Rep. Pierluisi Introduces Bankruptcy Code Amendment to Permit P.R. Municipalities to File Under Chapter 9

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Just days after the United States District Court for the District of Puerto Rico struck down the Commonwealth’s efforts to pass its own insolvency regime, Resident Commissioner Pedro Pierluisi introduced the “Puerto Rico Chapter 9 Uniformity Act of 2015” into the U.S. House of Representatives last week.  The bill, which is substantively similar to one introduced in 2014, would allow the Commonwealth of Puerto Rico to authorize its insolvent public corporations to file a chapter 9 petition; they currently are not able to do so.  The bill, H.R. 870, has been assigned to the House Judiciary Committee and is scheduled for a hearing before the Subcommittee on Regulatory Reform, Commercial and Antitrust Law on February 26th.  H.R. 870, 114th Cong. (1st Sess. 2015)

The Proposed Amendment

Section 101(52) of the Bankruptcy Code currently defines “State” to include the District of Columbia and Puerto Rico “except for the purpose of defining who may be a debtor under chapter 9” of the Bankruptcy Code.  Section 109(c) of the Bankruptcy Code states that an entity may be a chapter 9 debtor only if it is a “municipality.”  Section 101(40) of the Bankruptcy Code defines municipality as a “political subdivision or public agency or instrumentality of a State.”  Thus, political subdivisions, public agencies and instrumentalities of Puerto Rico currently are not eligible to seek relief under chapter 9 of the Bankruptcy Code.

Rep. Pierluisi’s bill would modify section 101(52) of the Bankruptcy Code so that the definition of State clearly “includes Puerto Rico” for the purpose of defining who may be a debtor under chapter 9 (and all other purposes).  The fix requires very little change to the Bankruptcy Code, and would thus permit all political subdivisions, public agencies and instrumentalities of the Commonwealth to file for chapter 9 bankruptcy (assuming they meet the other eligibility requirements of section 109(c) of the Bankruptcy Code, such as insolvency, being a municipality and express authorization to file).

Analysis

Generally, “political subdivision” includes counties, cities, towns, and the like, that exercise various sovereign powers such as the taxing power, the power of eminent domain, or the police power.  A “public agency” or “instrumentality” includes incorporated authorities, commissions, and similar public agencies organized for the purpose of constructing, maintaining, and operating revenue-producing enterprises. The term also includes local improvement districts, school districts, and the like, organized or created for the purpose of constructing, improving, maintaining, and operating improvements, schools, ports, and similar entities.

However, there is relatively little case law as to the meaning of these terms.  Below is a brief summary of the existing analysis.

Under the old Chapter IX, one court held that “[t]he legal test between a private and public corporation is whether the corporation is controlled by public authority, state or municipal.”  Kerr v. Enoch Pratt Free Library of Balt. City, 54 F. Supp. 514, 523 (D. Md. 1944).

In In re N. and S. Shenango Joint Mun. Auth., 14 B.R. 414, 415-18 (Bankr. W.D. Pa. 1981), the bankruptcy court considered whether a sewer system operated by two townships constituted a municipality.  The court, ruling under the Bankruptcy Code, held that the entity was a municipality for several reasons: because the entity was incorporated under the state Municipality Authorities Act; because state case law considered entities created under this act to constitute public agencies and instrumentalities of the state; and because the entity had governmental powers conferred upon it by statute.

In the mid-1990s, in In re Cnty. of Orange, 183 B.R. 594 (Bankr. C.D. Ca. 1995), the court looked closely at the eligibility requirement under chapter 9.  The court examined whether a related County investment pool constituted a municipality.  It found that the fund was not a “political subdivision,” which is meant to include public entities bestowed with sovereign powers.  The court also held that the fund was not a “public agency” because that phrase applied to “incorporated authorities, commissions, or similar public agencies organized for the purpose of constructing, maintaining, and operating revenue-producing enterprises” or ones that finance revenue producing enterprises through government-issued bonds.  Finally, the Orange Cnty. court held that the investment fund was not an “instrumentality” of the State because such phrase applies only to specific kinds of “local improvement districts,” such as a public school district.  Id. at 600-03.

In In re Las Vegas Monorail Co., 429 B.R. 770 (Bankr. D. Nev. 2010), the court suggested that the Orange Cnty. court may have construed the definition of a municipality too narrowly because “Congress clearly did not want to limit its definitions in a way that restricted eligibility.” Id. at 788. Thus, the Las Vegas Monorail court created its own definition of municipality, focusing on three factors:

  • Does the entity have traditional governmental attributes or engage in traditional government functions?  The court focused on whether the entity’s purposes or attributes “reflect goals and activities which augment the State’s provision of some public function.”
  • To what extent does the state control implementation of those functions?  “If the control retained or exercised is necessary or designed to allow the State to manage its finances or its fisc—the the traditional concerns of chapter 9—then the entity is an instrumentality.”
  • To what extent does the state categorize the entity as a municipality?  This factor is not determinative, but reflects the policy of not interfering with a State’s discretion to authorize a chapter 9 filing.

429 B.R. at 789.

The adoption of the proposed statutory amendment may not end the inquiry into the ability of the Commonwealth’s troubled public corporations, such as PREPA or PRASA, to file a bankruptcy petition.  Even if H.R. 870 is adopted into law, the Commonwealth must expressly authorize  a public corporation to file a chapter 9 petition and that public corporation must be a “municipality.”  Creditors might assert that a filing entity lacks eligibility for chapter 9 because it failed to satisfy the definition of municipality detailed above.

Thus, while parties seem interested in Congress amending the Bankruptcy Code to permit the application of chapter 9 to Puerto Rican public corporation, there is no certainty those entities are eligible to file.