An important aspect of the Puerto Rico Oversight, Management, and Economic Stability Act, 48 U.S.C. §§ 2101–2241 ("PROMESA")—the temporary stay of creditor collection efforts that came into effect upon its enactment—was the subject of a ruling handed down by the U.S. Court of Appeals for the First Circuit. In Peaje Investments LLC v. García-Padilla, 845 F.3d 505 (1st Cir. 2017), the First Circuit affirmed in part and vacated in part a lower court order denying two motions for relief from the PROMESA stay. The court held, among other things, that: (i) the lack of "adequate protection" of a secured creditor’s interest is "cause" for relief from the stay, even though PROMESA does not expressly include language to that effect; and (ii) the party seeking relief from the PROMESA stay bears the burden of demonstrating "cause" for relief because the Bankruptcy Code’s burden-shifting provision in connection with a motion for relief from the automatic stay does not apply under PROMESA, other than in a debt adjustment proceeding.

The Automatic Stay

Section 362(a) of the Bankruptcy Code provides that the filing of a bankruptcy petition operates as a stay of substantially all creditor collection efforts against a debtor or its assets. Subsection (d)(1) of section 362 provides that, on the request of a party-in-interest and after notice and a hearing, the court shall grant relief from the automatic stay "for cause, including the lack of adequate protection of an interest in property of such party in interest."

Except for the "lack of adequate protection" language quoted above, the term "cause" is not defined in the Bankruptcy Code. Courts have devised various tests to determine whether this flexible standard has been met in any given case. See, e.g., Sonnax Indus., Inc. v. Tri Component Products Corp. (In re Sonnax Indus., Inc.), 907 F.2d 1280 (2d Cir. 1990) (applying a 12-factor test to consider in connection with a request for stay relief to continue pending litigation); Izzarelli v. Rexene Prods. Co. (In re Rexene Prods. Co.), 141 B.R. 574, 576 (Bankr. D. Del. 1992) (applying a three-factor test).

Section 362(g) of the Bankruptcy Code allocates the burden of proof in connection with a motion for relief from the automatic stay as follows:

In any hearing under subsection (d) or (e) of this section concerning relief from the stay of any act under subsection (a) of this section— (1) the party requesting such relief has the burden of proof on the issue of the debtor’s equity in property; and (2) the party opposing such relief has the burden of proof on all other issues.

Prior to the enactment of section 362 in 1978, some cases found that parties seeking relief from the stay bore the burden of demonstrating that they would be harmed by its continuation, see, e.g., In re Planned Sys., Inc., 78 B.R. 852, 858 (Bankr. S.D. Ohio 1987); In re Anchorage Boat Sales, Inc., 4 B.R. 635, 641 n.6 (Bankr. E.D.N.Y. 1980), while other cases placed the burden on the trustee. See, e.g., In re Third Ave. Transit Corp., 198 F.2d 703, 705 (2d Cir. 1952). Where the alleged harm was a decrease in the value of the creditor’s collateral, the required showing included evidence that "the value of the collateral [was] not substantially in excess of the amount of the debt." In re Wynn Homes, Inc., 14 B.R. 520, 523 (Bankr. D. Mass. 1981).

PROMESA

On June 30, 2016, President Barack Obama gave his imprimatur to PROMESA. The bipartisan legislation was approved in a flurry of legislative dealmaking that preceded a deadline for Puerto Rico to make $2 billion in bond payments. Despite the passage of PROMESA, Puerto Rico defaulted on its general obligation debt for the first time on July 1, 2016.

The enactment of PROMESA followed a June 13, 2016, ruling by the U.S. Supreme Court that upheld lower court rulings declaring unconstitutional a 2014 Puerto Rico law, portions of which mirrored chapter 9 of the Bankruptcy Code, that would have allowed the commonwealth’s public instrumentalities to be restructured. See Commonwealth v. Franklin Cal. Tax-Free Tr., 136 S. Ct. 1938 (2016). PROMESA provides for, among other things, the establishment of an Oversight Board entrusted with determining the adequacy of budgets and fiscal plans for Puerto Rico and certain of its instrumentalities. It also provides a mechanism for the implementation of voluntary out-of-court restructuring agreements between an instrumentality and its bondholders, as well as bond debt adjustment plans (consensual and nonconsensual) in a case commenced in federal district court.

