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Thursday, March 28, 2024 | Back issues
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Puerto Rico Excluded from Bankruptcy Powers

(CN) - Puerto Rican municipalities cannot declare Chapter 9 bankruptcy, because federal law expressly excludes the island from federal bankruptcy protections, the First Circuit ruled.

Puerto Rico has approximately $72 billion in debt, and is struggling to pay its creditors. In 2013, Puerto Rico's gross domestic product was $103 billion.

However, in 1984, Congress amended the federal bankruptcy code, and prohibited Puerto Rico from "defining" a municipal debtor. Therefore, the island lacks the authority under the code to authorize its municipalities to file for Chapter 9 relief.

As its public utilities risk becoming insolvent, Puerto Rico sought to take matters into its own hands. It enacted a law in 2014, the Puerto Rico Public Corporation Debt Enforcement and Recovery Act, to allow utilities to restructure their debt.

The law provides expressly different protections for creditors than Chapter 9 of the federal bankruptcy code.

But bondholders of the Puerto Rico's power company, which hold $18 billion of the island's debt, challenged the law in federal court, claiming that the definition of "state" in the federal bankruptcy code excludes Puerto Rico, and denies it the power to authorize its municipalities to restructure their debt.

A judge in San Juan found for the bondholders, and the First Circuit affirmed Monday.

"Congress was quite clear in the Bankruptcy Code that Puerto Rico was to be treated like a state, except for the power to authorize its municipalities to file under Chapter 9," U.S. Circuit Judge Sandra Lynch said, writing for the unanimous three-judge panel.

The decision will require Puerto Rico's public utilities to engage in piecemeal negotiations with each of its creditors, rather than consolidating the debt and forming a comprehensive plan to repay debts.

Lynch said Congress retains the power to authorize Puerto Rican municipalities to seek Chapter 9 relief, and indeed, the island is presently seeking relief directly from Congress.

U.S. Circuit Judge Juan Torruella concurred in the judgment, but called on Congress to make extend federal bankruptcy protections to Puerto Rico, and said he would find the 1984 Amendments to the bankruptcy laws unconstitutional.

"Besides being irrational and arbitrary, the exclusion of Puerto Rico's power to authorize its municipalities to request federal bankruptcy relief, should be re-examined in light of more recent rational-basis review case law," Torruella said. "The 1984 Amendments are just another example of a historic pattern of disadvantage suffered by Puerto Rico."

He continued, "Why would Congress intentionally take away a remedy from Puerto Rico that it had before 1984 and leave it at the sole mercy of its creditors? What legitimate purpose can such an action serve, other than putting Puerto Rico's creditors in a position that no other creditors enjoy in the United States? While favoring particular economic interests -- i.e., Puerto Rico creditors -- to the detriment of three-and-a-half million U.S. citizens, is perhaps 'business as usual' in some political circles, one would think it hardly qualifies as a rational constitutional basis for such discriminatory legislation."

Plaintiff bondholders issued a statement Tuesday, saying, "We continue to work with the Commonwealth and Puerto Rico's electric company toward a mutually agreed upon revitalization plan, and expect to work with the Commonwealth generally to develop reforms that holders of Puerto Rico's bonds can support."

Puerto Rico's Attorney General Cesar Miranda told Bloomberg he is considering appealing the decision to the U.S. Supreme Court.

"It's arbitrary and inconceivable that Puerto Rico will be deprived of a tool that allows for an orderly negotiation of public debt," Miranda said.

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