Puerto Rico's Public Corporation Debt Restructuring Law Ruled Unconstitutional

Author:Mr Scott Greenberg and Mark G. Douglas
Profession:Jones Day

The Commonwealth of Puerto Rico's efforts to deal with more than $70 billion in debt have been a magnet for media scrutiny during the last two years. A question frequently asked in connection with the island territory's struggles to stay afloat is whether Puerto Rico, as an unincorporated territory of the U.S., could resort to a bankruptcy filing as a means of alleviating its financial problems. Puerto Rico, however, is statutorily barred from seeking protection under the Bankruptcy Code. In addition, Puerto Rico's municipalities and instrumentalities cannot be debtors under chapter 9. On June 28, 2014, Puerto Rico's governor, Alejandro García Padilla, attempted to remedy this problem in part when he gave his imprimatur to legislation that created a judicial debt-relief process modeled on chapters 9 and 11 of the U.S. Bankruptcy Code for certain public corporations, including the Puerto Rico Electric Power Authority ("PREPA"), which has $9 billion in bond debt. The Puerto Rico Public Corporation Debt Enforcement and Recovery Act (the "Recovery Act") was intended to ring-fence Puerto Rico from potential liabilities arising from defaults by its public corporations and to give the corporations a framework for restructuring their obligations. Puerto Rico's public corporation debt-relief initiative was dealt a severe blow on February 6, 2015, when a federal district court judge struck down the law as unconstitutional. In BlueMountain Capital Management, LLC v. García-Padilla, No. 3:14-cv-01569 (D.P.R. Feb. 6, 2015), the court ruled, among other things, that "[b]ecause the Recovery Act is preempted by the federal Bankruptcy Code, it is void pursuant to the Supremacy Clause of the United States Constitution." The ruling, which has been appealed by Puerto Rico, is a setback not only for PREPA and other public corporations attempting to restructure their bond debt (e.g., the Puerto Rico Aqueduct and Sewer Authority and the Puerto Rico Highways and Transportation Authority), but also for Puerto Rico itself.

The Recovery Act

As noted, the Recovery Act is patterned on chapters 9 and 11 of the U.S. Bankruptcy Code (with certain important distinctions) and is in all practical respects a nonfederal bankruptcy law. Under the Recovery Act, an eligible public corporation may pursue two alternatives, simultaneously or in sequence. The first is a "consensual debt relief transaction" akin to a prepackaged or prenegotiated chapter 11 case. To commence such a proceeding, an eligible entity must file a notice of a "suspension period," which stays collection actions by all identified creditors for up to 360 days, unless the entity elects not to seek approval for specified debt relief from a special Public Sector Debt Enforcement and Recovery Act Court (created under the Recovery Act). If court approval is requested, the stay remains in place until either: (i) any court order approving debt relief becomes final; or (ii) 60 days after the denial of such relief. Debt relief may be approved by the court only if: (a) creditors holding at least 50 percent of the amount of debt within a class of substantially similar obligations participate in a vote or a consent solicitation for a proposed amendment, modification, waiver, or...

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