Chapter 9

First Circuit Rules Bankruptcy Code Preempts Puerto Rico’s Recovery Act

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On Monday, July 6, the Court of Appeals for the First Circuit affirmed the February 6, 2015 order and injunction of the Puerto Rico District Court and held that section 903(1) of the Bankruptcy Code preempts the Puerto Rico Debt Enforcement and Recovery Act (the “Recovery Act”).  Franklin Cal. Tax Free Trust, et al. v. Commonwealth of Puerto Rico, et al., (1st Cir. July 6, 2015) (Case No. 15-1218): On February 10, 2015, we reported on the district court’s decision holding that the Recovery Act was unconstitutional.

As a result of amendments to the Bankruptcy Code in 1984, Puerto Rico, unlike states, may not authorize its municipalities, including its public utilities like PREPA or PRASA, to seek federal bankruptcy relief under chapter 9 of the Bankruptcy Code. In considering the appeal of the district court’s order, the Court first confirmed that it had jurisdiction to consider the bondholders’ claims of preemption, that those claims were ripe and that they had become ripe immediately upon adoption of the Recovery Act. The Court then ruled that the Commonwealth’s effort to allow its public corporations to restructure their debt by enacting the Recovery Act is expressly preempted by the federal Bankruptcy Code. Rejecting the Commonwealth’s arguments that the 1984 amendments made the preemption provisions of section 903(1) of the Bankruptcy Code inapplicable, the Court stated that “§ 903(1) has applied to Puerto Rico since the predecessor of that section’s enactment in 1946. The statute does not currently read, nor does anything about the 1984 amendment suggest, that Puerto Rico is outside the reach of § 903(1)’s prohibition. Op. at 4. Because the Court affirmed the district court’s order and injunction, the Court declined to consider the Commonwealth’s appeal of the district court’s order denying motions to dismiss the bondholders’ Contracts Clause and Takings Claims. Op. at 21.

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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)

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Detroit Confirms Chapter 9 Plan of Adjustment

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Approximately 16 months after filing the largest chapter 9 bankruptcy in history, Detroit received approval November 7 of its chapter 9 plan of adjustment.  Bankruptcy Judge Stephen Rhodes of the Eastern District of Michigan Bankruptcy Court, confirmed the plan at a several-hour hearing where he read into the record an “oral opinion.”  Judge Rhodes held that the plan “meets the legal requirements for confirmation” and lauded the plan, describing it as an “extraordinary accomplishment in bankruptcy and an ideal model for future municipal restructurings.”  In re City of Detroit, Case No. 13-53846 (Bankr. E.D. Mich., November 7, 2014). Click here to read more.

Bankruptcy Court Rules Detroit Eligible for Chapter 9

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At a hearing on December 3, Judge Stephen Rhodes ruled that the City of Detroit was eligible to file for protection under Chapter 9 of the Bankruptcy Code.  While the City filed for bankruptcy back in July and has been conducting a number of bankruptcy-related activities, this ruling officially launches the bankruptcy process.  Later in the week, Judge Rhodes issued a 143-page opinion detailing his analysis.  The analysis was largely based on the facts at hand and a simple application of those facts to the standards for a chapter 9 filing.  Among the Judge’s most noteworthy rulings: because pension rights are contractual rights under the Michigan constitution, they are subject to impairment in a federal bankruptcy proceeding.  Opinion.

City of Detroit’s Bankruptcy Enters Courtroom

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In the last two weeks, the Honorable Steven W. Rhodes of the Bankruptcy Court for the Eastern District of Michigan held two important in hearings in the City of Detroit’s chapter 9 case, the largest in history.

On July 24, Judge Rhodes heard arguments on two specific motions to confirm and extend the protections of the automatic stays under sections 362 and 922 of the Bankruptcy Code.  The Court approved both motions over numerous objections.  These objections were based primarily on the argument that the City’s bankruptcy case was not properly before the bankruptcy court because the Governor’s authorization to file for bankruptcy under PA 436 was not consistent with the Michigan Constitution and other state laws.

