León Cosgrove

U.S. Bankruptcy Code Complicates Puerto Rico’s Ability to Emerge from Fiscal Crisis

By: León Cosgrove LLC

By Andrew Zaron

bankruptcy-1With a total debt load of around $72 billion, the U.S. Commonwealth of Puerto Rico is on the brink of insolvency. In the summer of 2014, the island passed the Puerto Rico Public Corporations Debt Enforcement and Recovery Act. The law was aimed at providing an orderly process for restructuring the debts and labor contracts of struggling public corporations (including, most significantly, the Puerto Rico Electric Power Authority), which are collectively indebted for about $20 billion.

In February 2015, Judge Francisco A. Besosa of the United States District Court in Puerto Rico ruled the act void and enjoined Commonwealth officials from enforcing it. In July 2015, the U.S. Court of Appeals for the First Circuit affirmed the lower court decision. In the meantime, The U.S. Supreme Court agreed to hear the case, and Puerto Rico’s representative in Congress, Pedro Pierluisi, introduced a bill to include Puerto Rico in Chapter 9 of the U.S. Bankruptcy Code.

In the following, I discuss the Puerto Rican insolvency crisis with reference to the U.S. Bankruptcy Code.

Q. What significant legal challenges does the Puerto Rican bankruptcy pose?

A.  Section 109 of the Bankruptcy Code permits “traditional” states to authorize their municipalities to file for bankruptcy.  (States themselves are not eligible for bankruptcy because of the potential conflicts with the 10th and 11th amendments to the U.S. Constitution.) And, the Bankruptcy Code treats Puerto Rico as a state–with one glaring exception:  it does not permit Puerto Rico to authorize its municipalities to file for bankruptcy and restructure general obligation debt. There is no legislative history explaining the purpose or rationale for this treatment.


Q. 
How does Puerto Rico’s Recovery Act conflict with Section 903 of the U.S. Bankruptcy Code?

A. Puerto Rico is on the brink of insolvency. In response to the limitations imposed by the Bankruptcy Code on its ability to authorize municipalities to file bankruptcy, in 2014 Puerto Rico passed the Puerto Rico Recovery Act. The Act would allow a Puerto Rico municipality- including certain utility companies with billions of dollars in debt – to bind creditors to a restructuring plan, even without the consent of creditors.

The Act conflicts with section 903 of the Bankruptcy Code. Section 903 says that, while a state law may prescribe a method of composition of indebtedness for a municipality, it may not bind creditors who do not consent to the composition. Because Puerto Rico is a state for purposes of section 903 of the Bankruptcy Code, the U.S. Circuit Court of Appeal for the First Circuit determined Puerto Rico was bound by section 903, and struck down the Act on the basis that it is preempted by section 903.

 

Q. Which of these conflicts is of greatest interest to bankruptcy/restructuring lawyers, and why?

A. The struggle for restructuring lawyers advising Puerto Rico is that, if the Act is invalid as determined by the First Circuit, Puerto Rico lacks the leverage that may be necessary to successfully negotiate with its creditors to reach an equitable restructuring of its debt.


Q. Why do you think the Supreme Court took this case?

A. On Dec. 4, 2015, the U.S. Supreme Court decided to review the First Circuit’s opinion.  The rationale for the decision is likely rooted in the practical quagmire faced by Puerto Rico if it cannot restructure its debts and the potential for disastrous consequences to its residents and taxpayers. The Supreme Court was also likely concerned with the Constitutional questions posed by Puerto Rico’s unique status as a “territory” rather than a “state.”  The Supreme Court recently decided to review another matter involving Puerto Rico (Puerto Rico v. Valle) that focuses on Puerto Rico’s ability to enact its own criminal laws independent of the federal government.


Q. What is the most recent reaction by Congress to Puerto Rico’s impending insolvency?

A.  On March 14, 2016, according to The Bond Buyer, several Democrats in the U.S. Senate proposed two new bills aimed at helping the island restructure its debt. Perhaps the most important of these is the Puerto Rico Stability Act, which, among other provisions, would extend federal Chapter 9 bankruptcy protections for state public authorities to such authorities in Puerto Rico. The bill’s proposed restructuring would use similar mechanisms to those in the bankruptcy code, but it would not amend and does not sit within the bankruptcy code, according to a spokesperson for Sen. Bob Menendez, D-N.J.

The bill is quite controversial, according to The Bond Buyer, because it proposes a fiscal oversight board to address the island’s total debt burden—well beyond that of its struggling public corporations–and would treat the commonwealth’s pension obligations as senior secured debt. That would make general obligation (GO) bonds available for restructuring and give pensions higher priority than Puerto Rico’s constitutionally backed debt, “flying in the face of how state GOs are treated in the U.S. bankruptcy code,” according to Matt Posner of Court Street Group.

Also from The Bond Buyer: “The bills’ inclusion of territory-wide restructuring, an oversight board, healthcare improvements, and economic growth initiatives closely mirrors the ideas the Treasury Department had put forward when it released its proposal on Puerto Rico in late October. Since that time, Congress has been trying to forge an agreeable solution for the commonwealth with the Republican-led House Committee on Natural Resources taking the lead. That committee could also release a bill on Puerto Rico as early as this week.”

 

AndrewZaron_BW_webAndrew Zaron is a partner at León Cosgrove LLC who focuses on bankruptcy, restructuring and related commercial litigation. For more than 20 years, he has handled a wide variety of insolvency and litigation matters, with amounts in controversy exceeding $1 billion.