Puerto Rico’s Local Chapter 9, a Good Start

PR’s Local Chapter 9

Yesterday, Senators Nadal Power and Rosa Rodríguez filed a proposed act by which PR’s public corporations could reorganize its debts or even liquidate themselves. Essentially a local Bankruptcy Chapter 9. Both should be congratulated for having the moral fortitude to admit this must be considered. The preamble correctly indicates that state law may regulate those areas where Federal Bankruptcy law is silent or those entities excluded from the Bankruptcy Code, such as insurance companies or Puerto Rico’s municipalities and public corporations, expressly excluded via 11 U.S.C. § 101 (52). Moreover, the liquidation procedure of the P.R. Civil Code, Articles 1811-29, 31 L.P.R.A.  §§ 5171-5214 is totally obsolete since it dates back to the 19th Century.  In addition, the Preamble to this Act states that it is obsolete, making this a special law that preempts the more general law of the Civil Code.

The piece is a good start but lacks many of the necessary statutes that makes the Federal Bankruptcy Code a unique tool. Moreover, it should include the island’s municipalities, most of which are insolvent. In addition, it would make some sense for the law to require that some of the Commonwealth Courts be set for this type of procedure which will elicit massive litigation once it is started. Also, its judges should be especially trained in bankruptcy and dispute resolution since at this time the Puerto Rico bench is devoid of such knowledge. Now I will go to the specific areas that need to be added to the law. For your reference, I include English and Spanish versions but the statute states that the English version will prevail in case of doubt.

The law lacks a definitions section. The Bankruptcy Code has a long definitions section with more than fifty entries, see 11 U.S.C. § 101. For example, the proposed law does not define what is a public corporation, something which may cause further litigation and delay. The law should clearly define what entities are covered by the law.

Although the law specifies that the Court may grant a stay (Article 8(c)) it does not state the parameters pursuant to which it may be granted or even who can grant it. I believe there should be an automatic stay as in the Bankruptcy Code. Moreover, the law does not state who or even if, this stay, once granted, may be lifted. Anyone who litigates in Bankruptcy Court knows that a significant amount of the court’s time is consumed by this issue. Hence, it should be automatic on filing the petition and later any party in interest  could petition the court to do so under clear guidelines which should be in the law.

Article 2 of the law provides a procedure by which the Board of Directors or whomever has control over the corporation may make a declaration “declaring themselves eligible under this Act, subject to the process spelled out in Article 1. If the Governor so authorizes it, said resolution will be filed in the Court of First Instance (Superior Court).” Article 4 states that “[t}he resolution declaring eligibility under Article 2 shall state:

(1) the reasons why the public corporation is eligible under this Act and whether it is caused or not by lack of liquidity;

(2) recommendations as to the interim management of the public corporation;

(3) recommendations as to a plan for restoring solvency if possible, and complying with existing obligations and liquidation if necessary.

The information that is required by this section is de minimis. It should be that information required by the Bankruptcy Rules and Schedules D-H of the official forms. These include information of bank accounts, creditors, the corporate debtors, objections to creditors claims etc. Moreover, there is no procedure to object to the filing of the procedure, either voluntary or involuntary. Article 3 mentions that in an involuntary case there must be a public hearing; does that mean a hearing in Court or another type of hearing? When will the Schedules be filed in an involuntary proceeding? Not clear at all. In addition, in a Chapter 9, debtor is required to claim he has negotiated in good faith with his creditors to prevent the filing. Given the importance of some of the public corporations, this should be included in this Act.

There is no procedure in the law for the filing of proof of claim or what it must contain. The proof of claim is the means by which a creditor establishes his claim in a Bankruptcy Proceeding. Why is it important? Because it is vital for an orderly reorganization to know who is a creditor and how much is he owed. Moreover, it is not uncommon for debtors to forget a creditor who will then have to rush to file a motion explaining his claim. The procedure should be spelled out completely. Moreover, what is the effect of the filing of a proof of claim or the cut-off date to file it or to object to the claim.  In the Bankruptcy Code, the filing of the proof of claim is prima facie evidence of a claim’s validity. See Fed.R.Bankr.P. 3001(f). “Under this rule, a claim is presumed valid until an objecting party has introduced evidence sufficient to rebut the claimant’s prima facie case.” In re Inter-Island Vessel Co., 98 B.R. 606, 608 (Bankr.D.Mass.1988). A proof of claim will prevail over a mere formal objection. See, e.g., Juniper Dev. Group v. Kahn (In re Hemingway Transp., Inc.) 993 F.2d 915, 925 (1st Cir. 1993) (“The interposition of an objection does not deprive the proof of claim of presumptive validity unless the objection is supported by substantial evidence.”).

