How Can Puerto Rico Stay Afloat with Rising Debt and No Help?

By Jaime Balladares

Bankruptcy is a legal maze that no individual wants to travel through. But, what happens if an entire country is bankrupt? Hurricanes Irma and Maria ravaged the United States territory of Puerto Rico and will have long lasting effects on the small island. Before the hurricanes hit the small island, Puerto Rico filed for bankruptcy protection the day after its creditors filed a lawsuit looking to collect on the debt.[1] Now, Puerto Rico must not only attempt to rebuild its internal infrastructure, but must also deal with creditors that demand repayment.

Puerto Rico has been in a decade-long recession causing the government to owe nearly $70 billion in outstanding bonds (not including the $40 billion in unfunded pension liability).[2]  This created a debt-to-GDP ratio of over 100%, which will likely never be paid.[3] Governor Padilla signed into law the “Puerto Rico Public Corporation Debt Enforcement and Recovery Act” to allow Puerto Rican public utility corporations to declare for Chapter 9 bankruptcy.[4] However, the U.S. District Court for the District of Puerto Rico voided the Act, holding that it was preempted by the U.S. Bankruptcy Code. The court’s decision was subsequently affirmed by the Court of Appeals for the First Circuit and the United States Supreme Court.[5]

The Federal Bankruptcy Code contains a “gateway” provision that only allows municipalities authorized by state law to restructure their debts under Chapter 9 of the Code.[6] However, the Chapter 9 “gateway” provision only applies to municipalities on the mainland.[7] In 1984 Congress amended the definition of “state” to exclude Puerto Rico, implying that it allows Puerto Rico to seek Chapter 9 Bankruptcy. The Supreme Court decided that the amendment prevents Puerto Rico from authorizing its municipalities to seek Chapter 9 relief and found that Puerto Rico remains under the definition of “state” for all other purposes.[8] Under this interpretation, no municipality in Puerto Rico may ever seek Chapter 9 relief whereas municipalities on the mainland are allowed to do so.

Where does this leave Puerto Rico? Congress should enact its Territory Clause under the Constitution and get the creditors to reduce or cancel the debts.[9] Puerto Rico cannot save itself on its own. This solution will cause a lot of U.S intervention in order to fully oversee Puerto Rico’s budget. In return, the creditor community will likely re-invest and have a renewed trust in an island that has the potential for a substantial return.

[1] Puerto Rico v. Franklin California Tax-Free Trust, 136 S. Ct. 1938, 1940 (2016).

[2] Nick Brown, Puerto Rico oversight board favors more time for restructuring talks, Reuters (Jan. 18, 2017), http://www.reuters.com/article/us-puertorico-debt-oversightboard/puerto-rico-oversight-board-favors-more-time-for-restructuring-talks-idUSKBN15230T.

[3] John A.E. Pattow, What Bankruptcy Law Can and Cannot Do for Puerto Rico, 85 Rev. Jur. U.P.R. 689, 700 (2016).

[4] Recent Legislation: Puerto Rico Passes New Municipal Reorganization Act, 128 Harv. L. Rev. 1320, 1320 (2015).

[5] Franklin California Tax-Free Trust v. Puerto Rico, 85 F. Supp. 3d 577, 614 (D.P.R. 2015); Franklin California Tax-Free Trust v. Puerto Rico, 805 F.3d 322, 345 (1st Cir. 2015); Puerto Rico v. Franklin California Tax-Free Trust, 136 S. Ct. 1938, 1949 (2016).

[6] See 11 U.S.C. § 109(c)(2) (2016).

[7] William Hoke, Federal Role in Puerto Rican Debt Crisis Unclear, Tax Notes Today (Oct. 2015), https://www.taxnotes.com/tax-notes-today/collections/federal-role-puerto-rican-debt-crisis-unclear/2015/10/21/16849811.

[8] Puerto Rico v. Franklin California Tax-Free Trust, 136 S. Ct. 1938, 1942 (2016).

[9] See Puerto Rico Oversight, Management, and Economic Stability Act, 48 U.S.C. §§ 2101-2241 (2016).