Understanding Current Structures and Potential Changes to Federal Action in Puerto Rico Requires Analysis of the Enactment of PROMESA and its Provisions
In a continuing series on the recovery of Puerto Rico after Hurricane Maria, James Spiotto looks at the actions the Federal Government took before Maria, with the enactment of The Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA
By 2016, the serious financial problems of the territory of Puerto Rico had reached the tipping point of a crisis:
For years Puerto Rico, faced with a failing economy, financed operations with the issuance of tax-exempt bonds that the rating agencies had now deemed junk. Puerto Rico had ever increasing costs of essential services and needed infrastructure improvements, including an expensive health insurance program for low-income people without providing for a means of paying for it. Further, public pensions, including those for teachers, judges and general employees, were largely unfunded. Those who could left the island for better economic opportunities, resulting in a loss of over 250,000 residents/taxpayers since 2006. There was little or no significant economic investment or growth on the island, and the government could not meet its debt obligations and also provide basic governmental services simultaneously. Schools were closing and hospitals were in precarious positions.
The PROMESA solution
In an effort to save Puerto Rico from imminent economic collapse, particularly because of the $1.9 billion bond debt payment due July 1, 2016, Congress enacted the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”), which became law on June 9, 2016.
Origins of PROMESA – PROMESA was intended to be an eclectic mixture of past mechanisms used to resolve financial distress of governments, such as the Municipal Assistance Corporation for New York City in 1975, the Pennsylvania Intergovernmental Cooperative Authority for Philadelphia in 1999, and the Financial Responsibility and Management Assistance Authority for the District of Columbia in 1995. PROMESA took what it considered the best attributes of these and other mechanisms and incorporated them.
PROMESA goals – The principal goal of PROMESA was to provide the Commonwealth of Puerto Rico with an opportunity and framework to stabilize the economy, restructure its debt, develop a realistic budget, and create a recovery plan. The Act also provided a short-term stay on litigation and other efforts to collect debt that was in default. The Act encouraged consensual resolution with creditor groups under Title VI, where creditor groups can collectively agree with Puerto Rico as to a resolution and drag the non-consenting holders along. Such an agreement then could be a foundation, if all issues were not resolved with all creditor classes, for a plan of adjustment under a Title III proceeding. At the same time, the Act did not enact limitations on the Commonwealth’s exercise of its governmental powers.
The Plan, in Detail
The Act is structured into seven sections or titles:
Title I – Establishment and organization of Oversight Board:
- Title I establishes a Financial Oversight and Management Board (the “Oversight Board”) of seven voting members appointed by the President of the United States with the advice and consent of the United States Senate.
- The Oversight Board is not compensated.
- A majority vote of the Oversight Board is required for the approval of a fiscal plan or budget, to cause an act by the Puerto Rico legislature not to be enforced (the board has authority to halt enforcement of an act of the Puerto Rico Legislature, if deemed to effect an expedited permitting process), or to approve an infrastructure project.
- The Oversight Board is to carry out the purposes of PROMESA and may hire staff and counsel as necessary. Its powers include the power to:
- hold hearings,
- issue subpoenas, obtain data and creditor information,
- enter into contracts, enforce laws, and certify voluntary creditor agreements
- supervise to balance budgets,
- prohibit public sector strikes, and
- implement an efficient taxation system.
Title II – Responsibilities of Oversight Board: Stop the Bleeding and Bridge to Financial Stability:
- Title II of PROMESA sets forth the responsibilities of the Oversight Board:
- approving a fiscal plan covering at least five years,
- approving the budget that complies with the fiscal plan,
- making legislative recommendations to the Governor and Legislature of Puerto Rico to promote financial stability and economic growth,
- consenting to debt restructuring, and
- intervening in litigation against Puerto Rico.
Title III – Adjustment of Debts:
- Title III creates a procedure for the adjustment of the debt of the Commonwealth of Puerto Rico, akin in certain respects to the procedure under Chapter 9 of the Bankruptcy Code.
- PROMESA incorporates a number of sections of the Bankruptcy Code, including:
- Section 301 in PROMESA incorporates by reference provisions of the Bankruptcy Code into Title III, namely sections 902 (special revenues), 922 (automatic stay and exception for special revenues), 923 (notice of commencement of case), 924 (list of creditors), 925 (effect of claim list), 926 (avoiding powers), 927 (limitation on recourse), 928 (post petition effect of security interest), 942 (modification of plan), 944 (effect of confirmation), 945 (continuing jurisdiction and closing the case) and 946 (effect of exchange of securities before the date of filing of the petition), and
- Other sections of Chapter 9 are repeated with some modification in specific sections of PROMESA, such as 903 (reservation of power of state to control municipalities–Section 303 of PROMESA), 904 (limitation on jurisdiction and power of the court–Section 305 of PROMESA), 929 (municipal leases–Section 311 of PROMESA), 941 (filing plan–Section 312(b) of PROMESA), 942 (modification of plan section 942 incorporated by reference and set forth in Section 313 of PROMESA), 943 (confirmation–Section 314 of PROMESA).
