June 28, 2016

H.R. 5278 Puerto Rico Oversight, Management, and Economic Stability Act

Noteworthy

Background: The House Natural Resources Committee reported the Puerto Rico Oversight, Management, and Economic Stability Act, H.R. 5278, on June 3, 2016. The full House passed PROMESA on June 9, 2016, by a vote of 297-127 (R: 139-103; D: 158-24). On Monday, June 27, cloture was filed on the motion to concur in the House amendment to S. 2328, the vehicle for PROMESA.

Floor Situation: A cloture vote on the motion to concur in the House amendment to S. 2328 is expected Wednesday. The amendment tree is filled.

Executive Summary: The bill establishes a Republican-majority financial oversight board to take control of the territory’s finances and encourage economic reform. The bill stays creditor litigation temporarily to allow the island to get a handle on its finances. It authorizes Puerto Rico to restructure its debt in a court-supervised bankruptcy or through a creditor collective action process. It gives Puerto Rico a narrow exemption from the federal minimum wage, exempts the island from the Department of Labor’s new overtime rule, and implements an expedited permitting program for critical projects.

Overview of the Issue

Puerto Rico is in the middle of a financial crisis. The central government and the island’s various public corporations have accumulated approximately $70 billion in outstanding debt, and on July 1 the territory has a $1.9 billion debt payment that it is unlikely to make. Puerto Rico also has $43 billion in unfunded pension obligations. The three pension systems have no assets and will be entirely pay-as-you-go by fiscal year 2018, at which point pension payments will draw more from the general fund than debt service obligations.

Puerto Rico’s economy is also in a recession. Nominal GNP is stagnant. Unemployment is 12.2 percent – nearly double that of every U.S. state – and 60 percent of the working-age population has opted out of the workforce, compared to 40 percent in the rest of the U.S. One percent of the island’s population is emigrating to the states every year.

Puerto Rico has demonstrated that it is unable to balance its budget and is willing to not pay its debts in order to avoid reform. Its public sector remains bloated, with the government the largest employer on the island. Tax collection is meager, and audited financial statements are long past due. In an effort to avoid its debts, the island passed a debt moratorium law in April, authorizing the governor to stop all debt payments in order to prioritize government expenses.

To address these problems, PROMESA establishes a Republican-majority financial oversight board to take control of the territory’s finances and push economic reform. The bill also stays creditor litigation temporarily to allow the island to get a handle on its finances, and it authorizes Puerto Rico to restructure its debt in a court-supervised bankruptcy or through a creditor collective action process. For economic growth, it gives Puerto Rico a narrow exemption from the federal minimum wage, exempts the island from the Department of Labor’s new overtime rule, and implements an expedited permitting program for critical projects. 

Considerations on the Bill

Some conservatives are concerned that PROMESA puts too much trust in the financial oversight board. The board would control all major decisions regarding the restructuring of Puerto Rico’s debts, and thus would be responsible for resolving the competing interests of creditors, pension funds, and government services. The board must resolve these competing interests, while satisfying PROMESA’s command that the board “provide adequate funding for public pension systems” and seek a sustainable level of debt. With a Republican majority, the board is more likely to resolve these conflicts fairly, but if it does not, Republicans will be held accountable for the outcome nonetheless.

Some also argue that the board has too little power to make changes that encourage economic growth. The board may recommend changes to the island, but the island need only provide a justification to Congress and the president to ignore the board’s recommendations.  

There is also concern that the automatic stay and bankruptcy violate the contractual rights of creditors. Both are post-hoc alterations to creditor’s rights and could be challenged as unconstitutional takings. These challenges are unlikely to be successful. Changes to bankruptcy law frequently alter creditors’ rights and are not regarded as takings. And while the automatic stay does delay some contractual rights, it is unclear what, if any, value such rights have for purposes of a taking.

Additionally, PROMESA includes several provisions intended to protect creditor rights. It requires the board, who controls all restructuring decisions, to respect the “relative lawful priorities or lawful liens” of creditors. And the court supervising any bankruptcy may approve a restructuring plan only if the plan is feasible and “in the best interests of creditors.” This requires that creditor outcomes be as good in bankruptcy as they would be outside of it.

There is also controversy surrounding which debts should be subject to bankruptcy. Under traditional Chapter 9 – the Bankruptcy Code for municipalities – debt issued or guaranteed by a state government, such as general obligation bonds, is not subject to bankruptcy. PROMESA, however, makes it possible to put all of Puerto Rico’s debt, including the general obligation bonds, into bankruptcy.