The Court declined to address the merits of those arguments, and stated that the Court would address state authorization issues as a component of a future hearing on Detroit’s eligibility to file for chapter 9.  Judge Rhodes also found that there was no need for a state court to weigh in on these issues because (i) the statute does not require it and (ii) a bankruptcy court has determined the eligibility issues surrounding municipal debtors in every recent chapter 9 case.

The Court then granted the stay confirmation motion, concluding that the Emergency Manager is an officer subject to the protections of the automatic stay under section 922 of the Bankruptcy Code.  The Court also granted the stay extension motion and found that section 105 of the Bankruptcy Code empowers the Court to extend the automatic stay because: (i) the City’s interests are intertwined with the interests of the entities to whom the stay would extend; (ii) the creditors opposing the extension will not be harmed if the extension is granted; (iii) the City could suffer irreparable harm if the extension is not granted, as evidenced by the numerous state court lawsuits and the costs attendant thereto; and (iv) the extension motion serves the public interest by increasing the likelihood that the debtor can reorganize, reducing transaction costs and eliminating the risk of inconsistent judgments.

On August 2, Judge Rhodes then heard arguments on the Court’s proposed dates and deadlines regarding eligibility and the filing of a chapter 9 plan of debt adjustment.  Although the Court took the scheduling issues under advisement, the Court suggested October 23, 2013 as the date on which a trial on eligibility could be held.  The Court also suggested that it would set March 1, 2014 as the deadline by which the City must file its plan.  In response, the City stated that it hoped to file a plan before December 31, 2013.  Finally, the Court approved the creation of a committee of retirees and scheduled a hearing regarding the assumption of the City’s swap settlement agreement for August 28, 2013.  These time frames demonstrate that the Court and the City intend to resolve the City’s chapter 9 case relatively rapidly.

The City of Detroit Files for Chapter 9 Bankruptcy Protection

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On July 18, the City of Detroit filed for protection under chapter 9 of the Bankruptcy Code, making Detroit the largest municipality to file for chapter 9 relief in United States history.  Detroit is seeking to restructure approximately $18 billion in accrued obligations, consisting of approximately $11.9 billion in unsecured obligations and $6.4 billion in secured obligations.  Prior to the bankruptcy filing, the City offered to pay unsecured creditors a pro rata distribution of $2 billion in principal amount of interest-only, limited recourse participation notes. 

Detroit filed several significant motions in its first days in bankruptcy.  They included:

Bankruptcy Judge Steven W. Rhodes has scheduled a “first day” hearing on these and other matters for July 23.  We will continue to update developments in the Detroit Chapter 9 case.

Navigating the Municipal Bankruptcy Minefield – A guide for municipalities, bond investors, credit enhancement providers, trustees and counsel

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Personal and corporate bankruptcies are designed to give filers a “fresh start.” But struggling municipalities seeking the same outcome from a Chapter 9 filing are likely to be disappointed – instead facing months or years of expensive legal battles with angry employees and creditors, along with increased scrutiny from Federal regulators looking for bankruptcy-related and other disclosure and tax-law violations.

On March 22, 2012, Orrick’s George Greer, John Knox, Marc Levinson, Lorraine McGowen and Larry Sobel partnered with The Bond Buyer for a detailed web seminar that explained the fast-changing landscape for municipalities in bankruptcy, and strategies that issuers and their professional advisors can employ to streamline the process and avoid violations. Topics discussed included:

•Ins and outs of Chapter 9 workouts
•Keeping the market informed and avoiding liability with appropriate disclosure
•Tax-law opportunities and pitfalls relating to asset sales and workouts

Please click here to view the webinar.

Additional Resources:

•Webinar Presentation: Navigating the Municipal Bankruptcy Minefield
•Municipal Bankruptcy: Avoiding and Using Chapter 9 in Times of Fiscal Stress by John Knox and Marc Levinson
•SEC Investigations and Enforcement Actions by George Greer

Bankruptcy Rule 2019 Effective Date

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On December 1, Bankruptcy Rule 2019 became effective. This rule relates to the disclosure requirements in Chapter 9 and Chapter 11 cases for holders of distressed loans and eliminates the requirement for the disclosure of the price paid for a claim in bankruptcy and the date the claim was acquired (except in very limited circumstances) in Rule 2019 verified statements. Rule 2019.