Sovereign Debt Restructuring and English Governing Law

By Steven L. Schwarcz (Duke University School of Law)

This Roundtable post is based on the author’s forthcoming article, Sovereign Debt Restructuring and English Governing Law, scheduled for publication in a symposium issue of the Brooklyn Journal of Corporate, Financial and Commercial Law (available at http://ssrn.com/abstract=2952776).

Unsustainable sovereign debt is a serious problem for nations as well as their citizens and creditors. It also is a threat to global financial stability. The existing “collective action clause” contractual approach to restructuring that debt is inadequate. At the same time, a multilateral framework, such as a convention or treaty, is not currently politically feasible. Recent research shows a drastic rise in sovereign debt litigation by holdout creditors, suggesting the urgency of finding solutions.

This article proposes a novel legal framework, focusing on governing law, for restructuring unsustainable sovereign debt. Because a significant percentage of sovereign debt is governed by English law, the UK Parliament has a unique opportunity to modify that law to include the legislative equivalent of perfect aggregate-voting collective action clauses in all English-law governed sovereign debt contracts. That not only would facilitate the fair and equitable restructuring of unsustainable sovereign debt; it also should ensure the continuing legitimacy and attractiveness of English law as the governing law for future sovereign debt contracts.

The article also proposes and examines the text of a model law that Parliament could consider as a basis for its legislation. Additionally, the article explains why, even absent Parliamentary enactment, a model-law approach could contribute to the incremental development of sovereign-debt-restructuring norms.

The full paper is available here

Puerto Rico Files for Bankruptcy Under PROMESA Title III

posted in: Municipal Bankruptcy | 0

By Richard J. Cooper, Luke A. Barefoot, Jessica E. McBride, Daniel J. Soltman, and Antonio Pietrantoni (Cleary Gottlieb Steen & Hamilton LLP)

On May 3, 2017, the Commonwealth of Puerto Rico (the “Commonwealth”) and the Oversight Board established by Congress pursuant to the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”) filed for bankruptcy under Title III of PROMESA in what is poised to become one of the largest bankruptcies in American history.

Drawing on first-hand experience[1] to provide unique background on the unprecedented fiscal crisis confronting Puerto Rico, lawyers from Cleary Gottlieb Steen & Hamilton LLP (“Cleary Gottlieb”) are preparing a series of articles to inform readers on some of the key challenges and strategic considerations that Puerto Rico and the Oversight Board face in implementing a restructuring under PROMESA.  To date, four articles have been published.

Why Puerto Rico Will Likely Rely On PROMESA Title III,” published before the recent Title III filing, discusses PROMESA’s two restructuring frameworks: Title III (broad-based, in-court proceeding) and Title VI (voluntary negotiations, similar to collective action clauses).  It focuses on some of the challenges that a Title VI proceeding would present and why, as opposed to Title III, it is likely not a viable forum for restructuring the Commonwealth’s obligations.

Issues To Expect In A Title III Puerto Rico Restructuring” surveys some of the difficult choices that the Commonwealth and the Oversight Board will need to make in order to implement a debt restructuring and delves into some of the novel issues likely to arise in a Commonwealth restructuring proceeding under Title III.

What Should Puerto Rico Offer Its Creditors?” considers restructuring currencies that the Commonwealth and the Oversight Board could offer creditors as part of a PROMESA restructuring. It focuses on four important elements that could facilitate a debt adjustment under PROMESA and create a stronger foundation for Puerto Rico to regain access to the capital markets and attract new investment.

Disarming Puerto Rico’s Pension Time Bomb” provides an overview of the key strategic drivers in reforming Puerto Rico’s underfunded public pension systems. This article identifies the two legal pension reform mechanisms available to the Commonwealth — legislative action or implementation of reforms through one or more Title III proceeding(s) under PROMESA — and provides an overview of the most important factors likely to shape the ultimate outcome.


[1] Cleary Gottlieb assisted the Commonwealth of Puerto Rico and its instrumentalities with their financial challenges prior to the recent change in government. The firm also currently represents the Government Development Bank for Puerto Rico on a legacy matter.