A very important issue is attorney compensation. Since public corporations are not natural personas pursuant to PR law, they must act through and of attorneys before its courts. Attorneys are usually retained and paid by debtor BEFORE the filing of any bankruptcy papers and employees and attorneys on retainer could not represent the public corporation since there is an inherent conflict of interest since they may be creditors at a later date. Bankruptcy law requires that the compensation paid to the attorneys BEFORE the filing be disclosed. Moreover, attorneys and other professionals, indispensable to the reorganization effort have to have Court approval for their hiring and compensation. Provisions for the hiring and compensation of attorneys must be spelled out by the Act. In addition, the Act must specify how the public corporations are to make payments in the ordinary course of business and to whom. Also, there is no provision on how or if new credit can be secured, which is a necessary addition to the Act.

Once the resolution is filed, Article 7 of the Act states that “[t]he public corporation that has been declared eligible under this Act shall, while the proceedings go on, be administered by a Board of Receivers composed of 5 members. The Governor shall name 2 of the members with the advice and consent of the Senate, and the Court shall name 3. The Court shall establish the powers and duties and supervise the Board of Receivers and shall have the power to issue orders as necessary to execute its role.” Chapter 9 of the Bankruptcy Code, and Chapter 11, provide for the debtor to remain in possession administering the entity due to its large size and complexity This should be considered here and a procedure to remove them when necessary. Moreover, the Federal Bankruptcy system has the U.S. Trustees’ Office  responsible for overseeing the administration of bankruptcy cases and private trustees under 28 U.S.C. §586 and 11 U.S.C. §101, et seq. Its powers are clearly established by law. The PR Courts lack the knowledge and experience to know what powers receivers may have and should be clearly spelled out in the law. Moreover, Trustees in Bankruptcy court, no matter how complicated the case, handle the case with their staff. There is no need to involve 5 persons, much less 2 named by the Governor, who will be professional politicians to try to save his behind in the crisis. Also, it would take time to have the Governor do it. In addition, what procedure should be used to contest the power and actions of the Receivers? The Act is silent.

Another area that has always brought litigation in the Bankruptcy Code is the avoidance power of the Trustee or here, receivers. For example, any payment done 90 days before the filing of the petition or 1 year when it involves insiders (family, lawyers, etc.) would be considered a voidable preference. Also, the Act is silent about the rejection of executory contracts (rentals and union contracts, for example). The Act only generally states that the Court may, under certain circumstances, impair contracts. Since the main reason for this Act is to deal with bond holders, the procedure should be spelled out completely.

The Act is totally silent as to creditors’ committees, a very common and necessary feature of Bankruptcy proceedings. Provisions to this effect should be added.

Although the Act mentions a plan, which obviously has to spell out the reorganization, there are no timetables for its filing or what its contents must have. This is a necessary amendment to the Act, as well as a more clearly defined timetable of things to do.

No plan can function without a clear understanding of the type of creditors involved in the procedure. In Bankruptcy proceedings some creditors will be secured, some with preferences, even none secured may have different debts maturing at different times and some that will be impaired by the plan and others that won’t. The Act needs to deal with this and determine the order of payment.

Now lets discuss procedural matters. The Bankruptcy Code has many sections, but there are Federal Rules of Bankruptcy Procedure and even Local Rules of the Bankruptcy Court that need to be taken into account for this Act. Will one judge be able to handle all cases of one particular public corporation which include labor, environmental, torts, debt collection, etc.? Moreover, what happens when the Court issues a determination on a certain small but important aspect of the case? Can it be reviewed by the Appellate Courts as an Appeal or will it be a certiorari? Can a certiorari even be considered for such a case? The Act is silent as to these important issues. Also, will this procedure be eligible for the Puerto Rico Rules of Complex Litigation, which has different rules than those of Civil Procedure? The Act should address this question.

In addition, what effect will this Act or the Court’s orders have on environmental or other administrative claims by local agencies (we know it won’t have any on Federal Agencies)? Can the Court impair them or reverse them? Also, the Act does not make it illegal to accelerate debt due to bankruptcy or to in any way impair debtor and it should be considered.

There are other areas where the law is silent. If there is a claim that is not liquidated, a tort damages claim not adjudicated, can the Court, in imitation of 11 U.S.C. § 502(c)(1) estimate the amount? After the case is commenced, will payments to Social Security, pensions and others continue? Under what circumstances? Will the Retirement Administration be eligible for this proceeding? What happens if a creditor is not notified and only learns of the proceeding after the plan has been approved? The Senators and their staff should carefully review the Bankruptcy Code and its Rules, especially 3000’s and 6000’s. Also, the Act provides for liquidation but does not provide any details of how to do it.

