On February 6th, Federal District Judge Francisco Besosa ruled that Puerto Rico’s municipal debt-restructuring law, the “Recovery Act”, was unconstitutional stating that: “The Recovery Act is pre-empted by the federal Bankruptcy Code and is therefore void.” The Court also permanently enjoined current and future government officials from enforcing the Act. Puerto Rico has announced that it will be appealing the ruling.
So where does this leave municipal debt restructuring in Puerto Rico? In the same place it was before the Court’s ruling, in the hands of Puerto Rico and its creditors. It is interesting to note that none of the public corporations covered by the Recovery Act sought to restructure its debt under the Act. Indeed, in at least once instance, a standstill agreement was negotiated and subsequently extended. Notably, with the Recovery Act rendered unenforceable and given that Puerto Rico municipalities are not permitted to access Chapter 9, there remains no available court supervised restructuring process.
The Recovery Act would have required the covered public corporations to work first with creditors to attempt to reach agreement before commencing formal court proceedings. And, that is what continues to take place. Puerto Rico and its creditors are negotiating and considering a variety of debt restructuring solutions—out-of-court.
Indeed, while everyone at the table might prefer more certainty as to what process will apply if acceptable resolutions cannot be negotiated, the lack of a clear pathway may provide an avenue for different and possibly higher quality restructuring opportunities. All the parties at the table share the same risk regarding what happens if agreement is not reached while Puerto Rico appeals the constitutionality of the Recovery Act.
It is likely that the U.S. Congress will consider proposed legislation that would amend the Bankruptcy Code to permit Puerto Rico’s governmental entities to access Chapter 9. This may lead the parties to appreciate in real time that their destiny, for now, is in their own hands given the lack of available formal legal options. Negotiating consensual agreements, where possible, likely is the best place to start lining up the colors on the Rubik’s Cube that is Puerto Rico’s restructuring. A Rubik’s Cube can be solved and so can Puerto Rico’s economic and financial challenges, particularly with a focus on growing the economy and improving the “top line.” To accomplish this, good faith negotiation and participation by everyone involved in a “transactional” approach to restructuring is necessary.
The parties now have an opportunity to focus on what agreements can be made while Puerto Rico’s appeal winds through the appellate process knowing that negotiations will not be interrupted by a judicial proceeding under the Recovery Act—at least until the appeal is decided. The silver lining is the table has been reset for the time being and everyone can reclaim their seat and move forward.
Puerto Rico has been consistent in stating that the proceedings under the Recovery Act were to be an “option of last resort.” Everyone involved in the process should take the “breather” the appellate process provides to negotiate. Negotiation is what would be required under Chapter 9 and under the Recovery Act. Everything and nothing has changed.