On Saturday, June 28, Puerto Rico Governor Alejandro Garcia Padilla signed into law the euphemistically-named “Puerto Rico Public Corporation Debt Enforcement and Recovery Act” (the “Act”). The Act, which was unveiled by the Governor and introduced to Puerto Rico’s legislature only three days before, purports to create a new bankruptcy-like regime pursuant to which the debts of certain of Puerto Rico’s public corporations may be restructured.1 Although Puerto Rico describes the act as “not a bankruptcy act, but an orderly debt enforcement act for eligible public corporations,” it nevertheless borrows many concepts and provisions—including the power to “cramdown” and impair nonconsenting bondholders—directly from the U.S. Bankruptcy Code. In fact, in a number of respects, the Act purports to provide even more powerful restructuring tools than the Bankruptcy Code itself.
How it Works
The Act provides two restructuring options:
Chapter 2—“Consensual Debt Relief”
First, Chapter 2 provides a mechanism for an eligible public corporation to restructure some or all of its debt through a proceeding similar to a prepackaged bankruptcy. A Chapter 2 proceeding begins with the decision that an eligible public corporation should seek to enter into one or more “Consensual Debt Relief Transactions.” This decision may be made by either (i) the governing body of the eligible public corporation (subject to the approval of the Government Development Bank of Puerto Rico (the “GDB”)) or (ii) the GDB itself, at the Governor’s request. Once that determination has been made and notice has been posted on the public corporation’s website, a suspension period—similar to the automatic stay provided by the U.S. Bankruptcy Code—begins with respect to the obligations that the public corporation seeks to restructure. A Consensual Debt Relief Transaction becomes binding on all holders of a particular class of debt if:
- It is approved by the GDB;
- At least 50% of affected creditors within a class of substantially similar claims vote on the transaction, and at least 75% of those voting approve the transaction
- Only similarly-situated debt is classified together; and
- The appropriate Puerto Rico Commonwealth court enters an order approving the transaction (which appears to be essentially automatic if the correct procedures are followed).
Thus, despite being described as a mechanism for fostering “Consensual Debt Relief Transactions,” Chapter 2 allows Puerto Rico’s eligible public corporations to restructure a class of debt with the consent of holders of as little as 37.5% (50% x 75%) of that debt.
Chapter 3—“Enforcement of Debt”
In contrast to Chapter 2, Chapter 3 provides for what is, in substance, a full-blown insolvency case. Under Chapter 3, a case begins with an eligible debtor (with the permission of the GDB) or the GDB itself (on behalf of an eligible debtor) filing a petition with the appropriate Puerto Rico Commonwealth court. As in a typical case under the U.S. Bankruptcy Code, filing a petition under Chapter 3 gives rise to an automatic stay. The public corporation then, like a debtor under the Bankruptcy Code and subject to certain restrictions, can reject contracts,2 obtain new credit, prime existing liens on its assets, and ultimately seek to confirm a plan that impairs creditors. As with “cramdown” under the U.S. Bankruptcy Code, a plan under the Act may be confirmed if creditors comprising a majority by number, and at least two-thirds by amount of debt held in a single class, vote to accept the Plan and the Act’s other requirements are met. Unlike chapter 9 of the U.S. Bankruptcy Code, on which Chapter 3 of the Act is partially based, the Act does not provide special protections to holders of secured revenue bonds. To the contrary, the Act appears to be specifically intended to allow Puerto Rico’s eligible public corporations to impair holders of their revenue bonds.
Act Challenged as Unconstitutional
On the same day that the Act was signed into law, a group of creditors holding secured revenue bonds issued by the Puerto Rico Electric Power Authority (“PREPA”) filed a complaint in the United States District Court for the District of Puerto Rico (Case No. 14-1518) challenging the Act as unconstitutional. The lawsuit, which has been assigned to Judge Jay A. García-Gregory, raises four potentially serious challenges to the Act:
- The Act violates the Constitution’s “Bankruptcy Clause” because Congress has the exclusive power to enact a uniform bankruptcy law, and the Act is, in substance if not name, a bankruptcy law;
- The Act violates the Constitution’s “Takings Clause” by permitting existing liens to be primed without providing just compensation to existing lienholders;
- The Act violates the Constitution’s “Contracts Clause” by, among other things, authorizing the non-consensual restructuring of debt; and
- The Act violates the Constitution’s “Supremacy Clause” because its automatic stay provisions purportedly enjoin actions pending in Federal courts.
We are unaware of any other non-federal legislation in the United States that purports to empower public corporations and non-federal courts with such wide-ranging powers to adjust contractual relations and creditor claims. As such, substantial challenges to the Act are not only likely, but, in our view, inevitable.
For the moment, however, the lawsuit against the Act faces a substantial hurdle. Because neither PREPA nor any other eligible public corporation has actually sought to restructure under the Act, the plaintiffs may be unable to show the existence of any true “case or controversy,” which is a prerequisite for a court to hear the lawsuit. As a result, this particular lawsuit challenging the Act may be subject to dismissal as an impermissible request for an advisory opinion. Nevertheless, the lawsuit provides a useful first impression for what lies in store if, and when, a Puerto Rico public corporation does seek to restructure its debts under the Act. Future lawsuits may involve actions seeking to enjoin enforcement of the Act, either in a commonwealth court or a federal district court, pending a determination of the constitutionality and validity of its provisions.