On July 1, 2015, the Puerto Rico Electric Power Authority (PREPA) avoided default by making a $415 million payment to bondholders and buying time to continue restructuring negotiations over its approximately $9 billion of outstanding debt. PREPA financed the payment with $153 million from its general fund and the rest from debt-service reserves. As part of the deal, insurers that protect some of PREPA’s bonds agreed to buy $128 million in new short-term debt due by mid-December to preserve liquidity for operations. PREPA and its creditors have been working to reach a consensual restructuring plan since the beleaguered utility first entered a forbearance agreement with its creditors in August 2014. In conjunction with the $415 million payment, the forbearance agreement was extended through September 15, 2015.
The bond payment represents a positive step in light of Puerto Rico Governor Alejandro Garcia Padilla’s recent statements that the island would be unable to pay its debts without concessions from bondholders. Nonetheless, it is only a short term solution to PREPA’s insolvency – any long term solution will need to stem from a consensual restructuring plan. However, Puerto Rico is precluded from providing the assistance available under chapter 9 of the United States Bankruptcy Code (the Code) to its utility companies that may help to foster garnering such consensus. Thus, the hard-fought-for payment highlights the tough position that PREPA and its sister companies, the Puerto Rico Aqueduct and Sewer Authority (PRASA) and the Puerto Rico Highways and Transportation Authority (PRHTA) find themselves in.1
The dire magnitude of the situation cannot be overstated. PRASA, PRHTA, PREPA are each charged with providing for the basic needs of Puerto Rico’s citizens and collectively owe approximately $20 billion of Puerto Rico’s $73 billion dollar debt.2 These public companies are vital for the functioning of the island’s electric, transportation, and sanitation needs and any default, or ill-planned restructuring, could be catastrophic for the island (not to mention its bondholders).3 To make matters worse, Puerto Rico is struggling with an estimated unemployment rate of around 12% (approximately twice the U.S. average), seeing a rapid increase in emigration to the U.S (around 1,000 departures per week), and its central bank, the Government Development Bank, warns that the government is at risk of shutting down.4
The Chapter 9 Conundrum
A potential solution to Puerto Rico’s problems would be to allow PREPA, PRASA and PRHTA to seek consensus driven, court-supervised workouts with creditors through chapter 9 of the Code. Chapter 9 enables States to authorize "municipalities," which can include certain public utility companies, to declare bankruptcy and utilize the Code’s tools for restructuring.
Once a municipality files a chapter 9 petition, an automatic stay is imposed that prohibits creditor actions and provides the debtor with breathing space to reorganize its affairs. Additionally, chapter 9 provides a debtor with the ability reject burdensome contracts and modify existing obligations through the plan confirmation process, stemming the problem of holdouts that can hinder restructuring plans. Further, chapter 9 provides accountability and transparency by ensuring any restructuring is subject to court supervision and approval. Chapter 9 has arguably been successful in cities like Detroit and Stockton, and could help PREPA in its restructuring efforts, but Puerto Rico is excluded from authorizing chapter 9 relief under the Code.
Although Puerto Rico and its public utilities are some of the largest issuers of municipal bonds in the U.S.,5 Puerto Rican municipalities are ineligible to access chapter 9. The exclusion stems from the Code’s definition of the term "State," which excludes Puerto Rico (and the District of Columbia) for purposes of defining who may be a chapter 9 debtor (but for all other purposes can access the Code’s benefits).6 Consequently, unlike States, Puerto Rico, as a commonwealth, lacks the ability to authorize its public companies to file under chapter 9 of the Code.
The reason the Code excludes Puerto from allowing its municipalities to file chapter 9 bankruptcies is, in the words of one scholar "mysterious at best and at worst unintentional."7The original Bankruptcy Act of 1898 (the 1898 Act) actually included Puerto Rico under the definition of "States"8 and the subsequent Bankruptcy Reform Act of 1978 (the 1978 Act), which replaced the 1898 Act, removed the definition of "States" altogether.9 Consequently, a cogent argument could be made that Puerto Rico could allow its public companies to file under chapter 9 up until 1984. However, the Bankruptcy Amendments and Federal Judgeship Act of 1984 (the 1984 Amendments) added the definition of "State" we have today that excludes Puerto Rico’s municipalities from accessing chapter 9.
