Chapter 9 and PREPA: it’s in the agreement. And the precedent

Chapter 9 and PREPA:
it’s in the Agreement. And the precedent
Debunking the argument against the protection of Chapter 9
for the Puerto Rico Electric Power Authority
Maria de los Angeles Trigo
November 2015

Chapter 9 and PREPA: it’s in the Agreement. And the precedent
2
Lobbying?
Done.
Public relations?
Done.
Legal research?
Well… that one’s still pending.

3
Several Puerto Rico investors have launched public
relations campaigns and lobbying efforts against the
Congressional authorization of a restructuring mechanism
for Puerto Rico municipalities.
They argue that Puerto Rico issuers could never, ever,
ever, file bankruptcy — especially the Puerto Rico Electric
Power Authority.

4
Their efforts are directed at convincing Members of
Congress and other groups of interest that the mere
consideration of granting a restructuring mechanism to
PREPA is a way to punish good-faith buyers of its debt.
Even more astounding: Members of Congress repeat that
argument. For the latest iteration, see the hearing
celebrated on 22 October 2015 by the US Senate Energy
and Natural Resources Committee.
This argument of “you are changing the rules and taking
me by surprise” is cynical, or the result of the lack of due
diligence by investors in PREPA debt.

5
At the very least, it shows that investors did not read the
legal document under which the debt was issued.
Document that sets out the rules under which the debt
would be paid and with a strong disclosure of this
possibility.
• The Trust Agreement was issued in 1974, when
the bankruptcy law applied to PREPA and PREPA
was indeed authorized to file for bankruptcy
protection under the US Bankruptcy Code.

6
In addition,
• The Trust Agreement for PREPA has provisions for
the composition of debt and the adjustment of
creditors claims under existing or future laws
enacted by Puerto Rico or Congress.

7
More importantly,
• Every bankruptcy law enacted by the US
Congress, since the first one in 1800, has been
applied retroactively; that is, to loans granted
before there was a bankruptcy law.
For over 200 years the bankruptcy practice and
precedent in the US has been to subject all creditor
claims to bankruptcy, independently of when the loans
were granted.

8
Why, then, are investors and Members of Congress so
aghast about the implementation of a process mentioned
in the Trust Agreement?
It was not until 1984 when Congress, thru language
inserted by Senator Strom Thurmond, without any public
discussion or explanation for the record, prohibited
bankruptcy filing for Puerto Rico’s municipalities.
And just as what Congress giveth Congress taketh away,
what Congress taketh away it may giveth again.

9
For an investor to say that it bought PREPA debt because
of its absolute inability to restructure debt is absurd.
For a Member of Congress to repeat it… is…
I have no words.
After all, ever since the first federal municipality
bankruptcy law was enacted in the US in 1934, and until
the unexplained prohibition of 1984, Puerto Rico
municipalities were able to file for bankruptcy under the
US Bankruptcy Code.

This article will discuss:
• the provisions of PREPA’s 1974 Trust Agreement regarding
composition of debt and adjustment of claims
• whether these provisions are clear enough to put a buyer on
notice of the possibility of a bankruptcy
• the retroactive application of US bankruptcy laws
• the degree of seriousness of the argument of surprise being
raised by investors and Members of Congress
10

THE TRUST AGREEMENT, OR
“PLEASE READ”
12

13
PREPA’s outstanding debt has been issued under the Trust
Agreement of 1974. Some provisions of the Agreement
have been amended a few times since then, but not the
ones that refer to composition of debt and adjustment of
claims.
The following paragraphs of the Trust Agreement contain
the references to composition of debt and adjustment of
claims, which are identified as two of several Events of
Default (Section 802):

14
(f) an order or decree shall be entered, with the consent
or acquiescence of the Authority, for the purpose of
effecting composition between the Authority and its
creditors or for the purpose of adjusting the claims of
such creditors pursuant to any federal or Commonwealth
statute now or hereafter enacted, if the claims of such
creditors are under any circumstances payable from the
Revenues; or
(g) any proceeding shall be instituted, with the consent
or acquiescence of the Authority, for the purpose of
effecting a composition between the Authority and its
creditors or for the purpose of adjusting the claims of
such creditors pursuant to any federal or Commonwealth
statute now or hereafter enacted, if the claims of such
creditors are under any circumstances payable from the
Revenues;

NO, I DIDN’T READ THAT PART
15

16
Note that the Trust Agreement does not mention
“bankruptcy.” It refers to the broader concepts of
composition of debt and adjustment of creditor claims, in
which debtors and creditors agree to new terms of
repayment, or to repayment in full for less than the full
amount owed.
The Trust Agreement refers to the change in creditors’
rights, without any reference to the process or
proceeding used, and without any reference to the court
before which this composition of debt or adjustment of
creditor claims would be conducted.

