Puerto Rico Calls for Suit to be Dismissed

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Puerto Rico called for the dismissal of a lawsuit challenging the commonwealth's newly passed public corporation restructuring law.

The commonwealth's Department of Justice and Kirkland & Ellis LLP filed a motion to dismiss Monday on behalf of the commonwealth, Gov. Alejandro García Padilla, and the Government Development Bank of Puerto Rico. Gonzalez, Machado & Roig, LLC and Cleary Gottlieb Steen & Hamilton LLP filed a motion to dismiss on behalf of the Puerto Rico Electric Power Authority.

Oppenheimer Rochester Funds and Franklin Funds sued the three government bodies and the governor in the United States District Court for Puerto Rico on June 29. In the complaint the firms said PREPA might use the restructuring law very soon. Franklin Funds has $907 million in PREPA bonds and Oppenheimer Rochester Funds has $821 million of the bonds.

In both Puerto Rico court motions, the attorneys argue that the investment firms are launching their suit prematurely. "Plaintiffs lack standing to make those allegations, because neither PREPA - nor any other Puerto Rico public corporation - has sought relief under the Recovery Act [that allows public corporation debt restructuring]," PREPA's lawyers state.

In Puerto Rico's motion to dismiss, Secretary of Justice César Miranda Rodriguez and the other attorneys argue that the Recovery Act isn't preempted by the federal bankruptcy code and doesn't violate the U.S. Constitution's bankruptcy clause. They also argue that section 903 of the bankruptcy code doesn't conflict with the act.

"U.S. Supreme Court precedent makes clear that state and local governments retain the power to pass their own restructuring statutes, so long as they do not conflict with federal law," Puerto Rico said in a press release. The Supreme Court has also allowed governments to impair creditors' contractual rights and property rights under certain conditions, it said.

The Puerto Rico filings ask the judge to dismiss the suits.

Regarding Puerto Rico's claim that the court does not have standing to hear the case because the Recovery Act had not yet been used, municipal bankruptcy expert James Spiotto said there was some validity to this claim but that on balance he thought the judge would reject it.

Puerto Rico has made clear in the Recovery Act and the introduction to its motion to dismiss that the commonwealth and, in particular, PREPA are in pressing financial situations. PREPA and perhaps other public corporations may use the act in the near future, Puerto Rico stated. The imminence and likelihood of use of the act may lead the court to decide to rule on it, said Spiotto, managing director at Chapman Strategic Advisors.

If the restructuring law goes into effect, according to the law the creditors could possibly be barred from then filing suit in other state or federal courts to contest the law, at least until the restructuring proceeding is concluded. If courts subsequently overturned the law a great deal of time and effort, including time and effort by the courts in the restructuring proceeding, would have been wasted. Courts aim to reduce the wasting of their own time and on this principle may decide to hear the federal case now, Spiotto said.

In Puerto Rico's argument that the restructuring law was a potentially valid impairment of contract or taking, Puerto Rico cited Faitoute Iron & Steel Co. vs. City of Asbury Park, a 1942 decision.

In this decision, the U.S. Supreme Court pointed to the poverty of Asbury Park, N.J., at the end of the Depression as indicating the city probably wouldn't be able to pay the debt, Spiotto said. The court also said the city had a "paper" or unsecured debt. The court said it was not addressing a secured debt.

PREPA's bonds are revenue bonds and thus considered a secured debt. This difference could be a problem for Puerto Rico's argument, Spiotto said.

If the court rules that the creditors cannot challenge the restructuring law now, the ruling could put them in a Catch-22: the creditors would not be able to challenge it before a public corporation restructuring and they would not be able to challenge it after because the law itself puts a stay on all challenges to it, Spiotto said.

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