The Puerto Rico Oversight, Management, and Economic Stability Act, Pub. Law 114-187 (“PROMESA” or the “Act”), was enacted into law on June 30, 2016. The Senate had passed PROMESA on June 29, 2016, and President Obama signed the Act into law on June 30, 2016, one day before the Commonwealth of Puerto Rico was expected to, and did, default on substantial payment obligations.
PROMESA Overview
Background
Before PROMESA was enacted, Puerto Rico had passed the Puerto Rico Corporation Debt Enforcement and Recovery Act (the “PR Recovery Act”) in 2014.1 The PR Recovery Act would have enabled certain of Puerto Rico’s instrumentalities to adopt a recovery or restructuring plan for their debt. However, in Puerto Rico v. Franklin Cal. Tax-Free Trust, et al., 136 S. Ct. 1938 (2016), the United States Supreme Court held that the PR Recovery Act was invalid because it was preempted by the United States Bankruptcy Code, 11 U.S.C. §§ 101 et seq., as amended (the “Bankruptcy Code”). In sum, the Supreme Court found that the Bankruptcy Code applies to Puerto Rico by including the territory within the definition of a “State” (except in the case of Puerto Rico for purposes of determining whether a State’s municipalities may be debtors thereunder). The Court then concluded that the PR Recovery Act was preempted by a provision of the Bankruptcy Code prohibiting States from enacting their own bankruptcy legislation.
PROMESA
Unlike the PR Recovery Act, PROMESA is a federal legislative enactment. The Act is very extensive and the first of its kind in many respects. PROMESA includes a variety of provisions applicable to Puerto Rico, its instrumentalities and their liabilities and operations. The following is a summary of PROMESA, which is intended as a broad overview of primary provisions of PROMESA.
Automatic Stay: Upon the enactment of the Act, a temporary stay or statutory injunction went into effect under Title IV thereof which stays, among other things, all actions and litigation against Puerto Rico and its instrumentalities to collect or enforce liabilities or claims and actions to possess or control their property. The stay under the Act has certain very limited exceptions, but generally speaking all enforcement actions against Puerto Rico and its instrumentalities, or other actions to control their property, are stayed through the temporary stay period. As provided in the Act, the stay will continue in effect until February 15, 2017 unless it is temporarily extended by the Oversight Board for 75 days or by a federal district court for 60 days. The Act’s temporary stay goes into effect regardless of whether Puerto Rico or an instrumentality is subject to the Act’s debt restructuring provisions discussed below. However, if Puerto Rico or an instrumentality becomes subject to the Act’s debt restructuring provisions, then such restructuring provisions will impose an automatic stay during the restructuring proceedings which is substantially similar to the automatic stay under the Bankruptcy Code. PROMESA specifies that actions taken in violation of the temporary stay are void. Relief from the temporary stay may be granted “for cause,” but cause is not defined. The temporary stay is designed to enable Puerto Rico and its instrumentalities to, among other things, assess their respective finances and negotiate potential resolutions with creditors.
The temporary stay under Title IV does not have any exceptions to such stay for pledged “special revenues” or any “safe harbors” to terminate and liquidate financial contracts such as repurchase agreements, swaps or securities contracts. The terms of the temporary stay also preclude parties from exercising remedies, or terminating or modifying contracts, during the term of such stay if the event giving rise to the remedy is nonpayment of principal or interest or the debtor’s financial condition or insolvency, notwithstanding what is provided for in the related agreement. The stay also precludes enforcement of defaults under separate contracts, such as defaults under repurchase agreements, guaranteed investment contracts or similar agreements with bond trustees, that would otherwise occur based on the financial condition or insolvency of Puerto Rico or an instrumentality. Thus, bonds issued by Puerto Rico or its instrumentalities that are secured by special revenues are stayed during this period and parties to financial contracts such as repurchase agreements, swaps or securities contracts (whether with Puerto Rico or an instrumentality as a party, or which would be triggered by the financial condition of Puerto Rico or an instrumentality) are precluded from terminating and liquidating such contracts during this stay.
The Act permits Puerto Rico and its instrumentalities to voluntarily pay liabilities during the period of the temporary stay. Thus, Puerto Rico and its instrumentalities can elect to, but are not required to, make payments on debts or other obligations during the stay period.
Oversight Board: The Act establishes a seven-member Oversight Board, the members of which will be designated by Congress and the President. The Oversight Board is provided with broad authority over Puerto Rico and instrumentalities of Puerto Rico which the Oversight Board designates as “covered” instrumentalities.
