On February 26, 2015, testimony was presented to the House
Judiciary Committee's Subcommittee on Regulatory Reform,
Commercial and Antitrust Law (the "Subcommittee")
regarding H.R. 870, the "Puerto Rico Chapter 9 Uniformity Act
of 2015" ("H.R. 870").1. This
Commentary provides an overview of that testimony as well
as the written testimony of each witness who testified before the
Subcommittee and the text
of H.R. 870.
Hearing Overview
H.R. 870 was introduced by the Resident Commissioner of Puerto
Rico, Representative Pedro R. Pierluisi, on February 11, 2015.
Anecdotal comments from the Representatives participating in the
Subcommittee hearing, particularly Representative Issa, indicate
that this bill is being fast tracked and will be sent to the full
House Judiciary Committee for a vote in the near
future.
The hearing room was jam-packed—not a single open seat and at
least a dozen or standing on the periphery. The hearing on H.R. 870
lasted from 11:30 a.m. to approximately 12:45 p.m. Current and
former prominent Puerto Rican elected officials—the President
of the Puerto Rico Senate, Eduardo Bhatia, among
others—attended the hearing and were recognized by the
Subcommittee Chairman, Representative Tom Marino (R-PA). Numerous
members of the Puerto Rican media were also present.
Four witnesses testified before the Subcommittee:
John A. E. Pottow, professor at the University of Michigan Law
School;
Melba Acosta, President of the Government Development Bank for
Puerto Rico (the "GDB");
Robert Donahue, Managing Director at Municipal Market
Analytics, Inc.; and
Tom Mayer, Partner and Co-Chair, Corporate Restructuring and
Bankruptcy Group at Kramer Levin Naftalis & Frankel LLP
(current counsel to funds managed by Franklin Municipal Bond Group
and by Oppenheimer Funds, Inc.).
Each witness submitted written testimony to the Subcommittee prior
to the start of the hearing. Each witness's oral testimony
concisely summarized his or her written submission. As discussed
below, only one witness, Tom Mayer, spoke in opposition to H.R.
870. The remaining three witnesses spoke in support of H.R.
870.
There were 10 Subcommittee members present at some point during the
hearing, six of which questioned the witnesses: Chairman Marino and
Representatives Issa (R-CA), Conyers (D-MI), Johnson (D-GA),
Pierluisi (D-PR), and Cicilline (D-RI). Of the questioners, only
Representative Issa indicated some skepticism regarding the need
for H.R. 870, with the remaining questioners all voicing support
for the Act. Virtually every questioner yielded any time he or she
had remaining to Representative Pierluisi, who then took up the
balance of the allotted time to criticize Mr. Mayer's written
and oral testimony. Representative Pierluisi dug into details of
Mr. Mayer's testimony and attacked specific points.
Points Made in Support of H.R. 870
Puerto Rico's Exclusion from the Bankruptcy Code's
Definition of "State" May Be a Legislative
Anomaly. There is no evidence that Puerto Rico was
intentionally excluded from this definition by Congress. Evidence
indicates that Puerto Rico was inadvertently omitted from
the definition and that Congress made attempts to correct this
error, but, for some unknown reason, such efforts never yielded the
intended result.
H.R. 870 Does Nothing to Authorize a Chapter 9
Filing by Puerto Rico or Any of its Municipalities. It
merely gives Puerto Rico the same right every other
"state" has: the ability, if it so chooses, to enact a
law that authorizes a "municipality" to seek relief under
Chapter 9 of the Bankruptcy Code.
Chapter 9 Relief will Make a Smoother Restructuring of Debt
Possible. If Chapter 9 relief is available to
municipalities in Puerto Rico, it will facilitate a more
coordinated and orderly restructuring of debt associated with the
Puerto Rico Electric Power Authority ("PREPA"), the
Puerto Rico Aqueduct and Sewer Authority ("PRASA"), and
the Puerto Rico Highways and Transportation Authority
("PRHTA"). One witness stated that Chapter 9 would
provide a powerful motivating tool to bring all interested parties
into an organized restructuring effort.
Current Rules Provide an Ineffective Restructuring
Framework. The current rules under which public
corporations in Puerto Rico may restructure debts present grave
uncertainty and provide a wholly inadequate legal framework to
effectuate a highly complex financial restructuring. The most
notable example cited was the possibility of the appointment of a
"receiver" over PREPA who would have "vague
powers" and would be prohibited from "encumbering or
dispos[ing] of property."
Retroactivity Could Create Risks. In response to
concerns over the constitutionality of retroactively applying H.R.
870, witnesses noted that municipal bond funds, as estimated by
Fitch Ratings Inc., reduced their Puerto Rico holdings by
approximately 65 percent beginning in the second and third quarters
of 2013. Market trades indicate that these funds are now held by
opportunistic investors with a higher risk tolerance and awareness.