Some are concerned that exposing general obligation bonds would set a precedent for extending bankruptcy access to state governments under Chapter 9 of the bankruptcy code – this is the so-called “Super 9.” There are several reasons to discount this concern. PROMESA’s bankruptcy provisions work only with the supervision of an oversight board. This is something Congress is unlikely to impose on a sovereign state. States have repeatedly expressed their disinterest in Super 9, and it is unclear if Super 9 would be constitutional.

Some critics also argue that extending bankruptcy to Puerto Rico’s general obligation debt would disrupt the broader municipal bond market. While it’s difficult to predict how markets will respond, the market already has priced much of the deterioration in Puerto Rico’s finances into bond prices, and most market participants should recognize Puerto Rico’s unique situation. Ultimately, a July 1 default on Puerto Rico’s general obligation debt could be more disruptive to markets.

Lastly, the collective action process created in title VI of PROMESA could raise constitutional issues. Like the bankruptcy provisions, the process would retroactively change creditors’ rights, yet, it operates without the precedent on which the bankruptcy provisions rely. If utilized, this process could result in takings claims from creditors who did not consent to the change.

Notable Bill Provisions

Title I – Establishment and organization of oversight board

Section 101 – Financial Oversight and Management Board

Establishes a financial oversight board over the government of Puerto Rico and authorizes the oversight board to expand its jurisdiction to any of the territory’s instrumentality.

The oversight board consists of seven members appointed by the president. Two are to be appointed from two separate lists submitted by the speaker of the House; two from a list submitted by the Senate majority leader; one from a list submitted by the House minority leader; one from a list submitted by the Senate minority leader; and one of the president’s choosing. One of the lists submitted by the Speaker must include only individuals with a primary residence or place of business in Puerto Rico. The president, if acting quickly, could also select names not on the lists, but those appointees would be subject to Senate confirmation. If all appointments are not made by September 1, 2016, the president must choose a nominee from congressional lists by September 15, 2016. The governor of Puerto Rico or a designee would serve as an eighth non-voting member.

Members of the board cannot be a candidate for elected office, an elected or appointed official, a former elected official of the territory; nor an employee of the territorial government.

Members serve for a term of three years, but may continue to serve until a successor has been appointed. The president can remove members of the board only for cause. They are not paid, but can be reimbursed for reasonable and necessary expenses. The board may hire professionals to assist the board. The board would select its chair from among the seven members.

Consequential actions of the board require an affirmative vote of a majority of the members of the board and all members of the board must be appointed before the board can take actions such as approving a fiscal plan.

Section 104 – Powers of oversight board

Gives the board the power, among other things, to:

  1. Hold hearings and seek testimony;
  2. Obtain information and documents from the federal government and the government of Puerto Rico;
  3. Obtain information on the nature and aggregate amount of claims from creditors seeking to participate in voluntary negotiations;
  4. Issue subpoenas and seek civil enforcement of subpoenas in court;
  5. Enforce the laws of Puerto Rico prohibiting public sector employees from participating in a strike or lockout;
  6. Bring civil actions in court to enforce its authority;
  7. Certify and approve any voluntary restructuring agreements with bondholders; and
  8. Control any decisions to file for bankruptcy.

All voluntary restructuring agreements require board approval. The board may approve voluntary restructuring agreements only if the board determines, in its sole discretion, that the agreement provides for a sustainable level of debt; or the agreement simply delays payments for one year. Agreements reached before enactment of PROMESA would be grandfathered in.

Section 107 – Budget and funding for operation of oversight board

Requires the government of Puerto Rico to fund the oversight board, starting with an initial transfer of $2 million or an amount determined by the oversight board.

Section 108 – Autonomy of oversight board

Prohibits the governor or legislature of Puerto Rico from enacting any laws or taking any action to interfere with the actions of the board.

Title II – Responsibilities of oversight board

Section 201 – Approval of fiscal plans

Directs the oversight board to develop and approve a five-year fiscal plan that meets listed criteria. The plan may be submitted by the governor and approved by the board; developed and approved by the board without the governor’s participation; or jointly developed by governor and board then approved by the board.

