PROMESA, the federal law to alleviate Puerto Rico’s financial crisis, will not always be governed by principles established under the Bankruptcy Code, according to a First Circuit decision dealing with the automatic stay.
In a departure from the Bankruptcy Code, Chief Circuit Judge Jeffrey R. Howard found “policy reasons” in his Jan. 11 opinion to put the burden on the secured creditor to show cause for modifying the stay, including the lack of adequate protection.
PROMESA
After the Supreme Court ruled in June that Puerto Rico’s instrumentalities are ineligible for municipal debt adjustment under chapter 9 of the Bankruptcy Code and that the island commonwealth cannot adopt local laws dealing with the insolvencies of its units, Congress adopted the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA.
As part of the program to address what Judge Howard called Puerto Rico’s “financial crisis,” Section 405(m)(4) of PROMESA includes an automatic stay that lasts until Feb. 17 and can be extended to May 1. It automatically halts any proceedings against the Puerto Rico government “to recover a Liability Claim,” defined to mean “financial indebtedness for borrowed money, including rights, entitlements, or obligations whether” they arise from “contract, statute or any other source of law.”
Bondholders with liens on toll road revenue and employer contributions to a retirement fund filed motions to modify the automatic stay, contending they lacked adequate protection because Puerto Rico had cut off income streams from their collateral.
Without holding a hearing, District Judge Francisco A. Besosa of San Juan handed down a decision on Nov. 2 denying the motions, saying that their collateral was “constantly replaced.” He said they were not entitled to adequate protection because they only faced “a delay in recouping such funds, not a permanent loss of them.” To read ABI’s discussion of Judge Besosa’s decision, click here.
The bondholders took expedited appeals argued in the First Circuit on Jan. 4. Judge Howard concluded that the toll road bondholders were not even entitled to a hearing because they failed to allege facts showing a lack of adequate protection.
Without ruling on the merits, Judge Howard sent the motion by the retirement fund bondholders back to the district court because they were entitled to a hearing given the sufficiency of their pleadings.
PROMESA and Adequate Protection
Section 362(d) of the Bankruptcy Code says that “cause” for modifying the automatic stay includes lack of adequate protection. PROMESA, however, does not define “cause.” By the omission of a reference to adequate protection, Puerto Rico argued that deprivation of collateral is not grounds for modifying the stay under PROMESA.
Because it allows impairment of secured creditors’ property rights, Judge Howard characterized PROMESA as a “statute of questionable constitutional validity.” He therefore interpreted the statute to avoid constitutional infirmities and held that lack of adequate protection “constitutes cause to lift the PROMESA stay.”
PROMESA and the Burden of Proof
The disposition of the appeal depended in part on who had the burden of proof on adequate protection.
In bankruptcy, Section 362(g) altered prior law by putting the burden of proof on the creditor regarding the debtor’s equity in the property while it put the burden of everything else on the debtor. Because Congress did “not transplant the Bankruptcy Code’s express alteration of the pre-Code regime” into PROMESA, Judge Howard put the entire burden on the creditor to show “cause,” including lack of adequate protection.
In deciding to depart from the Code, Judge Howard cautioned courts not to infer “too readily” that silence in PROMESA represents congressional rejection of a concept from bankruptcy law. On the other hand, he said that silence in PROMESA may represent congressional intent “precisely.”
Judge Howard also found “sound policy reasons” to depart from the Code on burden of proof. He said that PROMESA addresses a “truly unique situation” dealing with an “‘immediate financial crisis.’” Moreover, the PROMESA stay endures for a maximum of 10 months, compared with the Bankruptcy Code, where the stay could be in place for years.
The Definition of ‘Cause’
To carry the burden justifying stay modification, Judge Howard said a creditor must prove that the lack of an equity cushion is “more likely than not.” He said the toll road bondholders’ motion did not contain facts showing the absence of an equity cushion, thereby justifying dismissal of their motion without a hearing.
In contrast, the retirement fund bondholders did make allegations about the insufficiency of future revenue to cover their claims. Consequently, Judge Howard remanded to the district court because they were entitled to a hearing.
Right of the ‘Board’ to Intervene
PROMESA created the Financial Management & Oversight Board. The district judge denied the Board’s motion to intervene in the lift-stay motions under Federal Rule 24, because the Board had not submitted a proposed answer to a complaint that the bondholders were yet to file. However, the Board did file a proposed pleading opposing modification of the stay.
Judge Howard reversed, finding an abuse of discretion in barring intervention. He said the circuits have “eschewed overly technical readings of Rule 24(c).” While he did not definitively rule on the right to intervene, Judge Howard did say that “PROMESA appears to grant the Board such a right.”