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Is Bankruptcy A Way Out For Puerto Rico?

In mid-2014, laboring under a public debt that exceeds its gross domestic product (GDP), Puerto Rico attempted to enact special legislation that would allow its public sector corporations to seek bankruptcy protection and give them an opportunity to restructure those debts. Many of its large creditors were not happy. Three major investment firms sued in federal court to have the law overturned.

The plaintiffs in the case needn't have worried – too much.

While there were good intentions behind the legislation (the main concern was to keep public utilities and services going), there were were a few problems. The primary one has to do with the fact that bankruptcy legislation is the exclusive province of Congress; legislators at the state level and in U.S. territories cannot create their own bankruptcy laws.  It was for this reason that Judge Francisco Besosa of  Puerto Rico's U.S. District court struck down the island's Debt Enforcement and Recovery Act earlier this year. Although municipalities can seek bankruptcy protection under Chapter 9, the law does not apply to states – or U.S. territories. Furthermore, because Puerto Rico is neither a state nor a sovereign nation, its municipal governments and public utilities are ineligible to file under Chapter 9.

While creditors and bondholders were pleased at Judge Besosa's ruling, it fails to solve the problem: how to allow Puerto Rico's public utilities to deal with their financial crisis.

This week, the Obama Administration stepped up in an attempt to bring order to what could become a financially chaotic situation. House Resolution 870 would essentially treat Puerto Rico like a state under current bankruptcy laws – specifically, Chapter 9. Also known as the Puerto Rico Chapter 9 Uniformity Act of 2015, the law states that:  “The term 'state' includes Puerto Rico and, except for the purposes of defining who may be a debtor under Chapter 9 of this title, includes the District of Columbia.”

An earlier attempt at this legislation, the Puerto Rico Chapter 9 Uniformity Act of 2014, was introduced last year by the Commonwealth's Congressional delegate, Pedro Pierluisi. After extensive research, Pierluisis determined that there was no reason that Puerto Rico should be excluded from Chapter 9. The legislation was endorsed by Fitch Ratings, the National Bankruptcy Conference and several lawyers, law professors and bankruptcy judges – as well as the Puerto Rican media.

Despite this, the bill was voted down.

Now that the crisis as intensified, there is a new urgency. Hearings on HR 870 began on 26 February, but even if the law were to pass, there are a number of complications. One of these lies in the presumption that when investors purchased Puerto Rico bonds, they were doing so under regulations existing at the time. If HR 870 were to pass and President Obama were to sign it into law, it would be tantamount to changing the rules in mid-game. In other words, Chapter 9 of the bankruptcy law would be applied retroactively.

While some creditors would come out of it better than others, a prominent economist from American University, Arturo Porzecanski, told the media that the law would damage “...what little investor confidence is left in Puerto Rico's ability and willingness to service its debt obligations.” Porzecanski adds that Congress would do better in “...establishing a Financial Control Board capable of addressing the root causes” of Puerto Rico's economic woes.

Professor Porzecanski makes a valid point. The current state of Puerto Rico's economy is the result multiple issues going back decades. For example, a report from the New York Federal Reserve Bank, published in 2014, points out that Puerto Rico is “...one of the few places in the world where finances are not regularly surveyed by a public agency.”  Unlike states, the government of Puerto Rico is largely dependent its Government Development Bank – an institution that is not subject to federal regulations and holds a significant about of public utilities' debt. There has also been a serious erosion of the island's tax base with an aging population and falling birthrate as well as a “brain-drain” as educated Puerto Ricans leave for the States in order to find better economic opportunities.

The current state of affairs has been a half-century or more in the making. While making Puerto Rico eligible for Chapter 9 bankruptcy protection could create a basis for negotiation and mutually-agreeable restructuring plans, it may take years before the situation is finally sorted out.

For more information regarding the UBS Puerto Rico Bond Litigation, click on Levin Papantonio UBS PR Lawsuit.

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