Puerto Rico encountered another roadblock in its efforts to resolve its looming debt crisis on July 6, 2015, when the U.S. Court of Appeals for the First Circuit affirmed the decision of the District of Puerto Rico that Puerto Rico’s Debt Enforcement and Recovery Act (the “Recovery Act”) is unconstitutional and permanently enjoined its enforcement.1 The Recovery Act, enacted in June 2014, created a bankruptcy-like regime through which select Puerto Rican public corporations could restructure their debt obligations without unanimous creditor consent. Like the district court, the First Circuit concluded that the Recovery Act was preempted in its entirety by Section 903(1) of the U.S. Bankruptcy Code, which prohibits “States” (including Puerto Rico) from enacting laws that bind non-consenting creditors to the terms of a debt restructuring. Unlike the district court, the First Circuit did not address whether the law violated the Constitution’s Contract Clause.
The First Circuit decision was handed down not long after the much anticipated Krueger report—a white paper commissioned by Puerto Rico’s administration that addresses Puerto Rico’s financial situation—indicated that Puerto Rico’s financial condition was worse than previously believed and is unlikely to be cured without a debt restructuring. In light of this report, and concurrently with Puerto Rico’s appeal to the Supreme Court, Puerto Rico is redoubling its efforts to obtain congressional support for an extension of chapter 9 of the Bankruptcy Code. Even if Puerto Rico secures chapter 9 protection, however, a chapter 9 filing will not be a panacea for its debt crisis as the island’s constitutionally protected government obligation (“GO”) bonds would not be addressed and obligations of the deeply troubled Government Development Bank (the “GDB”) would possibly fall outside chapter 9’s purview.
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