David Skeel is the S. Samuel Arsht professor of corporate law at the University of Pennsylvania. He is a member of the Financial Oversight and Management Board for Puerto Rico.

It’s hard to imagine a worse strategy for negotiating the largest public bankruptcy in American history than insisting that more than $6 billion of the debt should be declared null and void. Yet when Puerto Rico’s oversight board did precisely this in January, it broke a two-year logjam, opening a path to a new restructuring proposal filed on Sept. 27 that could help solve Puerto Rico’s debt crisis.

The process began in 2016, when Congress created the Financial Oversight and Management Board for Puerto Rico, authorizing me and other members of the board to certify five-year fiscal plans and, if necessary, to put Puerto Rico into Title III — a territory-specific form of bankruptcy. Even then, a year before Hurricane Maria, Puerto Rico’s roughly $70 billion of debt was “unpayable,” as its former governor had put it in 2015. We filed for Title III on May 3, 2017, shortly after a temporary freeze on creditor collection imposed by the 2016 legislation came to an end.

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Restructuring Puerto Rico’s debt would have been easy if we could simply develop a reasonable proposal and ask the court to impose it on the creditors. But one of the key requirements of Title III is that at least one “impaired” class of creditors — a class that will not be paid in full — vote in favor of the restructuring plan. We needed a partner, but no one wanted to dance with us unless we promised to pay much more than Puerto Rico could afford.

Last fall we took an unusual step. We briefly halted our many months of negotiations with the financial creditors to see whether we could reach an agreement with Puerto Rico’s public employee unions and retirees. The unions were skeptical. At our first meeting, one leader asked whether we were serious about negotiating with them. We said we were, which led to weeks of negotiations headed by the oversight board’s executive director, Natalie Jaresko, and board member Ana Matosantos.

One sticking point: how to protect payments to current retirees as Puerto Rico transitioned to a 401(k)-style pension system, given that the pensions are almost completely broke. The two sides agreed that a portion of Puerto Rico’s revenue will be set aside for future pension payments — and increased if Puerto Rico exceeds the projections of the fiscal plan.

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The decision to challenge $6 billion of bonds came several months later. By early 2019, two special committees of the board had spent well over a year investigating Puerto Rico’s debt. After concluding that $6 billion of bonds issued in 2012 and 2014 violated the debt limit in Puerto Rico’s constitution, we filed our first and biggest objection on Jan. 14. We knew the objection could complicate our efforts to devise a restructuring plan, but, as Puerto Rico’s representative in Title III, we have a duty to challenge any problematic debt.

The initial reaction wasn’t surprising. A bond market expert denounced the objection as “highly unusual” and “kabuki theater.” Creditors attacked the board as “more willing to disrespect the rule of law and litigate than engage in meaningful negotiations.”

Then a funny thing happened. A group of earlier (“vintage”) bondholders signaled that it agreed with the objection and said it would be willing to stake part of its recovery on a successful challenge. From this unlikely starting point came the remarkably innovative structure at the heart of the proposed plan of adjustment. The plan asks the judge to wait until after the plan is approved to rule on the objection and gives the holders of Puerto Rico bonds a series of choices, based on whether the bondholders believe the objection will succeed. If vintage bondholders vote yes, they will receive 64 percent of their claims. If the problematic bonds are ultimately disallowed, the vintage bondholders also would get a portion of the recovery that would otherwise have gone to holders of problematic bonds. (The rest will go to other creditors.) Holders of problematic bonds can either accept a lower payout or defend the legality of their bonds and receive as much as the vintage bondholders if they win.

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As this framework came into focus, we also finalized proposed deals giving union members a $1,000 signing bonus in return for a payroll freeze, and new protections for pension beneficiaries in return for an 8.5 percent reduction to pensions that exceed $1,200 per month. The union deal became controversial and has not yet been approved by all unions, but we believe it is essential to Puerto Rico’s emergence from bankruptcy.

Puerto Rico’s bankruptcy is often compared to Detroit’s, but there really is only one common theme: serendipity. Detroit’s “Grand Bargain,” which finally freed that long-suffering city from a crushing debt load, was triggered by a chance meeting between a mediator in the case and the head of a local foundation. If Puerto Rico’s plan of adjustment is eventually confirmed — a process likely to take many weeks — we might one day similarly recall an objection that seemed likely to derail Puerto Rico’s bankruptcy but actually became the cornerstone of a solution.

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