 

Puerto Rico and the Netherworld of Sovereign Debt Restructuring

By G. Mitu Gulati (Duke Law School) and Robert K. Rasmussen (University of Southern California Gould School of Law)

Puerto Rico has incurred debt well beyond its ability to repay. It attempted to address its fiscal woes through legislation allowing the restructuring of some its debt. The Supreme Court put a stop to this effort, holding that Congress in the Bankruptcy Code barred the Commonwealth from enacting its own restructuring regime. Yet all agreed that the Bankruptcy Code did not provide anything in its place. Congress quickly passed the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) in an attempt to address Puerto Rico’s fiscal ills by enacting a special proceeding to deal with Puerto Rico’s financial woes. The price Puerto Rico paid, however, was steep—the imposition of a control board to direct, in effect, the Commonwealth’s finances and any insolvency proceedings. In light of the conditions that gave rise to PROMESA, we explore whether, in the first place, Congress has the power to bar Puerto Rico from enacting a restructuring mechanism without offering an alternative. We submit that the answer is no. When it comes to a state, the Supreme Court has held the power to issue debt necessarily implies the power to restructure that debt. Congress can preempt that power so long as it puts something in its place. To preempt and leave nothing runs afoul of our federal system. The same reasoning, with even greater force, applies to Puerto Rico. The federal government entered into a compact with the citizens of Puerto Rico, granting them, among other things, the power to issue debt. Puerto Rico implicitly received the power to restructure this debt. Congress could offer a substitute to any regime that Puerto Rico might enact, but it cannot leave the Commonwealth without any means to address its fiscal affairs.

The full paper is available here.


For previous Roundtable coverage of Puerto Rico’s debt crisis, see “Puerto Rico Update: White House Weighs in with a Proposal,” “Puerto Rico Public Corporation Debt Enforcement and Recovery Act,” and “U.S. District Court Holds that Puerto Rico’s Recovery Act Is Unconstitutional.”

Gatekeepers Gone Wrong: Reforming the Chapter 9 Eligibility Rules

posted in: Municipal Bankruptcy | 0

By Laura N. Coordes (Arizona State University Law School)

In order to gain access to chapter 9 bankruptcy, municipalities must demonstrate that they meet several eligibility requirements. These requirements were put in place to prevent municipalities from making rash decisions about filing for bankruptcy. Too often, however, these requirements impede municipalities from attaining desperately needed relief. This Article demonstrates that as currently utilized, the chapter 9 eligibility rules overemphasize deterrence and are not rationally connected to the reasons the chapter 9 bankruptcy system was developed. This Article, therefore, posits that the chapter 9 eligibility requirements should be relaxed.

To support this claim, the Article conducts a detailed analysis of the history and theory of chapter 9 to determine the primary reasons for the eligibility rules and the core functions of a municipal bankruptcy solution. It then demonstrates how many of the concerns driving the eligibility rules’ existence are addressed in other chapter 9 mechanisms, and it proposes sweeping revisions to the eligibility rules to facilitate appropriate access to chapter 9. Specifically, municipalities in fiscal distress should be able to access bankruptcy when they demonstrate a need for the primary types of assistance that bankruptcy can best provide: nonconsensual debt adjustment, elimination of the holdout creditor problem, and breathing space. Through its analysis, this Article brings needed attention to the broader questions of who should have access to bankruptcy and when that access should be granted.

The full article is available here.


For more Roundtable posts on municipal bankruptcy, see Parikh & He, “Falling Cities and the Red Queen Phenomenon”; Skeel, “From Chrysler and General Motors to Detroit”; and Roundtable updates on Puerto Rico’s debt crisis (covering a call for congressional action and Puerto Rico’s Public Corporation Debt Enforcement and Recovery Act).

Falling Cities and the Red Queen Phenomenon

posted in: Municipal Bankruptcy | 0

By Samir D. Parikh (Lewis and Clark Law School) and Zhaochen He (Lewis and Clark College)

Cities and counties are failing.  Unfunded liabilities for retirees’ healthcare benefits aggregate to more than $1 trillion.  Pension systems are underfunded by as much as $4.4 trillion.  Many local government capital structures ensure rising costs and declining revenues, the precursors to service-delivery insolvency.  These governments are experiencing the Red Queen phenomenon.   They have tried a dizzying number of remedies but their dire situation persists unchanged.  Structural changes are necessary, but state legislatures have failed to respond.  More specifically, many states have refused to implement meaningful debt restructuring mechanisms for local governments. They argue that giving cities and counties the power to potentially impair bond obligations will lead to a doomsday scenario: credit markets will respond by dramatically raising interest rates on new municipal and state bond issuances. This argument – which we term the paralysis justification – has been employed widely to support state inaction.  But the paralysis justification is anecdotal and untested.

