2015 was a momentous year in the financial history of Puerto Rico. It is certain to be remembered as the year in which the Commonwealth’s long-running financial problems came to a head. In addition to being the 10th consecutive year of essentially zero or negative economic growth for Puerto Rico, 2015 was punctuated with a series of consequential (and almost uniformly negative) financial developments for the Commonwealth.
The year began with a challenging start for the Commonwealth’s government when, on February 6, the US District Court for the District of Puerto Rico struck down the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (the “Recovery Act”) as preempted by US federal law and likely unconstitutional for a variety of reasons. (Regular readers and those familiar with developments in Puerto Rico will recall that the Recovery Act, which was signed into law in June 2014, created a new bankruptcy-like regime at the Commonwealth level through which the debts of certain of Puerto Rico’s public corporations could purportedly be restructured without unanimous creditor consent.) For further discussion of the US District Court’s decision, see Chadbourne’s February 2015 Client Alert, Federal Court Strikes Down Puerto Rico’s Recovery Act as Unconstitutional. With the Recovery Act temporarily off the table, the Commonwealth lost significant leverage in its negotiations with creditors of the Puerto Rico Electric Power Authority 9 (“PREPA”),
which was then perhaps the most financially distressed of all of Puerto Rico’s instrumentalities.
The Commonwealth’s reported financial condition continued to deteriorate through the middle of the year, with apparent significant drops in year-over-year revenues and continued out-migration (the Commonwealth has not released audited financial statements for more than 2 years, resulting in a lack of transparency as to its true condition that cannot help the restructuring process). By June 28 the situation had become so dire that Puerto Rico Governor Alejandro García Padilla declared that Puerto Rico’s finances were in “death spiral,” and bluntly acknowledged that “[t]he debt is not payable.” The following day, on June 29, the Puerto Rico government released the so-called “Krueger Report” a 26-page high-level analysis of the island’s financial woes. The report’s opening paragraph accurately summarized the situation:
Puerto Rico faces hard times. Structural problems, economic shocks and weak public finances have yielded a decade of stagnation, outmigration and debt. Financial markets once looked past these realities but have since cut off the Commonwealth from normal market access. A crisis looms.
One week later, on July 6, the US Court of Appeals for the First Circuit upheld the district court’s earlier ruling that the Recovery Act was fully preempted by federal bankruptcy law. For further discussion of the Circuit Court’s decision, see Chadbourne’s July 2015 Client Alert, First Circuit: Puerto Rico’s Recovery Act Preempted, Ball in Congress’s Court—But a Curious Concurrence Too. (The Supreme Court has since agreed to consider the issue. An oral argument date has not yet been set.)
With the Recovery Act removed as an option barring an unexpected decision from the Supreme Court, the Puerto Rico government pursued a two-pronged approach of negotiating with creditors over a consensual restructuring while simultaneously seeking relief from Congress (either in the form of access to Chapter 9 of the Bankruptcy Code for Puerto Rico’s municipalities or enactment of a “super Chapter 9” for Puerto Rico as a whole). Although little headway has been made with Congress, the Commonwealth initially had some limited success negotiating with certain creditors. In particular, Puerto Rico reached a preliminary restructuring deal (involving, among other things, a 15% haircut) with certain of PREPA’s creditors in September, finalized portions of that deal in November, and obtained support for the deal from key monoline insurance companies
But despite its initial progress on PREPA’s debt, Puerto Rico as a whole has been unable to right the ship. As the year came to a close and resources available for mandatory January 2016 debt payments dwindled, Puerto Rico deployed its “constitutional clawback” for the first time in its history. At the governor’s direction, Puerto Rico’s treasury restrained revenue streams pledged for payment of the bonds of certain of Puerto Rico’s instrumentalities and diverted those revenues for payment of general obligation debt and various other Commonwealth obligations.
As a result, Puerto Rico has inauspiciously begun 2016 with multiple bond defaults (by its instrumentalities) and is now facing multiple lawsuits alleging that the “clawbacks” were illegal. Compounding those problems, the Commonwealth repeatedly failed to timely release a broad debt-restructuring proposal for consideration by its creditors. The proposal that was ultimately released, which calls for a $42.9 billion voluntary distressed exchange with near unanimous creditor participation, has been widely declared to be patently unworkable. A new and more constructive approach will be necessary for the Commonwealth to reverse its financial collapse.