Reforming municipal bankruptcy: lessons from Puerto Rico

AuthorHannah Geller
PositionAssociate in the Bankruptcy, Finance and Restructuring Division of Weil, Gotshal & Manges LLP, New York, NY; J.D., Columbia University, 2015; B.A., Yale University, 2007
Pages152-198
REFORMING MUNICIPAL BANKRUPTCY: LESSONS FROM
PUERTO RICO
HANNAH GELLER *
I. Introduction ....................................................................................................................... 153
II. Chapter 9 and the Puerto Rico Exclusion................................................................... 154
III. Puerto Rico’s Current Economic State .........................................................................157
A. Market Effect ..................................................................................................................... 158
B. Reasons for Puerto Rico’s Financial Distress ............................................................. 160
C. Rational Fiscal Irresponsibility of Politicians ............................................................ 160
D. Municipal Structure and Interdependence of Public Corporations ...................... 161
E. Issues Specific to Individual Public Corporations .................................................... 162
1. Puerto Rico Highways and Transportation Authority (“PRHTA”) .................. 163
2. Puerto Rico Electric Power Authority (“PREPA”) ................................................ 164
3. Puerto Rico Aqueduct and Sewer Authority (“PRASA”)..................................... 165
F. Dependence on Capricious U.S. Funding ................................................................... 166
IV. Solutions Other Than Statutory Restructuring ........................................................ 169
A. Out-of-Court Restructuring through Creditor Negotiations ................................ 169
B. Defaulting ............................................................................................................................ 171
C. Economic Development: Raising Revenues and Decreasing Liabilities ............... 172
V. Lessons From Puerto Rico .............................................................................................. 174
A. Efficiency of Bankruptcy Law Over Non-Statutory Alternatives .......................... 174
B. Suggested Code Amendments Inspired By the P.R. Recovery Act ........................ 177
1. Clarification of Intragovernmental Boundaries and Central Bank Role ............178
2. Refocus of Authorization Requirements Towards Boundary Transparency .. 180
3. Use of Financial Advisors ............................................................................................ 184
4. Enforcement ................................................................................................................... 184
5. DIP Period Judicial Monitoring ................................................................................. 186
6. DIP Period Creditor Monitoring ............................................................................... 188
7. Executory Contracts .................................................................................................... 190
8. Collective Bargaining Agreements ............................................................................ 192
9. Creditor Protection in Plan Confirmation .............................................................. 194
* Associate in the Bankruptcy, Finance and Restructuring Division of Weil, Gotshal & Manges
LLP, New York, NY; J.D., Columbia University, 2015; B.A., Yale University, 2007.
No. 1
Municipal Bankruptcy Reform & Puerto Rico
153
C. Additional Proposed Chapter 9 Amendments ........................................................... 195
1. Involuntary Filings ........................................................................................................ 195
2. Reduce Exclusivity Periods ........................................................................................ 196
VI. Conclusion ......................................................................................................................... 197
I. INTRODUCTION
Domestically and abroad, governmental bankruptcy is on the rise.
1
Reasons why abound and vary, but a few broad trends stand out. First of all, as
populations age, pension and healthcare liabilities increase. For another reason,
debt financing has become a more common practice for cities, states and
countries alike. Meanwhile, reverberations from the recession continue to reduce
revenues. Intergovernmental lending has been reduced, and taxes have declined
along with salaries and employment rates.
2
Governmental insolvency is costly and inefficient. Where there is no
relevant bankruptcy law, the debtor can become mired in litigation, as in
Argentina’s decade-long war with its hedge fund creditors.
3
The traditionally
stable municipal bond market has become increasingly volatile, discouraging
ordinary investors and raising the cost of borrowing.
4
And negative externalities
abound when the debtor is in the business of providing crucial public services.
Where insolvency law does apply to a public debtor, as with Detroit, the
legal procedure offers little comfort to creditors.
5
History has seen few filings
under Chapter 9, U.S. bankruptcy law’s proceeding for governmental debt
adjustment. The lack of precedent prevents lenders from anticipating ex ante the
outcome of their claims. As a result, municipal bonds are not optimally priced,
and overall lending is inefficiently restricted.