This article attempts to fill a significant gap in the literature by reporting the results of an unprecedented empirical study. Our study aggregates data for every general obligation, fixed-rate municipal bond issued in the U.S. from January 1, 2004 to December 31, 2014, over 800,000 issuances in total.  By employing multivariate regression analysis, we are able to conclude that the paralysis justification is a false narrative.  Municipalities located in states that offer meaningful debt restructuring options enjoy the lowest borrowing costs, all other things equal.  This article removes one of the largest obstacles to financial relief for many cities and counties. We hope to encourage recalcitrant state legislatures to enact the structural changes their local governments need desperately.

The full article is available here.

Municipal Borrowing Costs and State Policies for Distressed Municipalities

By Pengjie Gao (University of Notre Dame), Chang Lee (University of Illinois at Chicago), and Dermot Murphy (University of Illinois at Chicago)

Recent high-profile municipal default cases in Detroit, Puerto Rico, and various cities in California have underscored the importance of state laws for dealing with default proceedings, or even preventing default from occurring in the first place. However, the effects of these laws, or lack thereof, on municipal borrowing costs remain unclear. Does unconditional state support for distressed local municipalities lead to lower local borrowing costs? If so, are there tradeoffs?

The authors address these questions by examining differences in distress-related laws and statutes across states. Some states have proactive policies in place that activate when their local municipality is exhibiting signs of fiscal distress (“Proactive states”). Meanwhile, other states allow unconditional access to the Chapter 9 bankruptcy procedure, with no laws in place for dealing with distressed municipalities (“Chapter 9 states”).

The authors find that these differences significantly affect local borrowing costs. In particular, Proactive states have lower borrowing costs and significantly lower yield reactions following default. Furthermore, Proactive state yields are less sensitive to economic conditions because of the implicit insurance that becomes particularly valuable when economic conditions are weak. There is also a significant contagion effect in Chapter 9 states that does not exist in Proactive states, in that a default in a Chapter 9 state is more likely to lead to higher yields for other bonds located in that state. However, the authors also provide evidence that borrowing costs at the state level are somewhat higher in Proactive states because of the partial transfer of local credit risk to the state.

The full article is available here.

Puerto Rico Update: White House Weighs in with a Proposal

posted in: Municipal Bankruptcy | 0

With over $70 billion in debt and little cash to fund its ongoing operations, Puerto Rico remains in a state of fiscal crisis. After this summer’s decision by the First Circuit affirming that Puerto Rico’s attempt at legislative self-help, the so-called “Recovery Act,” was unconstitutional, the Commonwealth was left to negotiate with its many creditors or else seek relief from the federal government.

On October 21, the White House introduced a plan urging Congress to address the situation in Puerto Rico, claiming that it “could become a humanitarian crisis” absent federal intervention.

The heart of the Obama administration’s plan is a robust legislative framework for extending bankruptcy protection to Puerto Rico’s public organs. In addition to supporting currently pending legislation that would extend Chapter 9 to Puerto Rico – allowing Puerto Rico’s municipalities to file for bankruptcy – the plan also proposes “a broader legal framework that goes beyond Chapter 9 to allow for a comprehensive restructuring of Puerto Rico’s liabilities.” The plan conditions access to this new territorial bankruptcy regime on the establishment of a fiscal oversight body to ensure that Puerto Rico “adheres to its recovery plan and fully implements proposed reforms.” The plan also encouraged Congress to reform Puerto Rico’s Medicaid program and to provide Puerto Ricans with access to the Earned Income Tax Credit.

The plan, described by the White House as A Roadmap for Congressional Action, received a “chilly” reception at a Senate committee hearing on Thursday, largely due to its lack of detail and the limited amount of information available.

For our previous posts on the situation in Puerto Rico, see here and here.

(This post was drafted by Bankruptcy Roundtable Managing Editor Robert Niles, J.D./M.B.A. ’16.)