Among other things, the fiscal plan must:

  1. Ensure funding of public services;
  2. Provide for adequate funding of essential public services;
  3. Provide for the elimination of structural deficits;
  4. Provide for a debt burden that is sustainable;
  5. Provide for capital expenditures and investments necessary to promote economic growth;
  6. Prevent transfers from one debtor to another, unless approved by creditors; and
  7. Respect the relative priorities and liens of creditors.

Section 202 – Approval of budgets

Directs the oversight board to develop and approve the island’s budgets in coordination with the governor and legislature. The governor has an opportunity to propose a budget, but if the board determines the budget is not compliant with the applicable fiscal plan, then the board is authorized to submit a budget to the governor and legislature. Similarly, the legislature has an opportunity to adopt a compliant budget. But if the board determines the budget is not compliant with the fiscal plan, the board is authorized to submit a budget that is deemed approved by the governor and legislature. The governor, legislature and board can also work collaboratively to develop a budget.

Section 203 – Effect of finding of noncompliance with budget

Requires the governor to submit quarterly financial reports to the board identifying actual cash revenues and expenditures. If the board finds inconsistencies between the budget and actual finances, the board must order the government to take remedial action to address the inconsistency.  If the government fails to do so, the board must take action to reduce non-debt expenditures.

Section 204 – Review of activities to ensure compliance with fiscal plan

Requires the board to review all newly passed laws for compliance with the fiscal plan. If a law is inconsistent with the plan, the board may require the government to correct the law, or, if the government fails to correct the inconsistency, the board may block the enforcement or application of the law.

Authorizes the board to require board approval of government contracts, rules, regulations, or executive orders and to block such actions if not compliant with the fiscal plan.

Prohibits the government from transferring any funds outside the ordinary course of business prior to the appointment of all members of the board. Once appointed, the board may rescind any law enacted after May 4, 2016, that alters pre-existing creditor priorities.

Section 205 – Recommendations on financial stability and management responsibilities

Permits the board to submit recommendations to improve financial stability and economic growth to the governor and legislature. If the government rejects these recommendations, it must submit a statement to Congress and the president explaining why the recommendation was rejected.

Section 206 – Oversight board duties related to restructuring

Requires a vote of at least five of the board members to approve a restructuring agreement. The board must determine that the territory or instrumentality has negotiated with creditors in good faith and has procedures for releasing timely audited financial statements.

Section 207 – Oversight board authority related to debt issuance

Requires that any new debt issuance, exchange, or similar transaction be approved by the board.

Section 209 – Termination of oversight board

Terminates the board when the board finds that the government has access to short- and long-term credit markets at reasonable interest rates, and the island has balanced its budget for four consecutive years.

Section 211 – Analysis of Pensions

Requires the board to study any of the government’s pension systems that are underfunded.

Title III – Adjustment of Debts

Section 301 – Applicability of other laws; definitions

Applies many sections of the Bankruptcy Code, Title 11 of the U.S. Code, to create a process by which Puerto Rico may restructure its debts in a court-supervised bankruptcy. Among other things, these provision provide a new automatic stay against creditor litigation upon filing (Sec. 362 and Sec. 922); give administrative expenses highest priority (Sec. 507(a)(2)); authorize the discharge of the territory’s debts (Sec. 524(a)(1) and (2)); provide criteria for submission of a restructuring plan (Sec. 1123(a)(1)-(4) and (10)); and allow a “cramdown” (forcing creditors to accept a plan they do not support) of impaired classes, meaning those who are recovering less than the terms of their contract (Sec. 1129(b)(1)). A cramdown is permissible if at least one impaired class accepts the plan, the plan does not discriminate unfairly between similarly situated creditors, and the plan is fair and equitable.

Section 302 – Who may be a debtor

Puerto Rico may access the bankruptcy process under this title only upon approval of the board.

Section 303 – Reservation of territorial power to control territory and territorial instrumentality

Clarifies that the territory retains its territorial powers, except the territory may not pass any law that modifies the rights of creditors outside of bankruptcy without creditor consent.

Section 312 – Filing of plan of adjustment

Provides that only the board may file a restructuring plan within the bankruptcy process.

Section 314 – Confirmation

Establishes the standard for confirmation of a restructuring plan by the court. The court must confirm the plan if it finds that:

  1. the plan complies with the provisions of the Bankruptcy code and with the provisions of this title;
  2. none of the actions necessary to carry out the plan are prohibited by law;
  3. administrative costs and fees will be paid in full;
  4. all legislative, regulatory, or electoral approval necessary has been obtained or relevant provisions are expressly conditioned on obtaining such approval;
  5. the plan is feasible and in the best interest of creditors; and
  6. the plan is consistent with the fiscal plan. 