The Oversight Board is generally an autonomous body that has broad authority and discretion over Puerto Rico, including the ability to place Puerto Rico itself and a “covered” instrumentality into a debt restructuring proceeding established under the Act, require and approve a fiscal plan, require and approve a budget, oversee operations and implement changes that are necessary to comply with an approved fiscal plan or budget, approve the issuance of debt, hold hearings and issue subpoenas in furtherance of its functions, enter into its own contracts, analyze a territory’s pensions and pension liability, approve voluntary settlements with creditors, and become a direct party in litigation against Puerto Rico or an instrumentality. The Oversight Board is, in effect, considered a division of the territory and can hire officers, professionals and legal counsel.
Certain governmental entities in Puerto Rico may be organized as an instrumentality of Puerto Rico, while other entities may be organized as an instrumentality of an instrumentality. For example, certain governmental entities may not be organized as a direct instrumentality of Puerto Rico, but instead as an instrumentality of the Government Development Bank for Puerto Rico. The definition of “territorial instrumentality” in PROMESA provides that such definition includes an instrumentality “of a territory.” While not addressed in the express language of PROMESA, it would appear that an instrumentality of an instrumentality, such as an entity organized by the Government Development Bank for Puerto Rico, could also constitute a “territorial instrumentality” under the Act. The definition of “territorial instrumentality” specifies that it is to be construed broadly. In addition, by analogy, the definition of “municipality” in the Bankruptcy Code is similarly defined as an instrumentality “of a State.” However, courts have held, and commentators have noted, that a municipality under the Bankruptcy Code includes not only an instrumentality of a State, but also an instrumentality of an instrumentality of a State.
Fiscal Plans and Budgets: A critical component of PROMESA is the requirement of Puerto Rico and covered instrumentalities to develop and maintain a fiscal plan. A fiscal plan for the territory, or any instrumentality designated by the Oversight Board, generally must contain numerous provisions governing the operation of the territory or instrumentality, as the case may be, including plans to pay debts, eliminate deficits, maintain essential public services and impose internal controls for fiscal governance and accountability. Each fiscal plan is also required to set forth methods for the territory or instrumentality to access the capital markets. The fiscal plan must be developed by the governor, with oversight by the Oversight Board, and submitted to the Oversight Board for approval (the Oversight Board can submit its own fiscal plan if the governor’s fiscal plan is not acceptable in the sole discretion of the Oversight Board). A fiscal plan is also required to comply with Puerto Rico law and to maintain valid liens.
The Act further specifies that no budget can be submitted by the territory’s governor to its legislature unless the Oversight Board has approved a fiscal plan and the budget is consistent with the fiscal plan (and, similar to fiscal plans, the Oversight Board can submit its own budget if the governor’s budget is not acceptable in the sole discretion of the Oversight Board). As noted above, the Oversight Board has authority to monitor and impose changes in operations to require compliance with a fiscal plan and a budget.
Debt Adjustment: Title III of the Act creates its own provisions under which Puerto Rico itself or an instrumentality selected by the Oversight Board can file a case to reorganize its debts in a plan of adjustment. The Act incorporates by reference numerous provisions of the Bankruptcy Code, including many from Chapter 9 (which governs bankruptcy proceedings of a municipality under the Bankruptcy Code). Based on the incorporation of numerous Bankruptcy Code provisions into PROMESA, a debt adjustment proceeding of Puerto Rico or a covered instrumentality under Title III of PROMESA would also include (like a reorganization proceeding of a municipal debtor under Chapter 9 of the Bankruptcy Code) (i) the imposition of an automatic stay, (ii) the ability of a debtor to generally govern its operations and engage in post-petition financing and (iii) the ability of the debtor to exercise avoidance powers.
Notably, the provisions from the Bankruptcy Code that are incorporated into PROMESA include, among other things, many definitions, Sections 902, 922 and 928, which generally govern pledged “special revenues” and their treatment in a Chapter 9 bankruptcy commenced by a municipality, and Section 926, which generally exempts a municipal debtor’s payments on its bonds or notes from constituting an avoidable preference. The special revenue provisions in Sections 902, 922 and 928 of the Bankruptcy Code would, in the Bankruptcy Code context, specify that special revenues pledged to secure a municipal debtor’s bonds can continue to be transferred in a manner consistent with the Bankruptcy Code notwithstanding the automatic stay.
In addition to incorporating the Bankruptcy Code’s Chapter 9 “special revenue” provisions, the Act also incorporates the Bankruptcy Code’s “safe harbors” for certain financial contracts to which the municipal debtor is a party. The safe harbors for specified financial contracts would, generally speaking, permit the exercise of a contractual right to terminate and liquidate the contract based on the debt adjustment proceeding, notwithstanding the automatic stay.
