Puerto Rico Bondholders Can’t Compel Payment During Bankruptcy, First Circuit Says

In a second opinion on March 26, the First Circuit dealt bondholders another defeat, compelling them to stick around and participate in Puerto Rico’s debt restructuring before receiving payment on their special revenue bonds. The two March 26 opinions mean that the appeals court isn’t allowing any secured creditors to take home their marbles before they’re parceled out under the island commonwealth’s debt adjustment plan.

Yesterday, we reported the opinion by First Circuit Judge Juan R. Torruella ruling that the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.), does not enable holders of general obligation bonds to require the segregation of certain tax revenue, known as restricted revenue, that ordinarily would be devoted to the payment of their bonds. Indeed, the opinion would allow Puerto Rico to divert the restricted revenue to other uses during the pendency of debt restructuring proceedings.

The second opinion on March 26, also by Judge Torruella, goes a step further by ruling that nothing in PROMESA enables bondholders to compel payment on their bonds during the course of proceedings and before confirmation of a plan. In both opinions, Judge Torruella upheld decisions by District Judge Laura Taylor Swain, who presides by designation over Puerto Rico’s debt adjustment proceedings.

The Underlying Lawsuit

The insurer of bonds issued by Puerto Rico’s highway authority initiated an adversary proceeding in the authority’s debt adjustment proceedings under PROMESA.

The authority’s bonds are secured by liens on so-called special revenues, including tolls on the island’s four toll roads, excise taxes on petroleum sales, and excise taxes on motor vehicle license fees. The insurer contended, in substance, that PROMESA carves out exceptions to the automatic stay by requiring the continuing payment of the authority’s bonds by application of the special revenues.

Judge Swain dismissed the suit in January 2018 for failure to state a claim under Rule 12(b)(6). For the First Circuit, Judge Torruella affirmed in his 24-page opinion on March 26.

The Circuit’s Analysis

In an ordinary non-municipal bankruptcy, Section 552(a) of the Bankruptcy Code would cut off bondholders’ post-petition liens on special revenues. For municipal bankruptcies, Congress created an exception in Section 928.

“Notwithstanding section 552(a),” Section 928(a) provides that “special revenues acquired by the debtor after the commencement of the case shall remain subject to any lien [created] before the commencement of the case.” Sections 522 and 928 are incorporated into Puerto Rico’s proceedings by Section 301 of PROMESA.

The bond insurer contended that Section 928(a) requires the continued payment of special revenue bonds during the pendency of Puerto Rico’s debt adjustment proceedings. Based on the statute’s plain language, Judge Torruella concluded that Section 928(a) only “provides that consensual prepetition liens on special revenues will remain in place after filing.”

Next, the bond insurer argued that Section 922(d), also incorporated into PROMESA, requires the authority to turn over the revenue and exempts bondholders from the automatic stay.

Section 922(a) expands the Section 362 automatic stay in chapter 9 cases to cover actions to enforce liens arising out of taxes owing to the debtor. Notwithstanding the automatic stays in Sections 362 and 922(a), Section 922(d) goes on to provide that a chapter 9 petition “does not operate as a stay of application of pledged special revenues . . . to payment of indebtedness secured by such revenues.”

Judge Torruella interpreted the plain language of Section 922(d) to mean that a debtor may voluntarily pay creditors without violating the stay and allows secured creditors to apply payments without also violating the stay. On the other hand, he said, “Nothing in the statute’s plain language . . . addresses actions to enforce liens on special revenues, which are specifically stayed by Section 362(a)(4).”

Judge Torruella cited the Collier treatise for saying that Section 922(d) “does not suggest that its language compels payment of special revenues in the possession of the municipality.”

While Section 922(d) “is not an impediment to continued payment,” Judge Torruella said that his interpretation of the statute “permits rather than mandates payment during the course of the bankruptcy proceedings.” Compelling payment, he said, might run afoul of Section 305, which was a focus of his companion opinion on March 26.

Summing up what Sections 928(a) and 922(d) mean, Judge Torruella said that consensual prepetition liens secured by special revenues survive bankruptcy. The municipality, he said, “can elect to voluntarily continue payment.” On the other hand, the sections do not require the debtor “to continue payments to bondholders during the pendency of the [PROMESA] proceedings.”