Chapter 9 is the section of the U.S. bankruptcy law that allows municipalities — that is, cities, counties, school districts, public utilities, and similar entities — to restructure their debts. It was first enacted in the 1930s, and there have been close to 500 such bankruptcies since that time. Detroit may be the most familiar example, but Orange County also filed under Chapter 9, as have hospitals, parks, and school districts across the nation.
Puerto Rico is treated as a State under Chapter 9 in that Puerto Rico, like the States, cannot declare bankruptcy. However, Puerto Rico is explicitly excluded from naming municipalities as States can, under Chapter 9. This measure was added to the law in 1984.
This has been the case for decades, but Puerto Rico’s current financial crisis, and particularly the financial instability of PREPA, the electric utility, has made this issue an urgent one.
Last year, Puerto Rico’s territorial government passed a law allowing its municipalities to restructure their debt: essentially, to take bankruptcy as they would under Chapter 9 if they were allowed to do so. This law, called the “Puerto Rico Public Corporation Debt Enforcement and Recovery Act,” was struck down as unconstitutional by a U.S. district court. The Puerto Rican government has appealed.
Meanwhile, Congress is examining the issue. Legislation to extend Chapter 9 to Puerto Rico, has been proposed by Resident Commissioner Pedro Pierluisi. This bill would have the effect of altering Chapter 9 so that Puerto Rico is defined as a “state” for inclusion in the law.
Some of the holders of Puerto Rican bonds argue that making any change in the bankruptcy laws as they apply to Puerto Rico would be unfair to the bondholders. Their investments were made, they argue, under the assumption that Chapter 9 would not apply. Changing that now would change the terms of their investments.
Resident Commissioner Pedro Pierluisi pointed out in a press release that there is ample historical precedent. All previous changes to bankruptcy law, he says, have been retroactive in the same sense that HR 870 would be.
Pierluisi quoted John Pottow, an expert in bankruptcy law:
The Nation has had numerous bankruptcy laws throughout its history. Those laws generally applied to pre-existing debt when enacted, and the Supreme Court confirmed the permissibility of Congress exercising its power under the Bankruptcy Clause in this manner.
“H.R. 870 has broad-based support,” says Pierluisi, “and the opposition to it is narrow and unprincipled. I believe enactment of this bill is the most fair, logical and simple way to proceed.”