The criteria under PROMESA for Puerto Rico or an instrumentality to be eligible to file a debt restructuring proceeding include approval by the Oversight Board and the desire of such entity to effect a plan of adjustment. The Oversight Board, in approving the filing, must certify, among other things, that the entity has engaged in good-faith efforts to enter into voluntary agreements to restructure its debts, has an approved fiscal plan and has no “qualifying modification” of its bond debt (as addressed further below based on the collective creditor action provisions of PROMESA). However, unlike the eligibility criteria for municipal debtors under the Bankruptcy Code, PROMESA does not require that an entity seeking to file a debt adjustment proceeding be insolvent.
The Bankruptcy Code provisions for a federal court to confirm a Chapter 9 plan of adjustment are also generally incorporated into PROMESA, including that the plan be in the best interest of creditors (which is generally viewed in the Bankruptcy Code context as treating creditors at least as, or better than, they would be treated under non-bankruptcy alternatives to a debt restructuring proceeding). In addition to the Bankruptcy Code confirmation standards, however, PROMESA also requires that a plan of adjustment be consistent with PROMESA and the debtor’s fiscal plan.
The Oversight Board would continue to govern the territory or covered instrumentality during the debt restructuring proceeding and is the only entity with the authority to submit a plan of adjustment. The reorganization proceeding would be commenced in federal district court in Puerto Rico, and such court would oversee the proceeding under PROMESA. The plan of adjustment would be submitted by the Oversight Board to such court for confirmation. The Act permits a jointly administered reorganization proceeding and a joint plan of adjustment to address various affiliates (although affiliates are not substantively consolidated). The Federal Rules of Bankruptcy Procedure would also apply in a debt adjustment proceeding under the Act.
Collective Creditor Action to Modify Bond Terms: The collective creditor action provisions of Title VI of PROMESA are, generally speaking, a method to effectuate an overall bond restructuring of Puerto Rico or an instrumentality as a general alternative to the debt adjustment provisions under Title III discussed above. PROMESA includes, in Title VI thereof, provisions to permit the terms of bond obligations to be modified based on the collective action of applicable bondholders, but without 100% consent of all affected bondholders. Modifications to a bond financing can be proposed by the bond issuer (Puerto Rico, or an instrumentality) or by bondholders.
Generally speaking, if modifications to bond financings of an issuer are considered, the Oversight Board, in consultation with the bond issuer, will separate similar bond claims into separate pools. Title VI of the Act provides that bonds issued by Puerto Rico or an instrumentality can be modified and become a “qualified modification” binding on all bondholders in the applicable pool of bondholders if (i) holders of at least two-thirds of the pool’s principal amount who actually vote, and holders of at least 50% of the total principal amount outstanding in such pool vote, to approve the modification and (ii) the modification is approved by the Oversight Board. If less than 100% of the related pool of bond obligations does not approve the proposed modification, the modification will not become effective and binding on such holders until a federal district court has approved the modification. The collective creditor action provisions appear designed to permit resolution of all bond obligations of Puerto Rico or an instrumentality as bond issuer based generally on negotiated and voluntary agreements with a requisite percentage of bond claims in all related pools.
These provisions, which permit modification of bond terms without 100% holder consent, do not appear to have precedent in municipal bond law. These provisions also operate outside of traditional confirmation standards for a plan of adjustment (such as the “best interest of creditors” test), which could otherwise provide some protection to minority bondholders. Although these provisions appear designed to provide for a resolution of bond claims generally against a particular issuer, it is unclear how such provisions would be applied, especially if presented to a court for approval.
Additional Provisions: The Act addresses several other economic initiatives, including (i) infrastructure revitalization, (ii) appointment of a revitalization coordinator under the authority of the Oversight Board and (iii) provisions permitting Puerto Rico to temporarily lower the minimum wage of younger workers.