Today it is estimated that municipal bond funds collectively own
less than one-third of the island's debt, with holdings
concentrated in largely insured, general government issuers.
Additionally, witnesses pointed out that risks outlined in the
August 2013 PREPA Offering Statement included, among other things,
a risk that the ability to fund operations and finances could be
negatively affected if current and prior fiscal headwinds continue.
Thus, investors holding PREPA bonds during or after August 2013
were expressly warned of the risk that their debt could be
impaired. Further, witnesses noted that the U.S. Supreme Court has
dealt with retroactivity in the context of contract rights impaired
in bankruptcy cases before and did not find such retroactive impact
to be unconstitutional.
Professor Pottow did note, however, that retroactivity is a concern
only under the Takings Clause of the United States Constitution
(U.S. Const. amend. V), which is implicated only when property
rights are impaired. He noted that these concerns are
"rare" because, typically, secured creditors have many
protections under the Bankruptcy Code. Testimony on this subject
was cabined, however: while one could argue that the Bankruptcy
Code's invalidation of property rights might implicate
the Takings Clause, the issue has never been definitively resolved
by the U.S. Supreme Court, and its resolution would be complicated
and involve interpreting the intersection of the Bankruptcy Clause
and Takings Clause jurisprudence. See
Pottow at p. 4.
Risk Premium Could Affect Bonds Issuances. Puerto
Rico is currently paying a "risk premium" for all
issuances because there is "uncertainty in the market"
with respect to the island's ability to facilitate a
coordinated restructuring. This may negatively affect upcoming bond
issuances that are necessary to provide the central government and
the GDB with liquidity.
PREPA, PRASA, and PRHTA are Likely to Become More
Self-Sufficient. The current Governor and other elected
officials are working together to make PREPA, PRASA, and PHRTA
self-sufficient. With a clear debt adjustment mechanism it is more
likely that these entities will be restructured in an appropriate
manner and become financially independent from the central
government.
Passage of H.R. 870 May Avert a Great Fiscal
Crisis. More importantly, it could avoid the potential for
a request to the federal government for financial aid or a
bailout.
H.R. 870 has Bipartisan and Strong Support. This
support comes from members of Congress and Puerto Rico's
leaders in addition to support from the National Bankruptcy
Conference, notable bankruptcy practitioners and bankruptcy
academics.
Mr. Mayer's Points Made in Opposition to H.R.
870
Puerto Rico Should Not Have Access to Chapter 9.
According to Mr. Mayer, it is wrong to allow Puerto Rico to have
access now to Chapter 9 when billions of dollars of bonds were
issued in reliance on the fact that Puerto Rico's debt could
not be altered through a Chapter 9 restructuring. Mr. Mayer
pointedly stated that "H.R. 870 breaks the faith with those
millions of men and women."
The Public Corporations Are Not Exercising All Available
Options to Manage Their Debt and Operating Expenses. They
should, among other things, cut expenses, increase rates, and
engage in more robust collection efforts before going down the
Chapter 9 path or any other restructuring scenario.
Chapter 9 is Bad Policy for Bondholders, and Detroit was
not a Success Story for Such Bondholders. Mr. Mayer stated
that Chapter 9 should be altered to be more like the law prior to
the 1978 enactment of the Bankruptcy Code with respect to
bondholders: specifically, the requirement of an affirmative
bondholder vote before a plan affects bondholders. This would be
akin to the pre-1978 requirement that a Chapter 9 petition be
accompanied by a plan accepted, in writing, by creditors owning not
less than 51 percent of the securities affected by the plan.
Professor Pottow rebutted Mr. Mayer's arguments on this last
point by pointing out that certain Detroit bondholders may receive
a 74 percent recovery. He also stated that Mr. Mayer's
testimony is colored on this point because his Detroit clients
agreed to a settlement whereby they recovered only 13 percent
because of the strong arguments that those Detroit bonds were
illegal and the bondholders accordingly should receive
nothing.
Both Chairman Marino and Representative Issa voiced concern regarding the impact of "retroactively" impairing debt obligations and whether such conduct stands on firm constitutional grounds.
Various documents, including letters and other notes in support of H.R. 870, were moved into the record during the Subcommittee hearing. Also, Chairman Marino gave Subcommittee members one week to submit additional questions in writing to the witnesses. Those questions and any responses will become part of the hearing record.
Footnote1. This Commentary is meant to summarize what occurred during the Subcommittee hearing. The views, opinions, and recommendations of the witnesses and Members of Congress are not endorsed by or necessarily reflective of those of Jones Day. Issues regarding the scope and application of Chapter 9 are complicated. For further information on this subject matter, please contact any of the Commentary's authors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.