the abstract, should contravene Puerto Rico fundamental public policy), we are of the view that the provision specifying the laws of the State of New York or English law as the governing law for a Credit Support Document should be enforced by a Puerto Rico court. As outlined in the U.S. Collateral Memorandum and the English Collateral Memorandum, however, there are certain mandatory choice of law rules under New York law and English law concerning the perfection and priority of security interests based upon, for example, the location of the debtor, the location of the collateral or the applicable securities intermediary or bank holding securities or cash as collateral on behalf of one party or the other to an ISDA Master Agreement. In particular, the U.S. Collateral Memorandum covers, inter alia, the attachment, perfection and enforceability under Articles 8 and 9 of the Uniform Commercial Code as adopted in the State of New York (the NYUCC ), including the NYUCC s choice of law rules. To the extent Puerto Rican law is identified under the U.S. Collateral Memorandum or the English Collateral Memorandum as the law governing perfection and priority of security interests in particular items of collateral (including pursuant to title transfers under an English law Transfer Annex), the PRUCC has also adopted substantially all of Articles 8 and 9 of the Uniform Commercial Code, and the U.S. Collateral Memorandum s analysis of these issues, including choice of law principles, should generally be similar to that which pertains under the PRUCC. The PRUCC, including the PRUCC s choice of law rules, applies in principle to all Excluded Entities (except, in the case of Puerto Rico or its instrumentalities, when the applicable enabling legislation displaces the PRUCC for specific secured transactions). The U.S. Collateral Memorandum also addresses the impact of an insolvency on the part of a Covered Entity and discusses the extent to which realization of collateral in connection with Transactions is exempt from insolvency proceedings. Excluded Entities will be subject to the Safe Harbor Provisions for collateral realization under the FDIA, OLA, PROMESA or FDICIA to the extent applicable. There are no specific transfer restrictions under Puerto Rican law of local currency or foreign or other forms of collateral out of the jurisdiction. Matters of currency and exchange control laws/regulations are covered by federal law. 7. Is there any observation on the local regime for foreign (e.g. English, New York) judgments and foreign arbitral awards? 7
E. Other. Foreign judgments (in the sense of judgments of both other United States jurisdictions and of non-united States jurisdictions) require a separate exequatur proceeding in Puerto Rico in order to obtain recognition in Puerto Rico for purposes of enforcing post-judgment remedies. The courts of Puerto Rico will treat judgments of other United States jurisdictions in a manner similar to how the courts of the remainder of the United States treat the judgments of other United States jurisdictions. 12 The courts of Puerto Rico accord full faith and credit by means of limiting the issues in exequatur proceedings to an examination as to whether the applicable judgment was issued by a court with jurisdiction over the person and subject matter, with all due process guarantees, and [was] not... obtained by fraud. Ex parte Marquez Estrella, 128 D.P.R. 243, 1991 WL 735403 (P.R. 1991). In contrast, judgments from non-united States jurisdictions also require showings that (i) the legal system in which judgment is rendered is known for its impartiality and absence of prejudice against foreigners, and (ii) the foreign judgment is not contrary to the public policy order of [Puerto Rico] and that it is not repugnant to the basic principles of justice. Ef. Litograficos, C.A. v. Nat l Paper & Type Co. of P.R., 12 P.R. Offic. Trans. 486, 112 D.P.R. 389, 1982 WL 210640 (P.R. 1982). Arbitral awards, both from within the United States and abroad, may be enforced under the Federal Arbitration Act, 9 U.S.C. 1 et seq. Specifically, Chapter 2 of the Federal Arbitration Act incorporates the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards of June 10, 1958, and Chapter 3 of the Federal Arbitration Act incorporates the Inter-American Convention on International Commercial Arbitration of January 30, 1975. 8. Does local law/language standard documentation (sometimes referred to as local ISDA agreement ) exist or do market participants use bespoke documentation for domestic transactions (as opposed to cross-border transactions)? Does a local repo document or GMRA (which is the global MA for securities repurchase agreements) annex exist? We are not aware of any local ISDA agreements or local repo documents in general use in Puerto Rico. 9. Are there any efforts underway to enact legislation on bank resolution? Bank resolution legislation recognizing close-out netting already exists on the federal level, but there are at present no efforts underway to recognize close-out netting in the insolvency schemes for Uninsured Puerto Rico Banks, Foreign Branches that do not take federally-insured deposits or insurance companies. credit. 12 See 28 U.S.C. 1738, entitled State and Territorial statutes and judicial proceedings; full faith and 8
10. Any other issues under local law (e.g. conflict of law rules; jurisdiction issues (e.g. arbitration recommended))? There are no other issues of relevance to be noted under Puerto Rican law. This memorandum of law is rendered solely to ISDA for the benefit and use of its members. This memorandum of law may not be relied upon by any other person or used, circulated, quoted or otherwise referred to or relied upon for any other purpose without our prior written consent; provided that this memorandum may be shared with ISDA s advisors, ISDA s member advisors and ISDA s members supervisors and regulators on the basis that they may not rely on this memorandum. JONES DAY McCONNELL VALDÉS, LLC 250 Vesey Street 270 Muñoz Rivera Avenue New York, New York 10281 San Juan, Puerto Rico 00918 Dickson Chin Samuel Céspedes Sabater +1 212-326-7893 +1 787-250-2610 dchin@jonesday.com scs@mcvpr.com Benjamin Rosenblum Melba I. Acosta Febo +1 212-326-8312 +1 787-250-5615 brosenblum@jonesday.com mia@mcvpr.com Locke R. McMurray +1 212-326-3774 lmcmurray@jonesday.com 9