On July 31, 2014, Puerto Rico’s nonvoting congressional delegate Pedro Pierluisi introduced legislation (H.R. 5305)[1] that would empower Puerto Rico to authorize certain government-owned corporations to restructure their debt obligations under chapter 9 of the U.S. Bankruptcy Code. According to press reports, the U.S. territory and its corporations have a combined debt burden of $73 billion.[2] The bill has been referred to the House Judiciary Committee, of which Pierluisi serves.
The bill, the “Puerto Rico Chapter 9 Uniformity Act of 2014” (Click here for more information.), has been endorsed by editorials in the island press, Fitch Ratings, and the National Bankruptcy Conference, an organization of lawyers, law professors and bankruptcy judges that advises Congress about any proposed change to federal bankruptcy law.[3]
Under the U.S. Bankruptcy Code, only a “municipality” can adjust its debts under chapter 9. A Code provision defines this term as a “political subdivision or public agency or instrumentality of a State.” Another Code provision provides that the term “State” includes Puerto Rico, “except for the purpose of defining who may be a debtor under chapter 9 of this title.” Thus, Congress has empowered the governments of each of the 50 states to authorize municipalities to file under chapter 9, but it has not empowered Puerto Rico’s government to do the same. This bill would rectify this disparity.[4]
Prior to introducing this legislation, Pierluisi researched the relevant legislative history, mostly from the 1970s and 1980s, in order to comprehend why Puerto Rico was excluded from chapter 9 and has concluded that there is no principled basis for the exclusion.[5] Pierluisi also held dozens of meetings with key House and Senate offices to brief them on the proposal and consulted with outside experts working in private law practice and academia.[6]
The move comes a month after the governor of Puerto Rico unveiled — and the Legislative Assembly of Puerto Rico approved — the “Puerto Rico Public Corporation Debt Enforcement and Recovery Act,” which allows its public corporations to restructure any debts. Lacking a bankruptcy option, Puerto Rico approved this law, which would allow some public corporations to negotiate with bondholders, potentially forcing them to accept unfavorable terms.[7]
After the legislation passed, Fitch cut the commonwealth’s rating deeper into speculative grade and its bonds declined. The fallout from the Recovery Act continued the day that the bill was introduced, as Standard & Poor’s banished the Puerto Rico Electric Power Authority (PREPA) to the depths of speculative grade, cutting PREPA’s credit rating to triple-C from single B-minus. S&P also affirmed Puerto Rico’s general obligation bond rating at double B, stating that that the deep junk-rating indicates that PREPA’s debt is “vulnerable to non-payment” and any adverse business, financial or economic conditions could leave PREPA unable to pay its debts.[8]
Multiple investment firms that own Puerto Rico bonds such as Franklin Templeton Investments and OppenheimerFunds Inc. have sued the Puerto Rico government in U.S. federal district court, arguing that the local Recovery Act — which differs from chapter 9 in numerous respects — violates both the U.S. and Puerto Rico Constitutions. This litigation is likely to be complex, costly and time-consuming, with an uncertain outcome.[9]
As Pierluisi noted upon introducing H.R. 5305:
By enacting the Recovery Act, the governing party in Puerto Rico gave a clear signal that one or more of its government-owned corporations might seek to adjust their debts in the future. This signal generated strong negative reaction from the bond market and credit-rating agencies. It also led to legal challenges filed by investors represented by some of the best law firms in the nation, who argue that the Puerto Rican government does not have the power to enact this law. If the governing party concluded that restructuring is the only option in the case of specific government-owned corporations, it should have considered — and had a transparent public debate about — whether there was an alternative way to accomplish this objective.[10]
Reaction to the introduction of H.R. 5305 has been positive. According to Fitch Ratings, allowing Puerto Rico’s public corporations to file for chapter 9 protection would benefit holders of the agencies’ debt, as well as the commonwealth. Giving the chapter 9 option would allow investors to better assess potential losses, Fitch said. “Clarifying the rules for restructuring and aligning them to a federal standard with understandable precedent, albeit limited, and providing a federal forum for the proceeding would benefit bondholders,” Fitch analysts said in an Aug. 6, 2014, report. In the same report, the ratings agency called for an extension of chapter 9 provisions “a positive and important development for Puerto Rico and holders of its public utilities and public instrumentalities.” The restructuring law that the island passed threatens Puerto Rico’s sales tax bonds, known as Cofina, more than a federal bankruptcy alternative, Fitch said. Extending the chapter 9 option to the island’s agencies may bolster Cofina’s credit above that of the territory’s. Fitch also said that the new restructuring law would probably be withdrawn if chapter 9 becomes available.[11]
Municipal debt experts have stated “that the law might well pass…. Investors would doubtlessly prefer it to the existing local restructuring law, which puts them at the mercy of commonwealth judges and makes it easier for debtors to show they are eligible for creditor protection.”[12] During a July 30, 2014, hearing held by the House Foreign Affairs Committee Subcommittee on the Western Hemisphere, Ambassador James K. Glassman, former undersecretary of state for Public Diplomacy and Public Affairs, expressed criticism of the Recovery Act on both constitutional and policy grounds. “U.S. law does not provide for the bankruptcy of the states, and Puerto Rico, as a territory, is closer to a state than to any other U.S. entity,” Glassman said. “But Chapter 9 bankruptcy, which applies to cities and municipal agencies, could be adapted by Congress to Puerto Rico and provide a far better basis for an orderly disposition of assets in the case of default than the island’s home-grown, quickly passed Recovery Act remedy.”[13]
In a letter endorsing Pierluisi’s bill, the National Bankruptcy Conference observed that it “sees no bankruptcy policy reason why Puerto Rico’s municipalities should not have the same access as municipalities in the States to chapter 9…. Enactment of the Bill allowing Puerto Rico to authorize its municipalities to file for chapter 9 relief would ensure immediate access to debt adjustment for Puerto Rico on a less constitutionality contested basis than the Commonwealth’s Recovery Act.”[14] Pierluisi added that stakeholders should comprehend several important points about chapter 9.
