Washington's Puerto Rico rescue legislation makes its biggest break from municipal finance tradition in a section dealing with collective action, public finance lawyers said.
The section is "unique in our justice system," said James Spiotto, managing director of Chapman Strategic Advisors; it is the first law in U.S. history that carves out a period outside of bankruptcy for bondholders to negotiate terms of a restructuring.
Title VI, section 601(j) of the Puerto Rico Oversight, Management, and Economic Stability Act addresses how bondholders can agree to modify their own bond terms. It says that holders of at least two-thirds of each pool's principal who vote must approve the modification and holders of at least 50% of total principal outstanding in each pool must approve it. According to the act, every bond issuer has at least one pool of bonds and these bonds are divided into different pools if they have different priorities or security features.
Under the Trust Indenture Act, which normally applies to municipal bonds, 100% of bondholders have to agree to changes in certain terms like principal, interest, and maturity, Spiotto said. PROMESA, which Pres. Obama signed on June 30, trumps the Trust Indenture Act with regards to Puerto Rico bonds.
In Chapter 11 bankruptcy, available to both corporations and individuals, at least two-thirds of the holders of the debt by amount and half by number of holders must vote to accept a restructuring offer before the deal can be accepted. Ballard Spahr attorney Matthew Summers said this was similar to the PROMESA section.
Spiotto emphasized PROMESA's difference from Chapter 11, however, saying the latter involves a consideration of all of a creditor's debts in a court-supervised process, while PROMESA extends this negotiation and voting process to those negotiating a particular class or classes of debts and does so outside of a court-overseen process.
The issuer's pension holders or suppliers owed money aren't eligible under PROMESA to reach a collectively negotiated solution, though they could be affected by the court-supervised process found in PROMESA's Title III.
Title VI of PROMESA had its origin in the terms found in foreign sovereign debt, Spiotto said. These bonds allow holders to vote to change the fundamental bond terms. Several Greek bonds have been modified this way, he said.
Another section of PROMESA affecting restructuring, Title III, is basically a substitute for Chapter 9 but with an oversight board, Spiotto said. In Title III section 301(a) most but not all of the provisions of Chapter 11 that are incorporated into Chapter 9 are included in PROMESA, said Arent Fox Partner David Dubrow. Most of Chapter 9 has been included in PROMESA, Dubrow said.
Title VI is the break with tradition and will be the most controversial, Spiotto said.
"What is unusual here and has caused complaints by various bondholders," he said, "is that this provision may retroactively modify existing contractual rights through a process that is done without court supervision, without the protections that the Bankruptcy Code provides to dissenting class members, including the requirement that the debtor demonstrate that the various legal standards for confirmation contained in the Bankruptcy Code are met, and with review by the federal district court only to determine if the modification is 'manifestly inconsistent' with the act.
"This makes the collective action provision of the act unique in American law and has caused some to question whether the provision is constitutional."
Summers said that the law's conditions for court review of any successful creditor collective actions would make it unlikely that the court would overturn these actions.
Because PROMESA requires 50% of the holders of outstanding par to vote in favor of a modification of terms whereas Chapter 9 or 11 requires 50% of the votes of those who vote, Spiotto said that it may be more difficult to reach a voted-upon modification with PROMESA. Dubrow said he thought the PROMESA requirement would be easier to reach than the Chapter 9 requirement.
Title VI, section 601 (m)(1)(A) says that the modification of bond terms by creditor collective action are to be binding as long as the holders of the right to vote in "every pool of the issuer" have approved the modification. "Presumably this provision is designed to ensure that there is a holistic resolution of the issuer's debt in a manner acceptable to the issuer and requisite number of all classes of debt of that issuer," Dubrow said.
In Chapter 9 or 11, "in order to cram down a plan on dissenting classes, a debtor needs only to obtain the affirmative vote of one impaired accepting class and meet the other legal requirements for confirmation," Summers said. Because PROMESA requires all pools of an issuer's bonds to agree, the law will make it harder to reach an agreement. This is comparing two different situations – the former in a court-ordered bankruptcy and the other in bondholder negotiated deals.
Title VI, section 601(d)(4) indicates that, with the exception of Puerto Rico Electric Power Authority bonds, in any restructuring insured and uninsured bonds must be treated the same. Any restructured PREPA bonds can be treated differently according to whether they are insured, if the majority of the insured and majority of the uninsured agree to it.
If the creditor collective action clause fails, the PROMESA oversight board can request a court modify the bond terms in a bankruptcy proceeding ruled by PROMESA's Title III.
As in Chapter 9, PROMESA allows appeals of the court's decisions. The act makes clear that an appeal of one order would not result in a stay on other case matters, Summers said. This may allow a bankruptcy stage to advance at a reasonable speed, he said.
This appeals section "streamlines the process and prevents forum shopping," said David Fernández, public finance attorney at Buchanan, Ingersoll & Rooney PC.
Whereas parties in bankruptcies have the right to appeal first to the district court and then to a circuit court, parties in PROMESA will already be in the district court and only have the right to appeal decisions to the circuit court, Summers said. Hypothetically, in either traditional bankruptcy or in PROMESA, parties can appeal to the Supreme Court, but this court rejects hearing most cases.
While PROMESA gives a wide range of rights to the oversight board, if a court becomes involved in a bankruptcy process, the court's jurisdiction is to be limited to deciding on debt matters, according to Title III, section 305. This is similar to section 904 of Chapter 9, Spiotto said. Section 904 allows states to retain some sovereignty from the federal government in the bankruptcy process of their municipalities.
PROMESA gives this sovereignty to the oversight board.