By Carlos F. Ugalde
Puerto Rico continues to fall deeper into recession, piling up its current debt load. With more than $70 billion in total debt and no legitimate revenue-increasing mechanisms, insolvency is the most likely outcome. One of Puerto Rico’s largest contributors with $9 billion in debt is its government-owned Puerto Rico Electric Power Authority (“PREPA”), which virtually produces, transmits and distributes all of the electric power in Puerto Rico.
Despite generally considered a “State” for purposes of the United States Bankruptcy Code (the “Code”), Puerto Rico municipalities are excluded from participating in the orderly bankruptcy proceeding set forth by Chapter 9. Therefore, instead of voluntarily reorganizing PREPA’s operations to cut down costs and avoid default, the Commonwealth of Puerto Rico enacted the Puerto Rico Corporations Debt Enforcement & Recovery Act (the “Recovery Act” or “Act”).
As a general matter, the Recovery Act provides Puerto Rico’s public corporations, including PREPA, with two distinct mechanisms to restructure their debts. Chapter 2’s consensual debt modification procedure permits interest rate adjustments and maturity extensions, among other debt relief measures. The process requires a 75-percent supermajority vote from the affected class of creditors and court approval in order to bind the entire affected class. Alternatively, Chapter 3’s court-supervised procedure would defer repayment and decrease both interest and principal amounts for all bondholders. This mechanism requires full plan confirmation, which would similarly allow the debtor to bind non-consenting creditors.
PREPA bondholders Oppenheimer Funds, Franklin Municipal Bond Group, and Blue Mountain Capital Management immediately challenged the Recovery Act. On February 6, 2015, the District Court for the District of Puerto Rico struck down the Act as unconstitutional, and permanently enjoined the Commonwealth from enforcing it. Particularly, District Judge Besosa held that section 903(1) of the Code demonstrates Congress’s manifest purpose to preempt states from “prescribing [] method[s]of composition of indebtedness” that would bind non-consenting creditors. By operation, the Recovery Act is void under the Supremacy Clause of the United States Constitution. The Commonwealth appealed the decision to the First Circuit, requesting quick resolution to ensure the continuation of PREPA’s essential public services.
Meanwhile, Congressman Pierluisi, Puerto Rico’s sole representative in Congress, introduced H.R. 870, the Puerto Rico Chapter 9 Uniformity Act of 2015, to amend the Code to include Puerto Rico under the definition of “State” for Chapter 9 purposes. On February 26, 2015, a hearing on the bill was held on the House Subcommittee on Regulatory Reform, Commercial and Antitrust Law.
Support for the bill mainly came from Melba Acosta Febo, President of Puerto Rico’s Government Development Bank, stating that without the Recovery Act’s or Chapter 9’s protections, uncertainty would deprive Puerto Rico from future economic development. On the other side, Thomas Moers Mayer, partner at Kramer Levin Naftalis & Frankel LLP and counsel for two of the respondent-bondholders in the appeal, testified that inclusion in Chapter 9 is unnecessary since PREPA still has other reasonable cost-cutting and revenue-increasing alternatives, such as raising rates and negotiating voluntary workouts with creditors. Ms. Acosta adequately responded stating that the current recession has already adversely affected the island’s residents, and raising the currently sky-high rates would just slash all economic activity. Aside from the witnesses, Congressmen Robert Goodlatte, R-VA, and Darrell Issa, R-CA, raised the issues of retroactivity and fairness, which could materially impair the public corporations’ future ability to raise money in the capital markets.
The Commonwealth of Puerto Rico awaits a positive result from either front. However, experts and commentators believe that Congress and the Commonwealth has other viable options. For instance, Congress could repeal the Jones Act, which compels maritime trade to be uniquely carried out by U.S. ships. The Puerto Rican government can also improve the administration and collection of taxes. And finally, as a measure of last resort, Congress can create a financial control board that would oversee Puerto Rico’s debt and economic health.
Whatever the solution, necessary and prompt action is required, especially considering that PREPA will likely default on July 1st.
Sources
Brian Chappatta & Kate Smith, OppenheimerFunds Sticks With Struggling Puerto Rico: Muni Credit, Bloomberg (March 8, 2015), http://www.bloomberg.com/news/articles/2015-03-09/oppenheimerfunds-sticks-with-struggling-puerto-rico-muni-credit.
Dante A. Disparte, Puerto Rico’s Debt Crisis: A Lehman Moment for the Island, The Hill (March 4, 2015), http://thehill.com/blogs/congress-blog/economy-budget/234501-puerto-ricos-debt-crisis-a-lehman-moment-for-the-island.
Gov’t Dev. Bank for P.R., The Facts About Puerto Rico’s Public Corporations Debt Enforcement and Recovery Act, http://www.gdb-pur.com/documents/FactsAboutDebtEnforcementAndRecoveryAct.pdf.
John Burnett, Island of Disenchantment, U.S. News (March 11, 2015), http://www.usnews.com/opinion/economic-intelligence/2015/03/11/puerto-ricos-agencies-dont-need-chapter-9-bankruptcy.
John Dizard, Puerto Rico and US Hedge Funds Wander into Muni Minefield, Financial Times (Feb. 13, 2015), http://www.ft.com/cms/s/0/d1ce886a-b373-11e4-a45f-00144feab7de.html#axzz3UIE3KSUD.
Michael A. Fletcher, Can Bankruptcy Save Puerto Rico’s State-run Corporations?, The Washington Post (Feb. 26, 2015), http://www.washingtonpost.com/blogs/wonkblog/wp/2015/02/26/can-bankruptcy-save-puerto-ricos-state-run-corporations.
Pete Sepp, Puerto Rico Crisis Needs More than Bankruptcy Tweak, The Hill (March 9, 2015), http://thehill.com/blogs/congress-blog/economy-budget/235071-puerto-rico-crisis-needs-more-than-bankruptcy-tweak.
Prepa Delays Debt Restructuring Plan, Caribbean Business (Feb. 28, 2015), http://www.caribbeanbusiness.pr/news/prepa-delays-debt-restructuring-plan-105484.html.
Puerto Rico Asks for Quick Decision in Bankruptcy Ruling Appeal, Reuters (Feb. 20, 2015), http://www.reuters.com/article/2015/02/20/usa-puertorico-bankruptcy-idUSL1N0VU1MA20150220.
