By LEN WEISER-VARON and BILL KANNEL

 

A draft of the U.S. Treasury’s proposed debt restructuring legislation began circulating earlier today.  The draft legislation would give Puerto Rico, as well as other U.S. territories, and their municipalities access to U.S. bankruptcy court under a new chapter of the U.S. Bankruptcy Code (so-called “Super Chapter 9”) as well as making Puerto Rico’s instrumentalities (but not Puerto Rico itself) potentially eligible to file for bankruptcy under existing Chapter 9. The prospects for bipartisan cooperation on some form of such legislation appear somewhat more promising than those for the confirmation of a new Supreme Court justice, but whether this trial balloon will fly remains uncertain.

Some initial observations:

  • The legislation would provide access to bankruptcy to Puerto Rico and other U.S. territories (Guam, American Samoa, Northern Mariana Islands and U.S. Virgin Islands) and their municipalities.
  • The availability of bankruptcy to a territory and/or any “municipality” (i.e. political subdivision, public agency, instrumentality or public corporation of a territory) would be conditioned on the establishment of a Fiscal Reform Assistance Council (Council) at the request of the applicable territory’s Governor.  The Council would consist of 5 members appointed by the President of the United States and would have to approve any such bankruptcy filing.  The Council would have a variety of oversight powers including budget and debt issuance approval powers.
  • The legislation preserves the concept of “special revenue” bonds that benefit from more protective provisions under Chapter 9, such as the continued application of a lien on special revenues to such revenues arising after the filing of the bankruptcy petition, and the inapplicability of the bankruptcy stay to the application of special revenues to payment of debt service on special revenue bonds.  However, the definition of “special revenues” is narrower under the draft legislation than it is under Chapter 9.  As under Chapter 9, “special revenues” include “receipts derived from the ownership, operation, or disposition of projects or systems of the debtor that are primarily used or intended to be used primarily to provide transportation, utility, or other services, including the proceeds of borrowings to finance the projects or systems.”  However, for Puerto Rico and other territories, the draft legislation would not include as “special revenues” “special excise taxes imposed on particular activities or transactions,”  “incremental tax receipts from the benefited area in the case of tax-increment financing,” “other revenues or receipts derived from particular functions of the debtor, whether or not the debtor has other functions” or “taxes specifically levied to finance one or more projects or systems, excluding receipts from general property, sales, or income taxes (other than tax-increment financing) levied to finance the general purposes of the debtor.”  Accordingly, debtors that under the legislation could file under either Chapter 9 or this new chapter would have an incentive to file under this new chapter if their revenues would constitute “special revenues” under Chapter 9 but not under the new chapter.
  • The legislation creates a one-year stay (from the date of establishment of a Council) on (i) the commencement or continuation of any action or proceeding that seeks to enforce a claim against the territory and (ii) the enforcement of a lien on “or arising out of” taxes or assessments owed the territory.  Note that the stay becomes effective without regard to whether a bankruptcy petition is filed.
  • A territory may be a debtor upon the establishment of a Council and approval of the filing by the Council.  A municipality of a territory must, in addition, be specifically authorized by territory law to be a debtor.
  • In contrast to Chapter 9, a debtor need not be insolvent in order to be eligible to file for bankruptcy under the proposed new chapter.
  • A territory and its municipalities may file bankruptcy petitions and plans of adjustment jointly.
  • If the debtor is a territory, the presiding judge in the bankruptcy is appointed by the Chief Justice of the U.S. Supreme Court.  If the debtor is a municipality filing separately from a territory, the presiding judge is appointed by the chief judge of the applicable federal circuit court of appeals (the 1st Circuit, in the case of Puerto Rico).
  • Among the various conditions for confirmation of a plan, noteworthy conditions include that “the plan does not unduly impair the claims of any class of pensioners.”  The draft legislation does not define what is meant by “unduly.”
  • The legislation provides a limited degree of protection for Puerto Rico’s general obligation bonds, including as a plan approval condition that “if feasible, the plan does not unduly impair” the claims of holders of the territory’s general obligation bonds that are “identified in applicable nonbankruptcy law as having a first claim on available territory resources.”   Notably, this protection is provided “if feasible” whereas there is no feasibility requirement on the protection of pensioner claims.  Again, the protection of general obligation bonds, “if feasible” is against being “unduly” impaired, without clarity as to what constitutes undue impairment.  Oddly, the implication is that general obligation bonds can be “unduly impaired” if it is not feasible to “duly” impair them.
  • The draft legislation makes many but not all of the general provisions of the Bankruptcy Code, many but not all of the provisions of Chapter 9, and some of the provisions of Chapter 11, particularly those relating to plan confirmation,  applicable to a bankruptcy involving a territory or a territorial municipality.

By LEN WEISER-VARON and BILL KANNEL

As reported by the Wall Street Journal today and by other sources, the authorizing legislation for Puerto Rico’s much anticipated $3.5 billion non investment grade general obligation issue has become hung up in Puerto Rico’s Senate over language included in the bill passed by the territory’s House of Representatives that would authorize Puerto Rico’s Treasury secretary to agree that disputes over such bonds would be governed by the laws of, and could be brought in, a jurisdiction other than Puerto Rico. New York is the jurisdiction and law bondholders are presumed to prefer.

There are three possible outcomes.  If the legislation is enacted in the House form and the Treasury secretary so agrees, Puerto Rico could eliminate any doubt over the ability of bondholders to litigate disputes over the new general obligation bonds in New York federal or state court.  If the legislation as enacted is stripped of the House language, there may be no choice of law or forum provision in the documentation governing the general obligation bonds, in which case, as we have previously discussed, it would remain open to bondholders to bring suit in New York state court (or for injunctive relief in New York federal court), although Puerto Rico could seek to contest New York’s jurisdiction.  If the legislature or the Treasury secretary insist on affirmative language in the general obligation bond documentation requiring suit on the bonds to be brought in Puerto Rico, bondholders, if they accepted such terms, would be bound to litigate in Puerto Rico.

Today’s Wall Street Journal article asserts that “the vast majority of Puerto Rico’s existing bonds are subject to the island’s local law and jurisdiction.”  We believe that may overstate the case as to the jurisdiction element.  A sample of offering documents for Puerto Rico’s outstanding general obligation bonds contains no mention of a Puerto Rico jurisdiction requirement, and the bond resolution for COFINA bonds, while specifying that Puerto Rico law governs, does not reference Puerto Rico jurisdiction.  Although express agreement on New York jurisdiction would be preferable from the perspective of bondholders, it is not a given that silence on the topic in the documentation for the upcoming general obligation bonds would concede exclusive Puerto Rico jurisdiction.