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Constitutional Challenges Lie Ahead for Puerto Rico Bankruptcy Bill

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With its future undecided, a bill that would allow the municipal agencies of Puerto Rico to file for Chapter 9 bankruptcy remains a contentious subject for investors and legal analysts alike.

Puerto Rico’s fiscal situation reached a crisis point in the summer of 2014. At that time, the island carried $73 billion in municipal debt, and it faced the serious and quite real possibility of default. As tax hikes and reforms implemented by the government were proving insufficient to mitigate the situation, Puerto Rico created a new restructuring law in an attempt to protect key government entities. Proposed by Governor Garcia Padilla, the 134-page “Puerto Rico Public Corporation Debt Enforcement and Recovery Act” (the Act) was passed by the Puerto Rico Assembly in late June 2014. The Act provided new debt restructuring avenues for the island’s three most important municipal entities.

However, the Act immediately led to questions – as well as a lawsuit – about its constitutionality. Much of the debate sprang from Puerto Rico’s status as an unincorporated territory, which raised several statutory and constitutional challenges. One of the most significant concerns was that the Act was in fact preempted by federal law, specifically by the Constitution, which prevents states from enacting bankruptcy laws. Other language in the Bankruptcy Code clarifies that, for this purpose, the term “state” includes Puerto Rico. This concern about the constitutionality of the Act, therefore, appeared to be a valid one, and it was indeed upheld in February of this year, when a federal court struck down the Act.

At present, there is a bill before Congress that would allow Puerto Rico to file for Chapter 9 bankruptcy, wherein certain state-created corporations, as well as cities and counties, are permitted to file for federal bankruptcy protection with the agreement of the state. Historically, Puerto Rico has been specifically exempt from this privilege. While some argue that no public policy purpose is served by excluding Puerto Rico from Chapter 9, critics of the bill assert that extending Chapter 9 to the island is unfair to investors, who bought Puerto Rico debt on the understanding that bankruptcy was not permitted.

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