A plan is in the best interest of the creditors if it provides an equal or greater recovery than the creditor would receive outside of bankruptcy.

Section 315 – Role and capacity of oversight board

Establishes the board as the representative of the territory or instrumentality in bankruptcy and authorizes the board to take any action on behalf of the territory or instrumentality to prosecute the case.

Title IV – Miscellaneous Provisions

Section 403 – First minimum wage in Puerto Rico

Permits the governor of Puerto Rico to modify the island’s minimum wage, with the approval of the oversight board. Employers are able, for a period of up to four years, to modify the entry wage for newly hired workers up to age 25 to $4.25 an hour from the current minimum wage of $7.25 an hour. The provision expires when the board disbands. 

Section 404 – Application of regulation to Puerto Rico

Exempts Puerto Rico from the Department of Labor overtime rule until the comptroller general of the United States assesses the economic conditions in Puerto Rico and the impact the overtime rule would have in Puerto Rico, and reports its findings to Congress. The secretary of labor must take into account the report, and provide a written determination to Congress that the overtime rule would not have a negative impact on the economy of Puerto Rico. The government of Puerto Rico requested an exemption from the overtime rule.

Section 405 – Automatic stay upon enactment

Stays, upon enactment of PROMESA, any act to enforce, collect, recover, or setoff any liability claim, property claim, or lien against the government of Puerto Rico. The stay may not be treated as a default under existing contracts or law. The stay remains in place until the earlier of (1) the later of February 15, 2017 or six months after the board is established; or (2) the date on which the board files for bankruptcy under Title III. The stay may be extended if more time is needed to complete the process under Title VI. Parties subject to the stay may request relief from the stay in district court. The court must provide relief, after notice and a hearing, if cause is shown. The court must grant relief from a stay without a hearing if necessary to prevent irreparable damage to an interest in property.

Section 407 – Protections from inter-debtor transfers

Prohibits an instrumentality of Puerto Rico from transferring funds encumbered by liens or security interests to another governmental entity while the board is in operation. Bond insurers recently sued the Puerto Rico Highways and Transportation Authority for using toll proceeds secured by bond holders to pay for government expenses. This provision responds to concerns that Puerto Rico may attempt to similarly redirect funds in other areas.

Title V – Puerto Rico Infrastructure Revitalization

Establishes a process by which projects in Puerto Rico may be designated as “critical projects” and receive an expedited permitting process through Puerto Rico agencies. Project sponsors may submit applications to a “revitalization coordinator” – appointed by the governor from a list provided by the board – for classification as a “critical project.” An emphasis is placed on energy-related projects. Proposed designations must go through a public comment process. Any agency involved in the permitting of a critical project must create an expedited permitting process within 20 days of receiving a project submission. If the agency fails, the revitalization coordinator may create such a process for the agency. Critical projects may notify the oversight board if an agency is failing to comply with the expedited permitting process and the oversight board may take actions to enforce compliance.

Title VI – Creditor Collective Action

Establishes a process by which a supermajority of creditors may retroactively restructure Puerto Rico’s debt outside of a bankruptcy proceeding. Similar procedures have been included in European sovereign debt issuances for some time to expedite the negotiation of sovereign debt restructurings. The process is designed to override those creditors with an incentive to hold out for better terms.

Under PROMESA, creditors are divided into pools according to issuer, priority, and security arrangement. The oversight board is required to certify that a proposed restructuring agreement – referred to as a “qualifying modification” in this title – is consistent with the fiscal plan and treats like creditors similarly. Then, upon the affirmative vote of those holding two-thirds of the outstanding principal in each pool, the qualifying modification would be binding on all present and future bondholders, whether or not they participated in the vote. Issuers are not required to use this process before filing for bankruptcy; however, the process may run concurrent to bankruptcy and supersede it if an agreement is reached.

Administration Position

The administration supports passage of this bill.

Cost

CBO estimates that PROMESA will have no significant net effect on the federal deficit. It would increase direct spending by $370 million for the oversight board’s administrative costs, but those costs would be paid for by the government of Puerto Rico.

Amendments

Amendments are not expected on this legislation.