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Fiscal Distress

MuniNet Guide provides insights and commentaries on fiscal stress and municipal bankruptcies, including how to identify and prepare for it. 

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Illinois & Chicago MSA’s Challenging Financial Developments Due To The Great Recession (Part 1)

Comparisons of Key Economic and Debt Factors: The Good, The Bad, & The Ugly (Part 2)

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The First Circuit Court of Appeals Ruling on ‘Assured’ Should be Reheard or Reversed; Recent Ruling Sends a Harsh Message to Municipal Bond Market

“Puerto Rico’s ‘Assured’ Decision Should be Reconsidered or Reversed” by James Spiotto( )

Why the Municipal Bond Market Expects Pledged Special Revenues to be Timely Paid to Bondholders in a Chapter 9 Proceeding.  And, Why the First  Circuit’s Assured Ruling in Puerto Rico’s PROMESA Title III Proceeding Should Be Reheard or  Reconsidered on Appeal.

Update on “Puerto Rico’s ‘Assured’ Decision Should be Reconsidered or Reversed” (Originally appeared  in Muninetguide on  Feb 05, 2018)

by James Spiotto

On March 26, 2019, The United States First Circuit Court of Appeals ruled on the Appeal from the Title III adjustment of debt proceeding for the Commonwealth of Puerto Rico.  The First Circuit affirmed the ruling of the District Court dismissing the Amended Complaint of Assured Guaranty Corporation (“Assured”) and held that special revenues pledged to revenue bondholders are only exempt from the automatic stay (preventing creditor enforcement action for payments to bondholders) if the municipality voluntarily pays the special revenues to the bondholders, and that such timely payments are not mandatory in Title III or purportedly a Chapter 9 proceeding.

MuniNet previously has described the well-established justification of timely payments of special revenues pledged to bondholders in Title III and Chapter 9 proceedings and why the district court rulings should have been reversed in an article last year.  (Link “Puerto Rico’s Assured Decision Should Be Reconsidered or Reversed” February 5, 2018, James E. Spiotto.)

The First Circuit in ruling on this appeal saw no reason to write at length justifying this ruling, which was contrary to all prior case law precedent by courts hearing Chapter 9 cases, the recognized commentaries on special revenues and the legislative history for the 1988 Amendments to the Federal Bankruptcy Code 11 U.S.C. § 101 et seq. (“Bankruptcy Code”) which added Sections 902, 922(d), 927 and 928, among other provisions, into the Bankruptcy Code.  These sections were interpreted by the First Circuit in its opinion.

I. The First Circuit in Its Opinion Attempted to Reason to Answer the Following Questions:

  • Was the disputed language unambiguous?

    Section 922(d) and 928(a) are unambiguous, according to the First Circuit and therefore there is no need to consult the legislative history to understand the meaning of those sections.  According to the First Circuit, the plain meaning and interpretation of these sections should not be capable of a different interpretation.  However, this unique interpretation of the First Circuit was contrary to virtually every prior precedent, namely the prior rulings of every Chapter 9 bankruptcy court that had substantively considered special revenues and the automatic stay, recognized commentators on special revenues and the 1988 Amendments legislative history regarding Section 922(d) and 928(d) of the Bankruptcy Code.

  • Are Only voluntary payments of special revenue exempt from the stay?

    Section 922(d) of the Bankruptcy Code provides: “a petition filed under this chapter [Chapter 9] does not operate as a stay [preventing creditor enforcement action to be paid] of application [defined by Black’s Law Dictionary as related to payments] of pledged special revenues in a manner consistent with [s]ection 927[8], which provides the lien of bondholders on special revenues continues to be effective on special revenues collected after the municipal debtor files for the Chapter 9 protection] of this title [Chapter 9] to payment of indebtedness secured by such revenues.”  The First Circuit limits the nonoperation of the stay (of creditor actions) to voluntary payments made by a municipality after the filing of a Chapter 9 or Title III proceeding and not to mandatory payments required by a broader reading of Sections 922(d) and 928(a) of the Bankruptcy Code or state law mandates.

  • Is Section 922(d) needed so that the municipality can pay and bondholders can accept voluntary payments?