First, if the U.S. Bankruptcy Code is amended to empower Puerto Rico’s government to authorize its government-owned corporations to adjust their debts under chapter 9, its government would still be required to enact local legislation before it would be able to file for relief. Presumably, the Puerto Rico government would authorize the same government-owned corporations to file under chapter 9 that it purported to authorize to file under the local Recovery Act.[15]
Second, a government-owned corporation must be “insolvent” to be eligible for chapter 9 relief, not simply be financially distressed. A federal bankruptcy judge could dismiss a chapter 9 case filed if it fails to meet this test, which appears to be more stringent than the test established by the local Recovery Act.[16]
Third, no government-owned corporation could maintain a chapter 9 case unless it has attempted to negotiate in good faith with its creditors or has determined that such a negotiation is impracticable. A government-owned corporation that cannot make this showing would not be eligible for chapter 9 relief.[17]
Finally, and of particular importance, Puerto Rico — like the 50 U.S. states — is not currently eligible to use chapter 9, and this bill would not change that fact. Chapter 9 is reserved for municipalities, as the Code defines the term, and Puerto Rico is not a “political subdivision or public agency or instrumentality of a State.” Puerto Rico’s Constitution provides special protection to owners of Puerto Rico’s general obligation and related bonds.[18]
The bill has been referred to the House Judiciary Committee. Once Congress returns from its August recess, there will be fewer than 30 legislative days left in this Congress.
[1] H.R. 3505 would “amend title 11 of the United States Code to treat Puerto Rico as a State for purposes of chapter 9 of such title relating to the adjustment of debts of municipalities.”
[2] Brian Chappatta, “Puerto Rico Muni Bankruptcy Plan Would Aid Investors, Fitch Says,” Bloomberg, Aug. 6, 2014, available at www.bloomberg.com/news/2014-08-06/puerto-rico-muni-bankruptcy-plan-would-aid-investors-fitch-says.html (last visited Aug. 11, 2014).
[3] Press Release, “Pierluisi Introduces Bill to Include Puerto Rico in Chapter 9 of the U.S. Bankruptcy Code,” Resident Commissioner Pedro Pierluisi, July 31, 2014, available at http://pierluisi.house.gov/media-center/press-releases/pierluisi-introduces-bill-to-include-puerto-rico-in-chapter-9-of-the-us (last visited Aug. 11, 2014).
[4] Id.
[5] The logic behind excluding Puerto Rico from Chapter 9, to the extent it never made much sense, no longer does. All told, between 1898 (when Puerto Rico was acquired by the U.S. ) and the present, the federal government – through successive Acts of Congress – has delegated to Puerto Rico roughly the same degree of authority over local matters that the States inherently possess under the U.S. Constitution, although Puerto Rico’s status as an unincorporated territory of the U.S. has not changed. In the realm of the federal judiciary, Puerto Rico is part of the First Circuit, federal district court and appellate judges on the island are appointed by the President with the advice and consent of the Senate and enjoy lifetime tenure, and the island as a federal bankruptcy court with four judges appointed to 14-year terms, no different than the 50 States. Moreover, Puerto Rico bonds are widely traded in the U.S. market, at one point held by approximately 70 percent of U.S. municipal bond funds. (John Laufer, Legislative Director; “Why Was Puerto Rico Excluded from Chapter 9?: A Summary of the Legislative History and Conversations With Key Staffers”)
[6] Id.
[7] See Chappatta, fn.2.
[8] Michael Aneiro, “House Bill Proposes Puerto Rico Bankruptcy, S&P Downgrades PREPA Utility,” Barron’s, July 31, 2014, available at http://blogs.barrons.com/incomeinvesting/2014/07/31/house-bill-proposes-puerto-rico-bankruptcy-sp-downgrades-prepa-utility/ (last visited Aug. 11, 2014).
[9] William Selway and Derek Wallbank, “Puerto Rico Municipal Bankruptcy Proposed in U.S. House Bill,” Bloomberg, July 31, 2014, available at www.bloomberg.com/news/2014-07-31/puerto-rico-municipal-bankruptcies-proposed-in-u-s-house-bill.html (last visited Aug. 11, 2014).
[10] See Pierluisi, fn.3.
[11] “Fitch: Chapter 9 Extension Would Be a Positive for Puerto Rico,” Business Wire, Aug. 6, 2014, available at www.businesswire.com/news/home/20140806005724/en/Fitch-Chapter-9-Extension-Positive-Puerto-Rico#.U-jpLpRdXQk (last visited Aug. 11, 2014).
[12] http://www.law360.com/articles/563298/house-bill-would-open-up-ch-9-to-puerto-rico-public-cos
[13] Transcript, Written Testimony of Ambassador James K. Glassman, July, 30, 2014, hearing of House Committee on Foreign Affairs.
[14] Id.
[15] Id.
[16] Id.
[17] Id.
[18] Id.