On March 17, 2014, Mr. Leonard Weiser-Varon and Mr. William Kannel of Mintz Levin published an entry in his blog titled “Legislative Balloon for Puerto Rico Public Corporation Insolvency Attracts Bondholder Attention”. Although I agree with much of what is said there, a few issues need clarification.
Puerto Rico defaulting on its bond obligations is not an if, but rather a when. The island’s economy has not grown since 2006, with the exception of one quarter of .1% in 2012, clearly a case of depression rather than recession. The idea of Puerto Rico’s default has been discussed all over the bond and business media and there seems to be a general agreement that it will happen in the next three years. Hence, a orderly process for the reorganization of Puerto Rico’s public corporations and even municipalities is a must.
Felix Salmon recently stated that “[t]he default will be messy, however, since there is no chapter of the US bankruptcy code that encompasses Puerto Rico. A lot of different court cases will be held in a passel of different jurisdictions, and a lot of lawyers will get rich. In the end, everybody is going to have to take a nasty hit—including the island’s retirees, whose pension funds are woefully underfunded.” (footnote omitted). Given this scenario, it is in bondholders interest to have the administration of this impending default in the hands of one court with a clear statute to guide it. Moreover, Puerto Rico’s public corporations owe over $25 billion and municipalities, not yet included in the statute, owe $3.88 billion more. See, GBD presentation to investors of October 15, 2013, at page 56. It must also be remembered that the Puerto Rico Electric Power Authority, according to its financial statements of 2013, has $791,385,000 more in liabilities than in assets. See page 8. See also my blog entry.
The entry mentions Governor Garcia Padilla’s opposition to the proposed measure but this must be taken with boulders of salt. As it is very common, he speaks with one side of his mouth to the voters in Puerto Rico and from another to investors. His only comments in the local press were that he had not participated in its writing and that no specific plans for restructuring of corporations had been adopted. In addition, given that the next administration, coming in on January 2, 2017, will have to assume the bulk of payment of the new $3.5 billion bond emission, the measure could very well garner minority vote to override any veto by the Governor.
The entry continues with a general questioning of Puerto Rico’s power to enact a liquidation or reorganization law. Although the power to enact bankruptcy laws was delegated to Congress via the U.S. Constitution, it is nevertheless a fact that for a large part of our history it was not used. The first bankruptcy law was enacted by Congress in 1800 to 1803 when it was repealed. Later it was enacted twice and repealed twice but in 1898 it was here to stay, with several amendments and a complete overhaul in 1978. In the interim, several state laws were enacted to fill the void.
In this framework and considering that Puerto Rico’s public corporations and municipalities are explicitly excluded from Chapter 9 of the Bankruptcy Code, 11 U.S.C. § 101 (52), Puerto Rico can legislate since there is no preemption. With a doubt, however, any filing of a Puerto Rico public corporation or municipality pursuant to this law would trigger litigation but it would not take several years to resolve. Let us imagine that PREPA filed for protection of this new reorganization law. What would be the bondholder’s reaction? Rush to Federal Court to question the laws constitutionality? Very likely, but then they would be faced with several abstention doctrines, to wit, Railroad Commission v. Pullman Co., 312 U.S. 496 (1941); Burford v. Sun Oil Co., 319 U.S. 315 (1943) or Louisiana Power & Light Co. v. City of Thibodaux, 360 U.S. 25 (1959). Pullman requires the federal court to abstain when there are federal and state constitutional questions and send the case back to state court to litigate them. Unless plaintiff makes a specific reservation of federal rights via England v. Louisiana State Board of Medical Examiners, 375 U.S. 411 (1964), all claims will be litigated in state court and will be res judicata in federal court, see, Duty Free Shop Inc. v. Administración de Terrenos, 889 F.2d 1181 (1st Cir.1989). If there is such a reservation via Pullman, the plaintiff may return to federal court. Burford and Thibodaux are a bit more complicated for they involve undecided questions of state law of great public policy import. Case law is not clear if an England type reservation of rights would be possible pursuant to these abstention doctrines, see, Front Royal and Warren County Industrial Park Corporation v. Town of Front Royal, Virginia, 135 F.3d 275 (4th Cir. 1998) and Fields v. Sarasota Manatee Airport Auth., 953 F.2d 1299 (11th Cir.1992). Hence, the cases would be sent back to Puerto Rico’s courts.
Moreover, even if bondholders made a reservation of rights, the issues would be quickly decided. The Puerto Rico Supreme Court has very actively exercised its discretion to certify issues in the Courts of First Instance for quick decision. This was done in 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) Both Trinidad and Domínguez Castro were decided in a year or less on issues of the constitutionality of altering contractual obligations.
This brings us to the issue of the alteration of contractual obligations pursuant to the U.S., rather than Puerto Rico’s constitution. Federal courts, however, have been accommodating of a government’s efforts to alter its obligations. It is allowed as long as evidence of crisis and failure of other efforts is discussed in the legislation. This was affirmed by the First Circuit in the firing of over 12,000 employees due to the 2009 financial crisis, see, United Auto., Aerospace, Agr. Implement Workers of America Intern. Union v. Fortuño, 633 F.3d 37 (1st Cir. 2011). As evidenced by the dates in these cases, these controversies were decided in less than two years at the state Supreme Court level and the Circuit Court of Appeals level. Given the strictures of the U.S. Supreme Court’s certiorari practice, it is unlikely it would be granted. Also, irrespective of which court decides the case or when, the fact remains that once the reorganization filing occurs, bondholders will cease to be paid.
The entry also points out, quite correctly, that the law as it is now, does not provide for a cram down of a plan. However, the Senators who wrote the act knew that it was incomplete and were expecting input from several sources, including my own. Mr. Weiser-Varon and Mr. Kannel’s insight will undoubtedly be examined and adopted by the Puerto Rico legislature.