There is no legislative history that suggests Congress excluded Puerto Rican municipalities from chapter 9 intentionally.10 The Congressional record does show, however, that Senator Robert Dole introduced an amendment to add a reference to Puerto Rico in the Code because Puerto Rico was "inadvertently left out of the definition of ‘State’ during the passage of the  Reform Act."11 Dole’s statement is particularly curious given he sought to amend a definition that did not exist in the 1978 Act.12 Ultimately, for unrecorded reasons,13 sheer error, or indifference, the Code was amended to contain the definition of State that we have today, which expressly precludes Puerto Rico from availing its municipalities of chapter 9 protection.14 Another view is that the exception set forth in the 1984 Amendments relates to the different constitutional status of Puerto Rico which does not implicate the limitations on Congress’s ability to address municipal insolvency in the states and enables Congress to adopt a different insolvency regime altogether for Puerto Rican municipalities.15
Helpless to Help Itself
Without access to chapter 9 of the Code, and with PREPA, PHASA, and PRHTA ailing, on June 28, 2014 Puerto Rico passed its own insolvency law, the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (the Recovery Act) modeled on chapters 9 and 11 of the Code.16 Specifically, the Recovery Act provided for two types of restructuring relief: (i) Chapter 2, which provided for a market based approach for consensual debt relief, and (ii) Chapter 3, which provided a more court-centric framework for confirming a consensual debt relief plan. The Recovery Act conferred on eligible debtors numerous powers and benefits that are similar or identical to, and in some cases stronger than, those provided in the Code. For instance, it provided an automatic stay against the debtor, the ability to reject contracts (only available through a Chapter 3 filing), and the ability to modify debt obligations and force creditors to accept partial satisfaction of their claims in the event threshold levels of creditor support can be obtained.17
In Puerto Rico, the Recovery Act garnered a rare showing of bi-partisan support, demonstrating Puerto Rico’s desire to have a legal framework to restructure its public corporations.18 However, on June 29, 2014, one day after the enactment of the Recovery Act, a group of investment funds brought an action in the United States District Court for the District of Puerto Rico, seeking a declaration that the Act violates the US Constitution.19
On February 6, 2015 the U.S District Court for the District of Puerto Rico in Franklin California Tax-Free Trust, et al v. Acosta Febo, et al. enjoined the Recovery Act, holding it unconstitutional under the Supremacy Clause of the Constitution.20 The District Court held the Recovery Act unconstitutional, concluding it "[wasn’t even] a close case."21 The Court reasoned that the explicit text of Section 903 of the Code expressly preempted the Recovery Act. Indeed, Section 903 of the Code provides that a State may not enact a law prescribing a method of composition of indebtedness of a municipality that is binding on any creditor that does not consent.22 Finding that the Recovery Act, modeled on chapters 9 and 11 of the Code, comprised such a law, the Court struck it down as unconstitutional.
On July 6, 2015, the Court of Appeals for the First Circuit upheld the Franklin Court’s ruling that the Recovery Act is unconstitutional.23 Notably though, the Court’s majority went to great lengths to illustrate the convoluted history leading up to the 1984 Amendments that excluded Puerto Rico from the Code and concluded that "options remain open to Congress" to address the insolvency of Puerto Rico municipalities.24 Puerto Rico’s attempts to effect restructuring relief through legislative reform may be bolstered by Judge Torruella’s concurring opinion, which argues that the 1984 Amendments are unconstitutional because there was no rational basis for their enactment.25
Consequently, the First Circuit’s decision is not the final nail in the coffin for Puerto Rico’s hope to bring restructuring options to its ailing utility companies. Indeed, Puerto Rico’s representative in Congress, Pedro Pierluisi, introduced the Puerto Rico Chapter 9 Uniformity Act in the House of Representatives in February of last year.26 The bill would amend the definition of "State" in the Code to allow Puerto Rican municipalities to access chapter 9, and although relatively little action has been taken to date, the recent First Circuit decision may impact future debate.27
While PREPA has thus far been successful in extending creditor forbearance and avoiding default, it remains to be seen whether the $9 billion dollar debt of the public utility company can be restructured out of court. PREPA desperately needs money to meet its operating costs and revamp its operations, but it also has to ensure that the terms of any financing won’t impair the company’s ability to provide power going forward. Although many investors argue that PREPA has not availed itself of options that could increase revenue such as raising utility rates, the availability of restructuring under chapter 9 could facilitate more constructive negotiations between PREPA and its bondholders. Certain officials and advisors suggest that Congress needs to go further and permit Puerto Rico’s central government to file for bankruptcy. In June, Puerto Rico hired Steven W. Rhodes, the retired federal judge who oversaw Detroit’s bankruptcy case, as an adviser. According to Mr. Rhodes, "[t]here are way too many creditors and way too many kinds of debt . . . They need Chapter 9 for the whole commonwealth."28 However, for the time being, chapter 9 is beyond the reach for both Puerto Rico and PREPA. The spotlight is on Congress to see if chapter 9 tools will be granted to Puerto Rico. Until then, the 3.6 million U.S. citizens living in Puerto Rico depending on PREPA for electricity will have to wait and see if private negotiations can produce viable long-term solution.