Prepa: We Need Puerto Rico Bankruptcy Law Because RSA ‘Fragile’ and ‘Uncertain’
Nonprofits say Inability to Restructure Debt Will Hurt Essential Services
The Puerto Rico Electric Power Authority (Prepa) has urged the U.S. Supreme Court to validate a local bankruptcy law because the current restructuring support agreement (RSA) with creditors to restructure its finances is fragile, subject to numerous termination events and holdout risks, and still requires agreements with additional bondholders holding $2 billion of the utility’s $9 billion debt.
In addition, more than 10 nonprofit organizations also urged the top court to rule in favor of Puerto Rico because these groups, which provide services directly to the people and communities, could be forced to shut down or cut services because they will not get government funding.
Meanwhile, the Puerto Rico Manufacturers Association says a hike in rates by utilities that are not allowed to restructure debts will be detrimental to that sector and the economy in general.
These arguments were part of a reply brief and several amicus curiae, or friend of the court, briefs filed in the case of Puerto Rico vs. Franklin California Tax Free Trust, in which the top court of the land will decide if the local bankruptcy law is pre-empted by the federal bankruptcy law. The local law, the Debt Enforcement & Recovery Act, was declared unconstitutional by lower federal courts, leaving Puerto Rico without any legal recourse to restructure the debt of some of its public corporations. According to the respondents, however, the Recovery Act is a “‘state law prescribing a method of composition of indebtedness’” and is thus pre-empted insofar as it purports to “‘bind any creditor that does not consent to such composition.”
Prepa said that from its establishment, it has relied heavily on debt financing for the performance of its public functions. Prepa first issued bonds in 1945 (when it was named the Puerto Rico Water Resources Authority) and has periodically raised debt since that time to advance its mission. Prepa currently has 25 series of bonds outstanding, totaling more than $8.1 billion. In addition, Prepa has entered into revolving lines of credit in the amount of $700 million to purchase fuel and pay for other operating expenses.
Increasing this debt load has been facilitated by certain laws, and has occurred against a backdrop of explicit agreements and a common understanding that if Prepa were unable to pay its debt as that debt came due, there would be a mechanism for the orderly and equitable treatment of all its creditors without the proverbial “race to the courthouse.” The relevant laws in place at the time were the U.S
. Constitution and the U.S. Bankruptcy Code, the utility said in its brief to the court.
“Nothing in the Bankruptcy Clause of the Constitution prevents Puerto Rico from adopting a law allowing its public corporations to adjust their debts, nor had the Bankruptcy Code been interpreted to prevent Puerto Rico from treating its public corporations in the same way that the 50 States can treat their similarly situated entities. Likewise, the Trust Agreement governing the bonds recognizes that the Commonwealth could enact a restructuring law,” the entity states.
The significance of that background understanding has become manifest now, both in terms of Prepa’s current ability to provide services and its future ability to raise additional debt financing so it may continue to provide services in the future. Prepa cannot now repay its current debts in full. The utility currently owes $700 million under its fuel lines of credit and will owe about $428 million in principal and interest under bonds that mature in July. Nor can Prepa obtain additional financing to repay amounts now coming due because recent credit downgrades and Prepa’s severe financial condition have deprived the utility of access to new capital.
“In short, Prepa has neither the funds nor the means to obtain the funds sufficient to repay its debts in full. And, without those means or the ability to compel 100% of its creditors to agree to an equitable plan of reorganization, Prepa lacks the ability to reorganize its debt in a manner that would protect the interests of all creditors and the Commonwealth’s citizens, businesses and government agencies [that] need electricity. The Debt Enforcement & Recovery Act…that is the subject of this lawsuit provided such a legislative solution. In its absence, Prepa may literally be unable to provide the electricity that is the lifeblood of the Commonwealth,” the entity states.
‘Uncertainties’ in the RSA
Prepa’s negotiations with its creditors to date have demonstrated the wisdom of and necessity for a law such as the Recovery Act. While Prepa has reached an RSA with an ad hoc group of bondholders, some of the monoline insurers of certain Prepa bonds and its fuel-line lenders, the agreement is fragile and subject to a number of uncertainties including—most notably—numerous termination events and holdout risks.
“To demonstrate the fragility of the RSA, one needs to look no further than a few days ago, when the RSA terminated because required legislation was not enacted into law. Prepa is in discussions with creditors to revive the RSA, but even if those discussions are successful, any restructuring presents holdouts and other risks: it will require agreement from additional bondholders holding about $2 billion in Prepa bonds who were never parties to the RSA,” Prepa states.
Other highly uncertain “conditions precedent” would remain. The Puerto Rico Energy Commission (PREC) would need to approve a new rate structure; the contemplated new securitization notes would need to receive an investment-grade rating, a significant challenge in light of the commonwealth’s financial crisis; the commonwealth would need to enact supporting legislation, including a transition surcharge to refinance Prepa’s debt, in a form acceptable to creditors; and a Puerto Rico court would need to validate the new securitization bonds.
“If any of these conditions fails, or if they are not all satisfied by June 30, 2016, the RSA would fail. More specifically, $700 million would immediately become due under the matured fuel lines of credit, and Prepa will owe on July 1, 2016 an additional $428 million,” the utility adds.
