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1st Circuit Reverses District Court Opinion in PREPA Revenue Bond Case

Long-awaited opinion in Puerto Rico bankruptcy case may help settle uncertainties in the municipal market.

Puerto Rico Electric Power Authority power plant. Source: Wikimedia Commons
Puerto Rico Electric Power Authority power plant. Source: Wikimedia Commons

By: Ernest Lorimer, Partner, Soeder & Associates, LLC, in Westport, CT 

On June 12, 2024, a three-judge panel of the United States Court of Appeals, First Circuit, issued an opinion of significant interest to the municipal bond community, unanimously reversing the District Court’s opinion in the Puerto Rico Electric Power Authority (PREPA) revenue bond case. Since 1947, PREPA has issued revenue bonds payable from the revenues of PREPA’s electrical system after payment of the reasonable and necessary operating expenses of the system. The District Court previously concluded that after the filing of the bankruptcy petition of PREPA the bonds were payable solely from certain amounts that happened to be on deposit with the indenture trustee, and bondholders had no rights to post-petition revenues except in the unlikely event they were actually deposited with the Trustee. The First Circuit reversed, holding that:

  1. The future net revenues of the system were in fact pledged to pay debt service on the bonds,
  2. Such net revenues were subject to the pledge when PREPA acquired rights to the revenues, and
  3. The pledge of net revenues was properly perfected from the time of the pledge and not subject to claims of the hypothetical lien creditor (and thus the bankruptcy estate).

The court also held that the claims of the bondholders equaled the face value of the outstanding bonds plus accrued interest and that the bondholders were entitled to an accounting of the revenues. In these respects, the First Circuit reverted to a position in accord with expectations of the municipal bond community.

The First Circuit opinion relies on Article 9 of the Uniform Commercial Code and the laws of the Commonwealth of Puerto Rico, and at key junctures it adopts a common sense approach to a reading of the indenture and to the transactions at issue. Unlike most other U.S. jurisdictions, Puerto Rico did not adopt Article 9 until long after the bond indenture was adopted, and the version of Article 9 in effect at the date of the filing did not exclude or deal specifically with revenue bond pledges under other enabling legislation. Nevertheless, practitioners will benefit from a careful reading of both the District Court and First Circuit opinions to evaluate, on an issuer by issuer and state by state basis, relevant indenture language, enabling legislation and the interaction of the Bankruptcy Code and Article 9.

The First Circuit opinion is available here. The District Court opinion it reverses is available here.

The foregoing summary was provided by Ernest M. Lorimer, a partner with Soeder & Associates, LLC, in Westport, Connecticut. He has been a NABL member since 1986 and is a member of the NABL team exploring security interests in collateral for municipal bond issues and public finance projects. NABL thanks Ernie for his contribution.