Puerto Rico and Bankruptcy

Puerto Rico and Bankruptcy

The bankruptcies of public bond-issuing entities, such as Orange County, Calif.; Jefferson County, Ala.; and the City of Detroit, Mich. are still rare events, but they exert a lot of influence, in part because they demonstrate the possibility of that which isn’t supposed to be possible. The sort of entity in which one invests, and whence one generally accepts a low return, simply in order to keep one’s money safe: sometimes doesn’t.

These bankruptcies are also highly complicated bureaucratic tangles, and in the tangle there is alpha to be made for the wary and the nimble.

Now the spotlight is on Puerto Rico. There’s a lot going on concerning the Commonwealth’s insolvency, inclusive of a pending decision by the United States Supreme Court (expected literally any day as I write) on whether Puerto Rico was entitled to enact a specific municipal bankruptcy regime of its own that would bind creditors of its municipalities to debt restructuring plans, or whether that regime is void as having been preempted by the federal bankruptcy code.

On that subject, I will say for now only that BlueMountain Capital Management LLC, a New York-based hedge fund manager headed by Andrew Feldstein, has submitted an extensive amicus brief to the Supreme Court, one that makes the case for federal preemption.

What is to be done?

If that view is right, it emphasizes that Puerto Rico cannot address its insolvency and the concomitant insolvency of many of its subordinate entities, on its own terms, increasing the pressure on Congress to act.

Puerto Rico missed a $422 million debt payment on May 2. But what is even more important: it has a $2 billion payment coming up: July 1. That payment includes $805 million in general obligation bonds. So then … what?

And indeed another recent development is this: Congress does seem to be stepping up to the plate to answer that question even in advance of any decision by the high court. The Act is called PROMESA, or the Puerto Rico Oversight, Management, and Economic Stability Act. It’s one of those clumsy bill names that indicate that someone was very eager to make the acronym come out right.

What PROMESA’s Title III promises to create is a chapter-9-like process, though the process is to be initiated by the oversight board rather than by the government of Puerto Rico itself.

Title VI, on “Creditor Collective Action,” gets to the center of the debate over this bill and for that matter of debates over complicated public-entity insolvencies in general. It provides for the creation of distinct pools of creditors, to be acknowledged as such by the oversight board “in consultation with the Issuer,” corresponding to the relative priority or security arrangements of each holder of Bonds against each Issuer. Title VI also specifies that the term “priority” as used in this connection “shall not be understood to mean differing payment or maturity dates.”

The over-all scheme contemplated by the bill is a two-stage process for the restructuring of debt. In the first stage, the oversight board will develop a plan, and the members of each pool of creditors will vote on whether or not it accepts the plan. If the vote is “yes,” then the plan applies as to that pool. If the vote is “no,” then as a second stage, the pool’s members are assigned to the chapter 9 style bankruptcy, that is, Title III of this bill, where their claims will have to compete with over $40 billion of unfunded liabilities. So, yes, there is a voluntary element in the process, but the chapter 9 threat may act as a good sized stick, helping to bring “yes” votes about.

Whence the Whirlwind

A natural question: Why does Puerto Rico need a new parallel to Chapter 9? Why can’t it just employ Chapter 9? If that puzzles you, you’re in good company. The question also seems to have puzzled the Justices of the Supreme Court when they heard arguments on the related litigation. What is clear is that in the course of a 1984 revision of the Bankruptcy Code, Congress seems quite incidentally to have made Puerto Rico (and the District of Columbia too) special cases. Why? There is almost no legislative history on point.

One of the lawyers participating in that argument, Matthew McGill, told the Justices that the 1984 language was part of “a long history of intervening,” that is, a history of Congressional micromanaging of Puerto Rico’s affairs.

If so, then this Congress, in its struggles to devise a new law, has reaped the whirlwind sown by that precursor.

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