PROMESA § 2194 provided that its enactment would serve as a stay of substantially all creditor collection efforts against Puerto Rico, its instrumentalities, and their property until February 15, 2017. As permitted by PROMESA, the commonwealth sought and obtained from the Oversight Board an extension of the stay for an additional 75 days. The Puerto Rico government has since requested that the Oversight Board seek from the United States Congress a further extension of the stay to December 31, 2017. Acts violating the stay are void under section 2194(h).

Section 2194(e) provides that, upon the request of a party and "after notice and a hearing," the court—the U.S. District Court for the District of Puerto Rico—may grant relief from the stay "for cause shown." The term "cause," however, is not defined.

Under section 2194(f), the stay terminates automatically 45 days after a request for stay relief is made unless the court orders otherwise. Section 2194(g) provides that, upon the request of a party-in-interest, the court, with or without a hearing, "shall grant such relief from the stay provided under subsection (b) as is necessary to prevent irreparable damage to the interest of an entity in property, if such interest will suffer such damage before there is an opportunity for notice and a hearing" on a stay relief request.

PROMESA includes a separate stay triggered by the commencement of a debt adjustment proceeding by a qualified Puerto Rico instrumentality. Specifically, section 2161 provides that many provisions of the Bankruptcy Code, including section 362, shall apply in a PROMESA debt adjustment proceeding. PROMESA does not expressly provide that section 362 applies with respect to the stay imposed by PROMESA § 2194(b).

In Peaje Investments, the First Circuit considered the appeal of an order denying two requests for relief from the stay triggered by PROMESA’s enactment, one filed on behalf of a creditor of the Puerto Rico Highway and Transportation Authority ("PRHTA") and one filed on behalf of creditors of Puerto Rico’s Employees Retirement System (the "ERS").

Peaje Investments

Peaje Investments LLC ("Peaje") is the beneficial owner of certain bonds issued by the PRHTA. The bonds are secured by a lien on toll revenues. In July 2016, Peaje filed a motion seeking relief from the stay under PROMESA § 2194(e) so that it could challenge the Puerto Rico government’s diversion of the toll revenues to other uses, which Peaje alleged diminished the value of its collateral.

In September 2016, certain holders of bonds (collectively, the "Altair Movants") issued by the ERS also filed a motion to lift the PROMESA stay unless adequate protection were afforded the Altair Movants in the form of placing employer contributions subject to the Altair Movants’ lien in an account established for their benefit. See Altair Global Credit Opportunities Fund (A), LLC v. García-Padilla, No. 16-2433 (D.P.R.).

After procedurally consolidating the actions, the district court denied both motions without holding a hearing. Looking to section 362(d) of the Bankruptcy Code and the constitutional underpinnings of the adequate protection requirement, the court held that the "lack of adequate protection" necessarily constitutes "cause" to lift the stay under PROMESA § 2194(e), just as it does under section 362(d). However, the court concluded that both Peaje and the Altair Movants were adequately protected. According to the court, the toll revenues are "constantly replenished," and therefore, "to hold a security interest in a stable, recurring source of income that will eventually provide funds for the repayment of the PRHTA bonds" constituted adequate protection. Similarly, the court held that "pursuant to the terms of the applicable bond resolution," the Altair Movants "hold a security interest and lien in certain pledged property, including all future employer contributions." The court explained, "This lien continues indefinitely until the ERS’s outstanding debt obligations have been satisfied in full," stating that since "they will only be delayed in recovering the funds needed to repay their ERS bonds," the Altair Movants were adequately protected. Peaje and the Altair Movants appealed.