Other Territories
Territories of the United States, other than Puerto Rico and its instrumentalities, are not currently covered by PROMESA. An early draft of PROMESA as considered by the House proposed to include the U.S. Virgin Islands, Guam, American Samoa and the Commonwealth of the Northern Mariana Islands (along with their respective instrumentalities) by enabling such territories to elect to become subject to the Act.2 However, before PROMESA was enacted, the draft legislation was amended to effectively remove the other territories.3 Thus, as amended and enacted, PROMESA specifies in Section 101 thereof that an Oversight Board is appointed only for Puerto Rico and its covered instrumentalities. The House Report addressing the amendment specified that the amendment “[d]eletes the opt-in option for other territories.”4
The PROMESA draft was also amended at the same time to include, in effect, a savings clause for PROMESA which provides that other territories will be considered covered territories under PROMESA only in the event a court were to hold a provision of PROMESA invalid on the ground that PROMESA fails to treat territories uniformly. This provision, added as subsection (b) to Section 3, provides as follows:
(b) UNIFORMITY.—If a court holds invalid any provision of this Act or the application thereof on the ground that the provision fails to treat similarly situated territories uniformly, then the court shall, in granting a remedy, order that the provision of this Act or the application thereof be extended to any other similarly situated territory, provided that the legislature of that territory adopts a resolution signed by the territory’s governor requesting the establishment and organization of a Financial Oversight and Management Board pursuant to section 101.
Thus, absent such a court holding (or a future amendment of PROMESA), other territories are not covered by PROMESA.5
Conclusion
As described above, PROMESA is new and unique legislation. PROMESA also was enacted only very recently and has not yet been applied or been the subject of any court or similar proceeding which could provide guidance on the interpretation and application of PROMESA.6 Further developments under PROMESA will determine the manner in which it will be interpreted and applied by Puerto Rico, the Oversight Board, covered instrumentalities or a court.
Moreover, although the Act effectively incorporates much of Chapter 9 of the Bankruptcy Code, PROMESA is more than a Chapter 9 for Puerto Rico. Unlike the Bankruptcy Code, PROMESA is not solely a “stand-alone” debt adjustment enactment. Instead, the terms of PROMESA include many other provisions, including provisions concerning the Oversight Board and its authority. Based in part on PROMESA’s provisions appointing an Oversight Board over Puerto Rico, its covered instrumentalities and their finances, PROMESA has been described as having “significant changes from Chapter 9,” which include “a non-political oversight board.”7 In addition, in explaining the various provisions of PROMESA, a memorandum released by the House Committee on Natural Resources stated: “Claims that PROMESA is ‘Chapter 9’ for Puerto Rico are misleading and false” because “[u]nder PROMESA, the Oversight Board will ensure Puerto Rico remedies its finances.” PROMESA is thus not solely for the purpose of adjusting or reorganizing the debts of Puerto Rico or covered instrumentalities, but has broader purposes.8 Accordingly, PROMESA’s debt adjustment provisions may not be applied solely based on the Bankruptcy Code and its case law, particularly where an approved fiscal plan or the Oversight Board’s powers and rights are involved.
In addition, it remains uncertain, under PROMESA or otherwise, what actions a court may take if funds of Puerto Rico or an instrumentality are required to pay such things as critical expenses, police, fire or other public safety and health expenses, or similar costs. PROMESA contains provisions, similar to the Bankruptcy Code, restricting a court’s ability to interfere with the operations of Puerto Rico or a covered instrumentality.
Additional Information
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1 See 2014 Laws P. R. p. 371.
2 H.R. 5278.
3 H.R. Amend. No. 1156 to H.R. 5278.
4 H.R. Report No. 114-610, 114th Cong., 2d Sess. 3 (2016).
5 The other U.S. territories may also be precluded from adopting their own restructuring legislation similar to the PR Recovery Act. Unlike Puerto Rico, other territories are not included within the definition of “State” under the Bankruptcy Code. Thus, it is possible that another territory could argue that the Commonwealth of Puerto Rico v. Franklin case, discussed above, is distinguishable in connection with territorial bankruptcy legislation enacted by another territory. Such territory could assert that the Bankruptcy Code does not apply to such territory and thus does not preempt bankruptcy legislation of the territory. However, any such argument would also presumably need to establish that any territory bankruptcy legislation is not preempted by PROMESA. It would appear that the holding of the Commonwealth of Puerto Rico v. Franklin case, the passage of PROMESA addressing debt restructuring of a U.S. territory, and Congress’ power over territories would present significant hurdles to any territorial bankruptcy legislation enacted by another territory.
6 There has been one decision under PROMESA thus far, which addressed only the scope of the initial stay under the Act. See Brigade Leveraged Capital Structures Fund Ltd. v. Garcia-Padilla, 2016 WL 4435660 (D. P.R. Aug. 22, 2016) (holding that the stay under PROMESA stays the pre-existing litigation at issue against Puerto Rico).
7 Written Testimony of S. Kirpalani to H.R. Committee on Natural Resources Apr. 13, 2016 at 6.8 Section 3(a) of PROMESA also expressly states that the Titles of PROMESA involving the Oversight Board (Titles I and II) are not severable from, and are thus equally effective with, the Title of PROMESA on debt adjustment (Title III).