A New Fulcrum Point for City Survival

posted in: Municipal Bankruptcy | 0

By Samir D. Parikh, Lewis & Clark Law School

ParikhMunicipalities face daunting fiscal challenges that threaten debt repayment and undermine basic service delivery.  Policymakers and scholars have struggled to formulate meaningful restructuring options.  Up to this point, the literature has focused on federal bankruptcy law and the options available under Chapter 9.  But this resource-draining process is not the fulcrum point for any meaningful solution.  Indeed, for the vast majority of distressed municipalities, the lever of municipal recovery will not turn based on the solutions that have to date been offered.

In an article forthcoming in the 2015 William & Mary Law Review, I attempt to radically shift the municipal recovery debate by arguing that state law is the centralized point at which officials can exert the necessary amount of pressure to gain concessions from key creditor constituencies.  I propose a comprehensive system that (i) identifies pressured municipalities at a time where measured adjustments are sufficient to create sustainable viability, and (ii) shepherds distressed municipalities through a dynamic negotiation structure in an effort to capture Chapter 9’s primary benefits without the costs, inefficiencies, and constitutional quandaries.  Animating this proposal is a more nuanced understanding of the Contracts Clause that allows a municipality to explore unilateral contract modification in an effort to facilitate consensual agreements with creditor constituencies.

My proposal offers systemic rehabilitation at a time when a new approach is desperately needed.  The full version of the article is available here.

For previous posts on Municipal Bankruptcy see here and here.

From Chrysler and General Motors to Detroit

By David A. Skeel, Jr., University of Pennsylvania Law School

dskeel

In the past five years, three of the most remarkable bankruptcy cases in American history have come out of Detroit: the bankruptcies of Chrysler and General Motors in 2009, and of Detroit itself in 2013. The principal objective of this Article is simply to show that the Grand Bargain at the heart of the Detroit bankruptcy is the direct offspring of the bankruptcy sale transactions that were used to restructure Chrysler and GM. The proponents of Detroit’s “Grand Bargain” never would have dreamed up the transaction were it not for the federal government-engineered carmaker bankruptcies. The Article’s second objective, based the comparison of the Detroit cases, is to make a very brief case for reform of bankruptcy sales.

Part I of the Article briefly surveys the increased use of bankruptcy sales and related shifts in Chapter 11 practice over the past several decades. Part II describes the Chrysler and General Motors bankruptcies, which built on but radically expanded the scope of a bankruptcy sale. Part III turns to the Detroit bankruptcy, focusing primarily on the “Grand Bargain,” while also exploring the city’s use of another recent bankruptcy strategy, known as “gifting.” The Article concludes, in a brief final part, that the Detroit cases have pushed recent bankruptcy innovations to their logical extremes — and beyond — exposing the need to update the oversight of bankruptcy sales.

The full version of this article is available here.

 

U.S. District Court Holds that Puerto Rico’s Recovery Act is Unconstitutional

posted in: Municipal Bankruptcy | 0

By Mark Ellenberg, Howard Hawkins, Lary Stromfeld, Ivan Loncar, and Thomas Curtin of Cadwalader Wickersham & Taft LLP

On February 6, 2015, in Franklin California Tax-Free Trust v. Commonwealth of Puerto Rico, the U.S. District Court for the District of Puerto Rico held that the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (the “Recovery Act”) is expressly preempted by section 903 of the Bankruptcy Code. Section 903 of the Bankruptcy Code expressly prohibits all states, including Puerto Rico, from enacting laws that prescribe a “method of composition” that discharges debts. The Recovery Act, which was loosely based on chapter 9 of the Bankruptcy Code, would have permitted Puerto Rico’s power authority (PREPA), highway authority (HTA) and water authority (PRASA) to adjust their debts without the consent of all creditors. The court concluded that this scheme ran afoul of section 903, even though municipal entities in Puerto Rico are expressly excluded from the coverage of Chapter 9. The decision is among the first to explicitly hold that section 903 expressly preempts the states, including Puerto Rico, from enacting any debt adjustment scheme that results in the discharge of indebtedness, even if the affected entities have no remedy under the Bankruptcy Code. The court also denied the Commonwealth’s motion to dismiss the plaintiffs’ claims under the Contracts Clause and certain of the plaintiffs’ claims under the Takings Clause.

To read further, click here.

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