The First Circuit’s Ruling

A three-judge panel of the First Circuit affirmed the district court’s ruling as to Peaje but vacated the holding as to the Altair Movants.

The court rejected the commonwealth’s "threshold" argument that, by omitting the clause "lack of adequate protection" from PROMESA § 2194(e), but including that language in section 362(d)’s definition of "cause," Congress intended for the definition of "cause" under section 2194(e) not to include actions impairing collateral in a manner which leaves the secured creditor’s interest inadequately protected. The First Circuit explained that the concept of "adequate protection" is derived from the Fifth Amendment protection of property interests. According to the court, "The PROMESA stay implicates these same constitutional concerns." The First Circuit did not fault the district court’s conclusion that the existence of an equity cushion—a "common form" of adequate protection—meant that Peaje’s interest in its collateral was adequately protected and that relief from the stay was not warranted.

Because the district court did not hold a hearing on the stay relief motions, the First Circuit vacated the portion of the court’s ruling denying the Altair Movants’ request for relief from the stay. The court explained, as an initial matter, that the language "after notice and a hearing" in PROMESA § 2194(e)(2) and various provisions of the Bankruptcy Code does not require a hearing to be convened, such as in cases where the material facts are not disputed.

In inquiring whether a hearing should have been required on the stay relief motions, the First Circuit examined the burden of proof for such a motion. Under section 362(g) of the Bankruptcy Code, the court explained, Congress changed pre-Bankruptcy Code practice by expressly placing the burden of demonstrating the debtor’s lack of equity in property on the party seeking stay relief, but allocating the burden "on all other issues," including adequate protection, to the party opposing stay relief. In contrast, PROMESA § 2194(e)(2) places the burden of demonstrating "cause" on the movant.

"In light of Congress’s decision not to transplant the Bankruptcy Code’s express alteration of the pre-Code burden regime into PROMESA," the First Circuit wrote, "we hold that PROMESA, like the pre-Code regime, places the burden on creditors to establish cause, including lack of adequate protection." Due to the temporary nature of the PROMESA stay, as well as lawmakers’ intent to minimize "creditor lawsuits," the court explained, "it makes sense to require creditors to shoulder the burden of demonstrating that the impairment of the collateral will likely harm their protected interest in repayment."

Because Peaje did not allege that future toll revenues would fail to provide a sufficient equity cushion, thereby leaving its interest without adequate protection, the First Circuit ruled that the district court was not required to hold a hearing to consider a claim which was facially insufficient.

However, the First Circuit concluded that the Altair Movants’ motion warranted a hearing because the Altair Movants included in their filings statements by the ERS that "uncertainty about future employer contributions could affect ‘the repayment of [the ERS’s] bond payable.’ "

Outlook

PROMESA, which was patterned on chapter 9 of the Bankruptcy Code, incorporates many Bankruptcy Code provisions that apply in chapter 9 to govern debt adjustment proceedings of Puerto Rico instrumentalities. However, as illustrated by Peaje Investments, the PROMESA § 2194 stay and the Bankruptcy Code’s automatic stay are not identical. Thus, the First Circuit concluded that Congress intended that the burden of proof governing a motion for relief from the temporary PROMESA stay should be different from the evidentiary burden governing a request for stay relief in a debt adjustment proceeding under PROMESA. In a footnote, the First Circuit acknowledged that "[i]f debt-adjustment proceedings are commenced under Title III of PROMESA, the statute contemplates that the bankruptcy stay provision will become fully applicable. See 48 U.S.C. § 2161(a) (incorporating by reference 11 U.S.C. § 362)."

Nonetheless, due to the constitutional concerns underpinning the concept of "cause" for relief from the stay under both PROMESA and the Bankruptcy Code, the court determined that the "lack of adequate protection" of a secured creditor’s interest in its collateral should qualify as "cause" for relief from the PROMESA stay, even though Congress did not expressly say so in the statute.