Finally, some jurisdictional issues not mentioned in the Preamble of the Act. The Act would not have the ample police power of the Federal Government to stay actions by Federal Agencies and it cannot enjoin federal courts. However, even in cases where the Federal Court has exercised its jurisdiction in a Constitutionally valid way, the case may still be sent state court via Burford v. Sun Oil Co., 319 U.S. 315 (1943) or Louisiana Power & Light Co. v. City of Thibodaux, 360 U.S. 25 (1959) type abstentions. In addition, the case in Federal Court could be dismissed for reasons of comity, see, Smith v. Bayer Corporation, 131 S.Ct. 2368  (2011).  Finally, since the idea is to hand a type of discharge to the public corporations of their debts, does PR have to power to impair obligations of those who are not its residents? Can PR give a discharge to debts owed by those who do not live here? In Stellwagen v. Clum, 245 U.S. 608-615 (1917) the Court stated that “[I]t is settled that a state may not pass an insolvency law which provides for a discharge of the debtor from his obligations, which shall have the effect of a bankruptcy discharge as to creditors in other states, and this although no general federal bankruptcy act is in effect.” The questions need clear answer. As I said in the beginning, this is a laudable effort, but much more is needed.



What are the legal consequences of Puerto Rico not paying bondholders? Can Puerto Rico be sued? In which Court? Who can sue? All these are important questions for investors and the general public after Standard & Poor’s and Moody’s downgrades, which include the latter’s actions on the COFINA backed bonds.  Here, I will try to predict the possible scenarios.

The most obvious is that PR, nor any state of the Union, can file for US Bankruptcy law protection for the Code does not provide fro them to do so. In addition, none of PR’s municipalities or public corporations may do so. Not only does PR law expressly allow it, but 11 U.S.C. § 101(52)  expressly excludes PR and Washington DC from Chapter 9 protection. Hence, the organized reorganization that Detroit is undergoing is not possible for PR.

Puerto Rico is not an independent country nor is it a state of the Union. It is a self-governing non-incorporated territory of the United States, see, Harris v. Rosario, 446 U.S. 651 (1980). But for purposes of the Eleventh Amendment, it is a state, see, Fresenius Medical Care Cardiovascular Resources, Inc. v. Puerto Rico and the Caribbean Cardiovascular Center Corp., 322 F.3d 56, 61 (1st Cir. 2003). This Amendment was incorporated on the heels of Chisom v. Georgia, 2 U.S. (2 Dall.) 419 (1793), which decided that a state of the Union could be sued in Federal Court, even if it could not in its own courts. Soon after, the Eleventh Amendment was enacted and approved. Hence, PR cannot be sued in Federal Court without its consent.

PR has given its consent to be sued in its own courts for breach of contract, see, Hato Rey Stationery, Inc., v. Commonwealth of Puerto Rico, 19 P.R. Offic. Trans. 153 (1987)  and Montalvo & Comas Electric Corp. v. Commonwealth of Puerto Rico, 7 Offic. Trans. 613 (1978). The inquiry, however, does not end there.

Although it is usually agreed that PR owes around $70 billion, not all of the debt is owed by the Commonwealth of Puerto Rico, the official name of the island’s government. According to slide 56 of The Commonwealth of Puerto Rico,  Update on Fiscal and Economic Progress, FY 2014 Q1 Investor Webcast – October 15, 2013 , has a general breakdown of who owes what. This brings several issues to bear. Public corporations such as the PR Electric Power Authority that generate their own income are subject to federal court jurisdiction and these owe around $25 billion. In addition, municipalities owe over $3 billion and are not protected by the 11th Amendment. Moreover, only $16.233 billion which is GO debt backed by the full faith and credit of PR are Constitutionally protected and are required to be paid before anything else, see, Article VI, sections 2 and 8 of Puerto Rico’s Constitution, available here in English.

Hence, the bond holder or the insurance company that subrogates on its insured’s rights, has to examine who is the issuer of the debt, what if any 11th Amendment protection it may have and then determine where to sue for collection of moneys.

This does not mean that bond holders or their agents or subrogees will collect from PR. The island may unilaterally change the conditions of the contract. The guarantee against the impairment of contracts provided by the Contract Clause of the US and Puertorrican Constitution have been greatly eroded in the past years. This can be seen in United Auto., Aerospace, Agr. Implement Workers of America Intern. Union v. Fortuño, 633 F.3d 37 (1st Cir. 2011); Trinidad v. ELA, 2013 TSPR 73 and Domínguez Castro et al. v. E.L.A. I, 178 D.P.R. 1 (2010), cert denied, Domínguez Castro v. Puerto Rico, 131 S. Ct. 152  (2010).  This means that it is very likely that a court could conclude that PR may put a temporary moratorium or even repudiate part of its debt or that of its political subdivisions. Such a step would be radical and I doubt if the present administration would even consider it, but it is there to consider.