To Read Full Article, Click Here


On January 14, 2019, the Financial Oversight and Management Board, acting through its Special Claims Committee and the Official Committee of Unsecured Creditors, filed an objection to the validity and enforceability of more than $6 billion of the Commonwealth of Puerto Rico’s General Obligation Bonds.  The purported reason for the invalidity was the asserted violation of the Commonwealth’s Constitutional Debt Service Limit found in Article VI, Section 2 of the Puerto Rico Constitution, as amended in 1961, which provides that direct obligations of the Commonwealth “shall not exceed 15% of the average of the total amount of annual revenues…” (“G.O. Debt Limit”).  This claim of invalidity was asserted long after the issuance of the General Obligation Bonds, in which the Commonwealth and its professional represented that the Bonds complied with the Constitution and laws of Puerto Rico and were a valid, binding and enforceable obligation, and released to the market a calculation of compliance of the issuance with the G.O. Debt Limit.  In addition, there also is a claim by the objecting parties that issuance of the $6 billion of General Obligation Bond Debt violated the Balanced Budget Clause of the Puerto Rico Constitution, Article VI, Section 7 providing “the appropriation made for any fiscal year shall not exceed total revenues including available surplus estimated unless the imposition of taxes sufficient to cover said appropriation is provided by law” (“Balanced Budget Clause”).  These claims of invalidity when carefully reviewed from a historic perspective should be rejected.

Repudiation or claims of the invalidity of previously issued general obligation bonds by states or even local governments historically have never been viewed by the market as an acceptable or respectable position for an issuer who had earlier represented, through its statements and its agents, that the bonds were valid and in compliance with the law.  Generally, constitutional debt limits or balanced budget requirements are guide posts for the governmental issuer in conjunction with bond counsel prior to actual issuance to determine whether such debt can and should be incurred.  These provisions were not intended to create an artifice that clever government issuers could spring on unsuspecting good faith bond purchasers who had no prior notice of any defect and in fact were told at issuance there were no compliance problems with the constitution and law of the government.  Nevertheless, efforts by states and local governments to repudiate or invalidate debt after its issuance contrary to what they represented to induce the purchase of bond debt by good faith purchasers are not new.  Such attempts to invalidate or repudiate state and local government debt in the United States first took place in the 1800’s.  The lessons learned from those unfortunate efforts should not be forgotten and are instructive as to the current attempts of Puerto Rico to invalidate certain of its G.O. Debt.


By James E. Spiotto

Puerto Rico flag

The Treaty of Paris ending the Spanish-American War of 1898 resulted in control of Cuba, Puerto Rico, Guam and The Philippine Islands being given to the United States.  Cuba in 1902 and The Philippines in 1946 were given independence.  Puerto Rico and Guam remain territories of the United State.  In recent years, Puerto Rico as a Commonwealth flirted with independence or statehood with no clear decision.

In 1996, Congress repealed (effective 2006) Section 936 of the Internal Revenue Code (previously Section 931) that existed since the 1920’s to encourage U.S. corporations to invest in Puerto Rico by providing an exemption from federal taxes.  This measure promoted two-thirds of Puerto Rico’s GDP, namely, in finance, insurance, real estate (19.6%), and manufacturing mainly in pharmaceuticals and electronics (46.4%).

By 2006, Puerto Rico was in financial distress due to at least in part to the effect of the Jones Act that purportedly added 10-15% to the costs of many goods due to the duty on non-U.S. ships, combined with repeal of Section 936 of the Internal Revenue Code without any replacement, as well as, Puerto Rico’s claimed inequity of federal government funding compared to states costing Puerto Rico billions annually for decades relating to Medicaid, Medicare, Supplemental Security Income (“SSI”), earned income tax credit (“EITC”), child tax credit (“CTC”), etc.  All of this culminated in finance distress.  In 2006, Puerto Rico had $40 billion of public debt and public debt per capita of $10,666.66, double the average for state and local governments in the U.S.  Also in 2006, Puerto Rico’s public debt as a percentage of GDP was 45.82%.

Historians may well debate the causes and impact of Puerto Rico’s financial and operational distress, but it should be clear public debt was not the cause of financial distress of the government.  It is a symptom of a systemic problem.  As noted, the Merchant Marine Act of 1920 adding 10-15% to the price of many goods carried by foreign vessels, the repeal of Section 936 of the IRS Code (previously Section 931) encouraged U.S. corporation to invest in Puerto Rico and Puerto Rico’s claimed inequities in its funding and treatment compare to states purportedly costing Puerto Rico billions annually for decades are a fertile ground for blame.

Puerto Rico was founded on the principles that public debt has a first priority of payment upon default (along with expense of insular government) embodied in Section 34 of the 1917 Jones Act, which governed Puerto Rico prior the Commonwealth’s Constitution in 1952.  The inclusion of Article VI, § 8 in the 1952 Puerto Rico Constitution continued this policy providing constitutional public debt, upon insufficient funds to pay expenses, were first to receive payment from “available resources.”

When faced with the 2006 financial crisis, Puerto Rico, with $40 billion of public debt outstanding, chose to borrow more rather than restructure its debt.  Puerto Rico used the COFINA securitization structure to add another $17 billion of public debt by 2015 that purportedly was not limited by the constitutional debt limit, resulting in public debt of Puerto Rico totaling over $72 billion.

For Full Article:  Click Here

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