Social services could be hurt
On the other hand, Puerto Rico’s inability to restructure the debt of its public corporations as a result of the decision invalidating the Recovery Act will hurt social services for the island’s most vulnerable individuals, according to several nonprofit organizations.
Prepa is, for all practical purposes, the sole electric-power provider on the island. The cost of electricity in Puerto Rico in kilowatt-hours is the second-most expensive in the U.S., they said, adding that its infrastructure is both outdated and inefficient.
Other public corporations, namely Puerto Rico’s Transportation and Aqueduct & Sewer authorities, place a similar burden on the local economy. “Both operate as publicly sanctioned state monopolies, have deficient and costly infrastructure and [place] a heavy burden on taxpayers. Their respective fiscal situations are already impacting the economy,” the organizations’ brief states.
“For example, Puerto Rico’s Legislature has twice been forced to significantly raise taxes on petroleum-based products during the past year in an attempt to save the Transportation Authority’s finances. To make matters worse, Puerto Rico’s population is extremely dependent on automobiles and [the Transportation Authority] has been unable to develop a comprehensive and reliable public transportation system,” they add.
Nonprofits have already been severely affected by the economic and fiscal crisis. “Private donations have dried up and the fundraising capability of these entities has diminished as a result of the economic downturn. Nonprofits have been forced to invest time and effort defending their public funding before a government that is desperately trying to raise the resources necessary to meet the demands of its creditors,” the organizations state. “It is therefore unquestionable that the fiscal state of Puerto Rico’s public corporations has and will continue to have, a direct impact on the economy of the island and on its overall fiscal health.”
The austerity measures taken by the government of Puerto Rico have already started to affect the nonprofit sector. Due to reduced revenue projection, as recently as Jan. 13, the government’s Office of Management & Budget issued a decision reducing the amount of “special legislative grants” to various governmental entities and important nonprofit institutions. The total reduction was $254 million.
The effect of this reduction has already affected the services provided by these organizations and some have indicated they will completely shut down their operations. An example of an organization contemplating such drastic action is the Boys & Girls Club of Puerto Rico.
Other nonprofit organizations affected by the $254 million reduction in special legislative grants include: Iniciativa Comunitaria de Investigación (serving the homeless and those with drug-related problems); La Fondita de Jesús (helping the homeless to reintegrate in their communities and providing basic necessities); the island’s three main museums (Puerto Rico Museum of Art, Ponce Art Museum and the Contemporary Art Museum); and Instituto Nueva Escuela (promoting academic excellence and social change in disadvantaged communities).
The United Nations has said countries that cannot properly restructure their substantial debts have difficulties guaranteeing the human rights of their citizens, the nonprofits argued. On the other hand, countries that have been able to restructure their debts have experienced significant socioeconomic benefits such as increased school enrollments and healthcare subsidies.
PRMA: Manufacturing will also be hurt
The Puerto Rico Manufacturers’ Association (PRMA), which represents 1,200 companies, argued in its brief that, like the rest of Puerto Ricans, its members depend on public utilities to operate.
“If a viable and reasonable solution is not promptly offered or implemented, the Commonwealth would be forced to immediately suspend all basic services to its constituents,” the PRMA said in its brief written by former Justice Secretary Luis Sánchez Betances.
If utilities are forced to increase rates, it would seriously affect manufacturing, as utility costs have a high impact on the sector’s decisions regarding cutting jobs and making improvements or capital investments.
“We have repeatedly stressed that operating costs on the island are high, and if they continue to rise due to the inability to pay or restructure their debts, Puerto Rico’s competitiveness will be undermined, thus affecting millions of American citizens,” the brief states.
Meanwhile, two scholars and experts in municipal bankruptcy and bankruptcy law, Clayton P. Gillette and David A. Skeel Jr., argued that while Congress adopted a new definition of “State” in 1984 that excluded Puerto Rico from the bankruptcy law, there is no evidence Congress intended the new definition of “State” to leave the island without any restructuring options.
Gillette is a law professor at New York University and Skeel is a law professor at the University of Pennsylvania.
“By striking down the Recovery Act, the District Court took the extraordinary step of overriding Puerto Rico’s exercise of its territorial police powers. If Congress clearly intended to pre-empt a Puerto Rican restructuring law, it had the power to do so. But there is no evidence supporting the conclusion that it did. When the predecessor of section 903(1) was enacted, Puerto Rico was deemed to be a state for municipal bankruptcy purposes and thus permitted to allow its municipalities to make use of the federal bankruptcy laws,” the professors said.
Gillette and Skeel argue that a literal reading of the Bankruptcy Code indicates that the pre-emptive effects of Section 903(1) cannot apply to Puerto Rico. A finding that Congress intended Puerto Rico to have no ability—either from the Bankruptcy Code or from domestic legislation—to adjust municipal debts would jeopardize the delivery of public services, the very function that Puerto Rico municipalities were created to fulfill, they state.
“The history of municipal insolvency law demonstrates attention to the need for debt adjustment…to ensure the continued provision of municipal services without generating substantial increases in the cost of service or [an] exit by residents. It is, therefore, implausible that Congress, by denying Puerto Rico’s municipalities access to Chapter 9, intended that they have no avenue by which to adjust their debts,” the professors argued.