As previously reported, Puerto Rico’s Governor Alejandro Garcia Padilla declared in June 2015 that the island’s $72 billion in debt was “not payable.”
The Commonwealth of Puerto Rico has argued that it has been wrongly locked out of the bankruptcy courts, the only place it can reasonably expect to restructure its debt.1
Several financial creditors wanted to keep restructuring talks out of court.
On March 22, 2016, Puerto Rico presented its case to the U.S. Supreme Court. Puerto Rico has been saying for more than a year that it needs to restructure at least some of its debts under Chapter 9 of the U.S. Bankruptcy Code which covers insolvent municipalities. However, Puerto Rico cannot do so because Chapter 9 specifically excludes it.

The question before the Supreme Court is whether the island territory should be allowed to restructure debts under a court-supervised regime similar to Chapter 9 bankruptcy laws used by U.S. cities such as Detroit, Michigan and Stockton, California.
In 2014, Puerto Rico tried to get around the exclusion by enacting its own version of a bankruptcy law, called the Recovery Act, designed for its big public utilities which account for about $26 billion of the total debt outstanding. However, two U.S. court decisions deemed the Recovery Act invalid after the Puerto Rico Electric Power Authority (PREPA) creditors sued, with the Supreme Court agreeing in December 2015 to hear an appeal.
Christopher Landau, counsel for .the Commonwealth, stated “Congress has shut the door.” “There is no door for Puerto Rico, and no key for Puerto Rico.” He added “We’ve talked a lot about legal principles”, summing up his argument on behalf of the Commonwealth. “But this is also a flesh-and-blood situation in Puerto Rico.” Hanging on the outcome, he said, were questions like “whether people in a village in Puerto Rico will be able to get clean water.”
Many of the Justices’ questions, and the parties’ responses, involved possible rationales for tying Puerto Rico’s hands, as Congress went out of its way to do in 1984. Its amendment that year also barred the District of Columbia, without leaving any legislative history or indication of intent. “Why would Congress preclude Puerto Rico from Chapter 9?” asked Chief Justice John G. Roberts, Jr.
In 1984, Congress said Puerto Rico, as a U.S. territory, could not use bankruptcy laws that govern U.S. states. But federal bankruptcy law also dictates that no state can pass local debt-restructuring laws, and in one provision Puerto Rico is defined as a state.
“Why would Congress put Puerto Rico in this never-never land?” asked Justice Ruth Bader Ginsburg. “Why in the world? What explains Congress wanting to put Puerto Rico in this anomalous position of not being able to restructure its debt?”
“It’s the question that everyone asks when they pick up the case,” said Mr. Landau.
Puerto Rico has already defaulted on about $221 million of debt, prompting lawsuits by some creditors. Bigger and more contentious defaults appear imminent. On May 1, 2016, the island’s Government Development Bank must make debt payments of $422 million. Two months later, about $2 billion is due from the central government, PREPA, the water and sewer authority, and the highway authority, among others.2
Seven Justices heard the arguments on March 22 that Puerto Rico’s debt, as its Governor has warned, is bringing the island to the brink of ruin. The four liberal Justices signaled support for legislation to relieve the island territory of its debt burden.
House speaker Paul Ryan told reporters that Congress will take up a Puerto Rico relief bill in April.
On March 24, a plan, being drafted as legislation by House Republicans, would not grant Puerto Rico’s most fervent request: permission to restructure its entire $72 billion debt in bankruptcy but would however give the island certain crucial tools that bankruptcy proceedings can offer – but only if it first comes under close federal oversight and meets other conditions. An oversight board would audit Puerto Rico’s government, improve operations, find savings and ultimately determine how much of the $72 billion debt really has to be restructured, if any.3
The Supreme Court case’s outcome could threaten a hard-fought, consensual restructuring at PREPA, where creditors holding most of the utility’s $8.3billion in debt agreed to take 15% reductions in payouts.
Reinstating the Recovery Act could allow Puerto Rico to scrap that deal and instead put PREPA into bankruptcy, where it could impose deeper cuts and bind holdout creditors to the deal.4
But it remains unclear how the Supreme Court will rule on whether Puerto Rico’s Recovery Act can be changed to allow the island territory to escape some of its $72 billion debt.
The economic crisis has left Puerto Rico facing a mass exodus of residents – 84,000 people left Puerto Rico for the United States mainland in 2014, a 38% increase from 2010. Some 45% of people live in poverty and the unemployment rate is the highest in the United States.
The Supreme Court is due to rule by the end of June.5
Endnotes
  1. Peluso, Romano I., “Debt Crisis in Puerto Rico,” Perkins Coie LLP, www.corporatetrustinsider.com, October 12 2015.
  2. Walsh, Mary Williams, “Supreme Court Hears Plea for Help from Puerto Rico,” The New York Times, March 23, 2016.
  3. Walsh, Mary Williams, “Plan to Rescue Puerto Rico Advances Led by House Republicans,”The New York Times, March 24, 2016.
  4. Reuters, FORTUNE magazine, ‘Puerto Rico’s Debt Relief Bid Is Going to the Supreme Court,” March 22, 2016, and Reuters, The Guardian, “U.S. Supreme Court signals support for bill to relieve Puerto Rico of $70bn debt,” March 22, 2016.
  5. Endnote 4.