New Bill Entails Debt Reorganization Process for Puerto Rico Public Corporations

Senate Bill No. 1164, also known as the “Puerto Rico Public Corporation Debt Enforcement and Recovery Act” (hereinafter, the “Act”), was recently signed by the Governor of Puerto Rico.  The Act establishes a debt enforcement, recovery and restructuring system for eligible local public corporations that are experiencing financial insolvency.  It creates two debt relief solutions; a consensual debt relief process and a debt enforcement judicial process contemplated in Chapter 2 and Chapter 3 of the Act, respectively.  The Act will have a significant impact on both distressed eligible governmental entities and the creditors of such entities.

Because of the grave fiscal situation and the recent downgrades of Puerto Rico’s general obligation bonds, instrumentalities and public corporations have significantly reduced the public corporations’ ability to obtain interim financing through the Government Development Bank of Puerto Rico (GDB), private financial institutions, and/or capital markets in order to cover operational expenses.  According to the Act, the provisions of title 11 of the United States Code applicable to municipalities or corporations in state of insolvency (Chapter 9 and Chapter 11 proceedings) are inapplicable to the Commonwealth’s public corporations and there is no Commonwealth statute providing an orderly recovery regime for public corporations that may become insolvent.

The Act creates the Public Sector Debt Enforcement and Recovery Act Courtroom at the Court of First Instance of San Juan, a specialized court that will have exclusive competence and jurisdiction over all matters arising under or related to this Act.

Chapter 2 of the Act

Chapter 2 of the Act contemplates a consensual debt relief process, which provides a mechanism for eligible public corporations to adopt a recovery program with minor court intervention. This Chapter will enable such eligible entities to become financially self-sufficient, allocate equitably among all stakeholders the burdens of the recovery program and provide the same treatment to all creditors.  Chapter 2 was designed on the basis of case law that has determined that no impairment of contractual obligations exists when adopting a debt adjustment regime if the following characteristics are met: (i) the existence of a fiscal emergency that necessitates the enactment of this legislation, (ii) a supermajority vote of creditors in order to bind the minority and (iii) the creation of an impartial oversight boards to supervise compliance with the recovery program, (iv) ratable distributions and (v) court approval.

Chapter 3 of the Act

The debt enforcement process contemplated in Chapter 3 of the Act is a model similar to Chapter 9 and 11 of title 11 of the United States Code. This Chapter is a system to ensure the orderly payment of debt, to the extent of each eligible public corporation’s capacity to do so. Unlike Chapter 2, Chapter 3 addresses the debt problem of the Commonwealth’s eligible public corporations under a process overseen by a court. It enables each eligible public corporation to defer payment and to decrease interest and principal to the extent necessary to enable each entity to continue to fulfill its vital public functions.

One of the greatest concerns of the Supreme Court of the United States is the petitioner’s autonomy to establish the debt restructuring terms. In order to address this concern, Chapter 3 adopts even more stringent economic standards than Chapter 9 and Chapter 11 of the Bankruptcy Code. In order to be eligible for Chapter 3, a petitioner must be (i) currently unable or at serious risk of being unable to pay valid debts as they mature while performing its public functions without additional legislative or financial assistance, (ii) ineligible for relief under chapter 11 of title 11 of the United States Code and (iii) authorized to file a petition by its governing body and GDB or by GDB at the Governor’s request on behalf of the public corporation.

Objection by Creditors Already Raised in Federal Law Suit

Although the Act is the government’s initiative to ensure the continuity of essential services to the public in an attempt to stabilize the fiscal situation of the public corporations of Puerto Rico, it has already been met with stern opposition.

U.S. mutual funds holding billions of dollars in Puerto Rico debt have sued the Commonwealth, accusing it of passing a law modeled after the U.S. bankruptcy code that could undermine the rights of investors.  Under its constitution, Puerto Rico does not have the power to enact a bankruptcy law for the adjustment of its debts. The complaint contends Puerto Rico improperly passed an Act modeled after title 11 of the U.S. Bankruptcy code, which is used by U.S. corporations to reorganize.  It is expected that other creditors will follow suit and join in this lawsuit in the exercise of their legal rights.

The passage of the Act has adversely affected the municipal bond market, reducing prices of revenue bonds issued by Puerto Rico’s government.

If you have any questions about how the Act may impact you and how to best protect your interests and rights, please contact Firm Member and Federal Litigation Chair Kenneth Suria at and/or Bankruptcy and Reorganization Practice Manager Paul Hammer at at your convenience.