- The Oversight Board may file a voluntary petition under Title III in the United States District Court for the District of Puerto Rico.
- The Oversight Board prosecutes the case on behalf of the Commonwealth of Puerto Rico.
Differences between Chapter 9 and PROMESA Title III:
The Oversight Board has a key role in the proceeding and prosecutes Puerto Rico’s case (Section 315), unlike Chapter 9 where the municipality as debtor represents itself. The plan of adjustment must be the one approved by the Oversight Board (Section 315), unlike Chapter 9 where the debtor municipality develops and files the plan without need of approval from another entity.
There is a mechanism for professionals to be paid during the interim and at the end of the case – compensation for representing the debtor, the Oversight Board, creditor committee(s) appointed by the court, or a trustee to pursue avoidance causes of action (Section 316), unlike Chapter 9 where there are no provisions to compensate professionals. This Section 316 could conflict with Section 305 of PROMESA that provides the court does not have jurisdiction over revenues of Puerto Rico without the consent of the Oversight Board.
The presiding judge shall be a federal district court judge to conduct the proceedings (Section 308). An Article III judge, while under Chapter 9, the judge presiding by reference would be bankruptcy judge (Article I). Appeals of the Title III court rulings are to be taken like an appeal of a district court ruling (Section 306) to the Federal Courts of Appeals for the First Circuit, unlike a Chapter 9 where appeals are made to the district court or to the Bankruptcy Appellate Panel (BAP) first before going to the federal appellate court.
Title IV miscellaneous provisions, automatic stay, and inter-debtor property transfer protection:
Included in the miscellaneous provisions are sections that assure the right of Puerto Rico to determine its future political status (Section 402), to deal with minimum wage for certain workers (Section 403), the review of certain labor regulations’ applicability to Puerto Rico (Section 404), to impose automatic stay upon enactment to prevent preferential creditor action and encourage consensual resolution (Section 405), to create a Congressional task force regarding economic growth in Puerto Rico (Section 409), and to implement new reporting requirements of the comptroller general relating to Puerto Rico’s debt and financial condition (Section 409 and 410).
Title V – Puerto Rico infrastructure revitalization:
PROMESA provides for a revitalization coordinator to review proposed projects for revitalizing the infrastructure of the Commonwealth of Puerto Rico (Section 502):
- Critical project reports, including expedited permitting processes, and prioritization of action items subject to Oversight Board approval (Section 503).
- Expedited review and action by any federal agency, including as to federal grants and loans (Section 505).
- Expedited judicial review of any claim related to infrastructure revitalization.
This Title V also has provisions governing expediting critical projects required because of an emergency, that affect the physical infrastructure and threatening public health and safety. This may provide a vehicle to address emergency infrastructure improvements (water, electricity, roads, etc.), given the devastation of Hurricane Maria.
Title VI – Creditor collective action:
- PROMESA provides for a method of debt restructuring outside of Title III.
- The Oversight Board is required to divide the Commonwealth of Puerto Rico’s creditors into separate pools, based upon the nature of the debt, and at least one pool for each issuer.
- Each pool, after delivery of adequate information, would then vote on a qualifying modification to the debt owed. The vote would become binding if supported by a two-third majority of outstanding principal in the pool that has voted, provided at least a majority of the outstanding principal of that pool has voted and the district court approves the resolution. Note: If 51% of the outstanding amount of debt affected vote and two-thirds of those voting approve the restructuring, it is possible that about 34% of all outstanding amount of debt of a class of creditors could direct a resolution and drag 66% of the outstanding amount of debt along.
- The District Court in Puerto Rico has the power to order any dissenting creditors to accept the qualifying modification.
- This collective action by creditor groups has no real precedent in government debt restructuring in the U.S., but a collective action clause is common in other foreign country debt agreements.
Title VII – The Sense of Congress
The sense of Congress is to establish permanent, pro-growth fiscal reforms that feature a free flow of capital between the United States and the Commonwealth of Puerto Rico.
Up next: How PROMESA should work, including obtaining accurate information, and promoting consensus and transparency.
by James Spiotto