1
Jeffrey B. Ellman & Daniel J. Merrett, Pensions and Chapter 9: Can Municipalities Use Bankruptcy to Solve
Their Pension Woes?, 27 EMORY BANKR. DEV. J. 365, 36566 (2011).
2
See STATE BUDGET CRISIS TASK FORCE, FINAL REPORT (2014), http://www.statebudgetcrisis.org/
wpcms/wp-content/images/Report-of-the-State-Budget-Crisis-Task-Force-Full.pdf.
3
Daniel Cancel, Topsy-Turvy Bond Market Means No Default Pain: Argentina Credit, BLOOMBERG BUS.
(Dec. 29, 2014, 8:00 PM), http://www.bloomberg.com/new s/articles/2014-12-30/topsyturvy-bond-
market-means-no-default-pain-argentina-credit.
4
Michael J. Casey, Argentina’s Default Is a War ning to Frothy Government Bo nd Mark ets, WALL ST. J.
(Aug. 3, 2014, 5:33 PM), http://blo gs.wsj.com/moneybeat/2014/08/03/argentinas-default-is-a-
warning-to-frothy-government-bond-markets/.
5
Steven Church, Muni Mutual Fund Exposure to Detroit Falls on New Analysis , THE BOND BUYER (July 29,
2013, 4:12 PM), http://www.bondbuyer.com/issues/122_145/muni-mutual-fund-exposure -to-
detroit-falls-on-new-analysis-1054176-1.html; Bloomberg News, Detroit bankruptcy teaches muni bond
investors painful lessons, CRAINS DETROIT BUS. (NOV. 7, 2014, 5:52AM), http://www.crainsdetroit
.com/article/20141107/NEWS01/141109896/detroit-bankruptcy-teaches -muni-bond-investors-
painful-lessons.
University of Puerto Rico Business Law Journal
Vol. 7
Expansion and reform of Chapter 9 could turn the law from a foe to a
friend of investors. Expansion would enhance predictability, a premium goal in
lending law. With reforms, Chapter 9 could serve rather than stymie economics.
Bankruptcy law is legally, economically, and ethically complex. As
scholarship on municipal bankruptcy acknowledges, additional complexities
arise when the debtor is a governme nt. Legally, a host of additional balance-of-
power issues arise on top of typical federalist bankruptcy issues. Financially, a
bankruptcy judge must assess projections of future financial performance, which
involve future tax collection predictions when the debtor is a government.
Ethically, additional issues arise when the debtor is in the business of providing
public services.
This article provides an in-depth case study of Puerto Rico, a
governmental debtor that is currently in financial crisis, to propose efficiency-
enhancing reforms for Chapter 9. Because of Puerto Rico’s unique status as a U.S.
Commonwealth, the island provides a useful lens through which to examine legal
issues affecting insolvent states, cities, and countries alike.
Recent legal scholarship on Chapter 9 surveys the various political, legal,
and structural problems complicating governmental insolvency. This article fills
a gap by, first of all, allowing the reader to consider legal solutions upon a
foundation of in-depth, practical and financial understanding of a representative
governmental debtor. Secondly, the article draws recent scholarship to i ts
relevant conclusion by proposing concrete amendments to municipal insolvency
law.
II. CHAPTER 9 AND THE PUERTO RICO EXCLUSION
When a borrower cannot pay back his creditors in the amount or time
they originally agreed upon, it may appeal to federal law to scale back its
obligations. If the borrower is a private firm, the relevant law is outlined in
Chapter 11 of Title 11 of the U.S. Code.
6
If the borrower is a government, the
relevant law is in Chapter 9.
7
Though corporations, individuals, banks and railroads located within
Puerto Rico may appeal to federal bankruptcy law just like corporations,
individuals, banks or railroads located within any of the fifty states of the U.S.,
neither Puerto Rico nor any of its political subdivisions, public agencies, or
instrumentalities may amend their debt obligations under the Code. When read in
conjunction, two statutory provisions exclude Puerto Rico from Chapter 9:
municipality is defined as a “political subdivision or public agency or
instrumentality of a State”
8
whereas “the term ‘State’ includes the District of
6
11 U.S.C. §§ 11011174 (2015).
7
§§ 901946.
8
§ 101(40).

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