Puerto Rico seeks bankruptcy protection

July 10, 2015
Contact: umichnews@umich.edu

FACULTY Q&A

After a decade of economic decline, Puerto Rico is suffering a financial crisis and is on the brink of default. The government has more than $70 million in debts that it says it can’t repay.

Puerto Rico, a U.S. commonwealth, wants Congress to grant it the same authority that U.S. states have to allow municipalities to file for Chapter 9 bankruptcy.

A leading expert on the issue is John A.E. Pottow, a law professor at the University of Michigan. Earlier this year, he testified before the House Judiciary Committee regarding House Bill 870, which seeks to give Puerto Rico the bankruptcy authority it wants.

Pottow discussed the issue with Michigan News:

Q: Under the federal bankruptcy code, U.S. states have the ability to decide if their municipalities can file for bankruptcy. Why can’t Puerto Rico do that?
Pottow: As a commonwealth, it can’t. In 1978, Puerto Rico could have likely authorized its municipalities to seek relief under Chapter 9. When the Bankruptcy Code was amended in 1984, Puerto Rico was left out. The word ‘states’ was introduced into the wording of Chapter 9 with a formulation that excluded Puerto Rico.

Q: Puerto Rico still can negotiate its debt with creditors. Wouldn’t that be more preferable than bankruptcy?
Pottow: If it could get all creditors in a room to agree to the same thing, sure, but that’s why we need bankruptcy law. If I negotiate with nine of my 10 creditors, but the 10th refuses, he’s called a ‘holdout.’ He says he doesn’t want to make any concessions. But then No. 9 gets wind of that and says, ‘Well, heck, why should I make a concession if No. 10’s not?’ And then everything unravels. To solve the holdout problem, bankruptcy law allows you to bind dissident minorities – with some procedural protections – if a supermajority of creditors vote that the plan is fair and makes sense.

Q: Why is this important to Puerto Rico?
Pottow: Puerto Rico itself can’t file bankruptcy, and even the law proposed would not allow it to do so. It would only allow Puerto Rico to decide whether its public entities – like the city of San Juan or the PERPA electric utility – could file. Indeed, Michigan can’t file for bankruptcy, but Detroit can and did. Bankruptcy for a city allows a chance to renegotiate with its creditors a viable repayment plan but also involves debt forgiveness when the debt is just unpayable. All creditors take hits. They hate it, but you can’t draw blood from a stone. Many public entities in Puerto Rico are in this state of financial distress.

Q: Is Congress willing to change the code so municipalities can go into bankruptcy in Puerto Rico?
Pottow: The House has seen such a bill proposed but no vote yet. A companion bill is about to be introduced in the Senate.

Q: There has been a lot of comparisons between Puerto Rico’s financial crisis and the one faced by Detroit. Could you explain how the laws regarding bankruptcy affect both entities?
Pottow: Chapter 9 worked well for Detroit. Despite the hurt that workers and pension holders felt, street lights are literally coming back to the city, and public services like public transportation are being restored. But most importantly, Michigan-elected officials had the choice to allow this. Puerto Rico’s governor has said it cannot repay its debts, and he has no access to a process that would allow him to efficiently renegotiate them.

Q: Are there detractors to allowing Puerto Rico to be treated as a state in this regard?
Pottow: Yes, investors with current bonds in the electric authority are fighting it tooth and nail.

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