The Puerto Rico “Bankruptcy”: A Cheat Sheet

On May 3, 2017, the Financial Oversight and Management Board of Puerto Rico launched an unprecedented restructuring proceeding under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA” or the “Act”). This article provides a very high-level summary[1] of some of the unique provisions in PROMESA, the bankruptcy analogue crafted specially by Congress for the debt crisis in Puerto Rico, and highlights some of the main players and key developments thus far.[2]

What Happened?

The Commonwealth of Puerto Rico incurred a substantial amount of debt during the end of the last century. According to a statement filed by the Oversight Board (discussed below) in its first-day papers, the Commonwealth and its affiliates (local municipalities and public corporations) owe approximately $74 billion, including approximately $13.3 billion in general obligation bonds.[3] Those figures do not include an additional $49 billion in pension liabilities, of which it is estimated only 1.5 percent is funded.[4] The Oversight Board predicts that the retirement systems will have no liquid assets by the end of 2017.[5]

The Oversight Board lays the blame on a variety of flaws in the Commonwealth’s “governance and fiscal controls,” including a 1917 federal law that authorized the Commonwealth to issue “triple tax free” bonds that were “extremely attractive to investors” and the relaxing of budget restrictions and debt limits to “near irrelevance.”[6] Other problems identified by the Oversight Board include massive pension liabilities, flawed financial reporting by the Commonwealth, a collapse in housing, low employment and population loss.[7]

What Is PROMESA?

To obtain relief from its massive debt, the Commonwealth had no access to chapter 9 of the Bankruptcy Code, which is only available to municipalities “of a State” and specifically excludes Puerto Rico.[8] Congress passed PROMESA to specially address the crisis in Puerto Rico and create a mechanism for the government and stakeholders to restructure the territory’s debts. President Obama signed the Act on June 30, 2016.

What Is the PROMESA Oversight Board?

Central to the Act is the creation of a seven-member governing committee, the Financial Oversight and Management Board of Puerto Rico (the “Oversight Board”). President Obama appointed members of the Oversight Board based, in part, on recommendations by Congress. The Board members include experts in finance, law, health care and public policy, including Hon. Arthur J. Gonzalez, a retired bankruptcy judge from the U.S. Bankruptcy Court for the Southern District of New York. The Oversight Board also includes one ex officio non-voting member appointed by the governor of Puerto Rico.

The stated purpose of the Oversight Board, according to its website, is to “work[ ] with the people and Government of Puerto Rico to create the necessary foundation for economic growth and to restore opportunity to the people of Puerto Rico.” The specific powers of the Oversight Board are defined by the Act and include the power to approve fiscal plans and budgets and debt-restructuring plans.

Section 201 of the Act requires the Oversight Board to develop a “fiscal plan” with the governor of Puerto Rico. The fiscal plan must meet 14 specific objectives related to economic stability, access to credit markets, and sufficient funding of public services and pensions.[9] To provide the Oversight Board some “breathing room,” § 405 of the Act provided a temporary and limited automatic stay against collection efforts by certain creditors of the Commonwealth.[10] Unlike § 362 of the Bankruptcy Code, however, the § 405 automatic stay went into effect as soon as PROMESA was enacted and continued through May 1, 2017, as extended.

While the automatic stay was in place, the Oversight Board met with a variety of government officials, economists, consultants and creditor constituencies and reviewed fiscal plans submitted by the governor of Puerto Rico.[11] The Board ultimately rejected the first fiscal plan submitted by then-Governor Alejandro Padilla in November 2016.[12] When newly elected Governor Rosello Nevares took office in 2017, he submitted a new fiscal plan to the Oversight Board, which the Board eventually certified in March 2017 after various modifications and amendments.[13]

After the fiscal plan was approved, in March and April 2017, the Board began negotiations and mediation with creditor constituencies and the Commonwealth to develop consensual reorganization plans.[14] No resolution could be reached by the expiration of the automatic stay, however, forcing the Oversight Board to file a petition for the Commonwealth under Title III of PROMESA on May 3, 2017.[15] The Commonwealth’s Title III proceeding is pending in the U.S. District Court for the District of Puerto Rico. However, the docket has been transferred to the PACER platform of the U.S. Bankruptcy Court for the District of Puerto Rico. Questions raised about the extent of consensual negotiations by the Oversight Board are addressed in the ABI article “Developing: Puerto Rico Enters Bankruptcy.”

Subsequent petitions under Title III were filed in May 2017 for the Puerto Rico Sales Tax Financing Corporation, Puerto Rico Highways and Transportation Authority, and the Employees Retirement System of the Government and Commonwealth of Puerto Rico.

What Is a Title III Proceeding?

Title III of PROMESA creates a court-supervised process for the Oversight Board, the Commonwealth and its affiliates and creditors to reach a consensual plan of reorganization. The process has similarities with chapters 9 and 11 of the Bankruptcy Code, but many provisions are unique to PROMESA. The following are some notable aspects of Title III.

• Title III incorporates § 362 of the Bankruptcy Code and imposes a new automatic stay distinct from the automatic stay under § 405 of PROMESA. In addition, Title III incorporates over 70 other sections of the Bankruptcy Code, drawing from both chapters 9 and 11, including provisions related to the rejection of executory contracts and unexpired leases (§ 365), the filing and allowance of claims (§§ 501-506, 928 and 1111(b)), avoidance actions (§§ 544, 547, 548 and 926), committees (§§ 1102 and 1103), contents of a plan (§ 1122, portions of § 1123, and § 1124), and plan confirmation, including cramdown (portions of § 1129).[16]
• Title III requires a U.S. district court judge appointed by the Chief Justice of the United States to oversee the Title III proceeding rather than a bankruptcy judge.[17] On May 5, 2017, Chief Justice Roberts appointed Hon. Laura Taylor Swain from the U.S. District Court for the Southern District of New York.
• Similar to chapters 9 and 11, Title III permits the Commonwealth to remain in possession of its assets during the restructuring. The Oversight Board is the representative of the Commonwealth (and its affiliates) in the Title III proceeding and may take “any action necessary” in the case.[18] The Oversight Board has sole authority to initiate the Title III proceeding and controls the debtor’s actions therein. This differs from chapters 9 and 11, where the municipality or debtor in possession controls, respectively.
• Title III contemplates the parties negotiating a plan of adjustment that is “consistent with” the approved fiscal plan.[19] Only the Oversight Board, however, may file a plan of adjustment.[20] The court shall confirm the plan if, among other requirements, it complies with the applicable provisions of the Bankruptcy Code, is feasible, and is consistent with the fiscal plan certified by the Oversight Board.[21]
• The Federal Rules of Bankruptcy Procedure apply to proceedings under Title III.

What Professionals Are Involved So Far?

The Oversight Board has hired Proskauer Rose and O’Neill & Borges LLC as legal counsel, McKinsey & Co. as strategic consultant, Citigroup Global Markets as investment banker, Ernst & Young as financial advisor, and Prime Clerk as the claims and noticing agent. Thus far, parties have filed papers in the Title III proceeding requesting appointment of an unsecured creditors’ committee and retiree committee.

Conclusion

It is difficult to exaggerate the novelty, complexity and size of the Puerto Rico restructuring under PROMESA. It is without historical precedent. The successes and failures of the Title III proceeding will almost certainly shape future municipal restructurings, particularly with respect to the treatment of chronically underfunded pensions. Moreover, although PROMESA only applies to Puerto Rico, some commentators believe that the Act may provide a statutory framework that could be adapted to address any financial crises facing the nation’s states.