17
The Trust Agreement requires that an order or decree be
entered, or any proceeding instituted, with the consent
of PREPA for it to be an Event of Default. This language
includes, by its terms, bankruptcy proceedings voluntarily
filed by PREPA.
If the Trust Agreement had referred exclusively to
bankruptcy proceedings, any composition of debt and
adjustment of creditor claims made outside of a
bankruptcy proceeding would not have been an Event of
Default under either of these two paragraphs.

18
But the Trust Agreement doesn’t refer exclusively to
bankruptcy.
It expressly refers to compositions of debt and
adjustments of creditor claims, without any limitation or
reference as to how and in which fora those changes to
creditors’ claims would come to be determined.

WELL, I DON’T LIKE IT
19

20
The argument by investors that “I bought these bonds
because PREPA could not file for bankruptcy, ever”
ignores US Supreme Court precedent, US centuries-old
bankruptcy practice, and is an argument for limiting
Congress’s powers over enacting bankruptcy laws in the
US.
It is also a call for an expansion of Congressional rule
over Puerto Rico that may border in despotism.
I’ll explain.

21
Federal bankruptcy laws in the US have always been
applied retroactively, beginning with the first one
enacted in 1800. That was done by necessity, since all of
them, until 1978, were enacted in response to major
financial disasters.
The 1841 Bankruptcy Act was the first to provide for the
voluntary filing by a debtor, and it applied to all persons
owing debt.
The first municipal bankruptcy legislation was enacted in
1934 during the Great Depression, revised in 1937 and
upheld by the Supreme Court in 1938 — and it applied to
existing debt.

THE COURT SAID
22

23
In 1982 the Supreme Court agreed with the argument
that the authority granted to Congress under the
Bankruptcy Clause “has been regularly construed to
authorize the retrospective impairment of contractual
obligations,” citing a 1902 case.
The matter of retroactivity had been considered by lower
courts before; however, “the decisions of the lower
federal courts generally indicated that the retroactive
feature of the amendments was not constitutionally
problematic, on the ground that the bankruptcy power
necessarily entails the power retroactively to impair
contractual obligations and related liens.” (See, Rogers.)

24
The Supreme Court has held that there is no
constitutional prohibition for approving retroactive
federal bankruptcy laws that impair contractual rights,
since the prohibition of the Contract Clause of the
Constitution applies only to laws enacted by the States.
Therefore, there is no constitutional prohibition for
approving a federal bankruptcy law that applies to debt
issued before the law was enacted.

25
For over 200 years bankruptcy legislation has been
applied retroactively.
For at least 170 years bankruptcy legislation has been
retroactively applied to creditors of a debtor who has
voluntarily filed a petition.
As to municipalities, bankruptcy legislation has been
applied retroactively for 77 years: ever since it was first
enacted, when it applied to Puerto Rico municipalities.

OLD IS NEW AGAIN
26

27
Perhaps this group of investors is preparing a new
argument: that the Territorial Clause trumps the
Bankruptcy Clause when dealing with debt issued by a
territory. Investors could be trying to create a hierarchy
between these two Constitutional Clauses.
This way, the clear precedents on bankruptcy law would
not apply to Puerto Rico.
If the powers of Congress under the Territorial Clause
were so absolute, Congress could ignore the Bankruptcy
Clause and its precedent, as to Puerto Rico.

28
Consider that investors cannot argue now that the
Bankruptcy Clause does not apply to Puerto Rico
government’s debt.
After all, they argued that it was the only remedy Puerto
Rico municipalities had, and won that argument before
the First Circuit Court in the Franklin California case.
They won in spectacular fashion, and shackled the Puerto
Rico government in the process.
But, as the devil is in the details, if the Bankruptcy
Clause applies to Puerto Rico, so does all judicial
precedent and interpretation of the Bankruptcy Clause.

29
To get out of the limitations investors imposed upon
themselves with that litigation, they could now be trying
to “annul” the application to Puerto Rico of the
Bankruptcy Clause, its judicial precedent, and the way it
has been implemented for more than 200 years.
Investors could try to argue that, regarding the debt of
Puerto Rico municipalities, the Territorial Clause is higher
in a Constitutional hierarchy than the Bankruptcy Clause.

GO TERRITORIAL
30

31
These arguments would be a blatant attempt to use the
Territorial Clause and Puerto Rico’s subordinated political
status to get a special benefit for themselves.
If they prevailed, they would be able to ignore centuries-
old precedent that affects their profits.
They would “neutralize” judicial precedent that
authorizes the retroactive application of a bankruptcy
law and that hurts their expected investment returns.

32
If the purpose of Chapter 9 is to “provide a financially-
distressed municipality protection from its creditors
while it develops and negotiates a plan for adjusting its
debts,” the idea of a non-retroactive bankruptcy makes
no sense.
It would be fascinating to see if a Court in the US would
be willing to establish that the Territorial Clause trumps
the Bankruptcy Clause, and in that way carve out a
super-exception to specially benefit the territories’
creditors over the creditors of the 50 States.
Particularly since States and territories issue debt in the
same market and under the same market rules and
regulations.

33
Such a holding would provoke higher debt costs for State
issuers, since debt issued by the territories would, in
theory, never be subject to default.
Therefore, interest rates ought to be considerably lower
for debt issued by territories, since there would be no
“default risk” for which investors ought to be
compensated.
Lower cost for territories, higher cost for States…
But I digress.

SO…
34

35
PREPA’s Trust Agreement was issued in 1974, when PREPA
was authorized to file for protection under Chapter 9 of
the Bankruptcy Code.
The language providing for the composition of debt and
the adjustment of creditor claims has not changed in 41
years, and logically includes bankruptcy proceedings.
All of PREPA’s outstanding debt has been issued subject to
that language.

36
For over 200 years bankruptcy law in the US has been
applied retroactively. In the case of municipalities,
always — ever since it was enacted.
The Supreme Court held the constitutionality of the
retroactive application in 1982, referencing a 1902 case.
In 1984 Congress, with no publicly disclosed rationale,
excluded Puerto Rico municipalities from the protections
of Chapter 9.

WHY NOT?
37

38
Are investors and Members of Congress confused?
No.
What they seem to want is for someone to make up to
them the losses they have recently suffered in other
Chapter 9 bankruptcies.
That is what, for all intents and purposes, investors’
representative told Congress last February.

39
The written testimony states that “Chapter 9 hurts
bondholders”, and details “how badly” they were hurt in
the bankruptcies of Detroit, Stockton, Vallejo, and
Jefferson County.
The oral testimony repeated the argument, and
buttressed the idea of the surprise, ignoring decades of
judicial precedent and centuries of US bankruptcy
practice.
It’s not difficult to conclude why these declarations
about losses on prior bankruptcies are being made.

THE COLLISION
40

41
Congress could refuse to extend Puerto Rico
municipalities the right to file for bankruptcy based on
the argument of “what a surprise it would be to
investors.”
No matter if that argument goes against the historical
bankruptcy practice in the US and against Supreme Court
precedent.

42
Such a refusal presupposes that the Territorial Clause
overrides the Bankruptcy Clause as to Puerto Rico.
It presupposes that judicial precedent and centuries-old
bankruptcy practice do not apply to Puerto Rico.
Just because.
And if that makes Puerto Rico seem like an 18th century
colony, well, that’s precisely when the Territorial Clause
was written.

43
The filing for protection under Chapter 9 of any Puerto
Rico municipality merely starts a process in which the
debtor has to comply with the requirements and hurdles
of the Bankruptcy Code.
There are matters of eligibility, insolvency, feasibility,
guarantees, protections, and nature of debt to be argued
before a bankruptcy court, and for a bankruptcy judge to
decide under the provisions of the uniform Bankruptcy
Code.
It is not for Congress to decide under the provisions of
the autocratic Territorial Clause.

44
Although, given the dysfunctional relationship between
Puerto Rico and the US, anything is possible.
To paraphrase Puerto Rico’s sole, non-voting
representative in the US Congress, “welcome to life in
the territory.”

POSTSCRIPT
45

46
On 5 November 2015, PREPA and some of its creditors
entered into a Restructuring Support Agreement, which
does not amend the Events of Default discussed here.

EXTRAS
47

48
The Impairment of Secured Creditors’ Rights in
Reorganization: A Study of the Relationship Between the
Fifth Amendment and the Bankruptcy Clause, by Prof
James S. Rogers, Professor of Law, Boston College Law
School, at page 1017.
United States Courts, Chapter 9 Bankruptcy Basics,
webpage maintained by the Administrative Office of the
U.S. Courts, on the purpose of Chapter 9.
Testimony from Mr Thomas Moers Mayer, Esq., 26
February 2015 Hearing of the House Judiciary
Committee’s Subcommittee on Regulatory Reform,
Commercial and Antitrust Law on H.R. 870, Puerto Rico
Chapter 9 Uniformity Act of 2015, at page 3.

49
The History of the Bankruptcy Laws in the United States,
by Prof Charles J. Tabb, Mildred Van Voorhis Jones Chair
in Law, University of Illinois College of Law.
Puerto Rico and the Bankruptcy Clause. I had made
reference to this article by Prof Stephen J. Lubben in a
previous post. It should be read by everyone interested in
this matter of bankruptcy for Puerto Rico, so here it is
again.

50
Why Republicans should endorse Treasury’s proposal for
restructuring Puerto Rico’s debt. Article on Puerto Rico
from the perspective of a government official by Kristi
Culpepper, Commonwealth of Kentucky.
First Circuit decision fails to relieve Puerto Rico's debt
crisis. Article on the absurdity of the Puerto Rico’s
restructuring situation by Sally J Sullivan, of Caplin &
Drysdale.

51
On 21 August 2015 Puerto Rico filed a Petition for a writ
of certiorari before the US Supreme Court in the Franklin
California case.
The petition is pending; it has been distributed for the
Conference of 24 November 2015. That's when the
Supreme Court will decide whether to grant the petition.
Here is the SCOTUSblog case page.

Chapter 9 and PREPA: it’s in the agreement. And the precedent

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