Bond Market Shaken (Not Stirred) As Supreme Court Declines To Hear Puerto Rico Municipal Bonds Dispute

March 11, 2020Herrick Restructuring Review

The Herrick Restructuring Review provides insights and information related to restructuring and finance litigation. The Herrick team regularly represents official and ad hoc creditor committees, hedge funds, distressed debt investors, bondholders, and other parties in interest, and often serve as conflicts or special counsel for large-scale complex litigation matters.

On January 13, 2020, the Supreme Court denied petitions for writ of certiorari on the question of whether payments on municipal bonds secured by special revenues are required during the issuer’s bankruptcy. Special revenue bonds are paid from pledged revenues generated from a specific activity. The case arose because after the Puerto Rico Highway and Transportation Agency (PRHTA) commenced its municipal reorganization case in 2017, it refused to make a July 2017 payment of $219 million, arguing that the automatic stay of the Bankruptcy Code precluded such payments. That dispute followed actions by Puerto Rico’s governor and legislature in 2015 and 2016, in which they had diverted PRHTA’s special revenues, which consisted of tolls, motor fuels, taxes and other transportation-related revenues, for payment of the Commonwealth’s other obligations.


In 2016, Congress addressed Puerto Rico’s ongoing financial crisis by passing the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). PROMESA authorized Puerto Rico to seek bankruptcy relief, and closely followed Chapter 9 of the Bankruptcy Code, which houses the Code’s municipal bankruptcy provisions.

PRHTA, a public corporation, was created in 1965 to manage the development of roads and transportation in Puerto Rico. PRHTA was authorized to issue municipal bonds to finance its projects, and when PRHTA’s PROMESA proceeding was commenced in May 2017, it had approximately $6 billion in outstanding bonds, all of which were insured by bond insurers. Beginning in 2015, Puerto Rico began diverting the PHRTA special revenue for general purposes of the Commonwealth and stopped making bond payments. In 2015, bondholders were paid from debt service reserves for the various bond issues. In 2016, the bond insurers made the payments owed to the bondholders. After PRHTA commenced its PROMESA proceeding, it refused to make scheduled debt service payments of $219 million, arguing that such payments would violate the automatic stay of PROMESA.

First Circuit’s Opinion

In June 2017, bond insurers filed adversary proceedings against the Commonwealth and PRHTA, in which they claimed that Puerto Rico’s failure to remit the special revenues into the reserve accounts and make post-petition interest payments violated Chapter 9 of the Bankruptcy Code. The district court dismissed the complaint, finding that Chapter 9 does not require PRHTA to deposit the special revenues into the reserve accounts or make the payments. The First Circuit affirmed, finding that Chapter 9 permits, but does not require, continued payment of special revenues during the PROMESA proceedings.

Section 922(d) provides that “[n]otwithstanding section 362 . . . a petition filed under this chapter does not operate as a stay of application of pledged special revenues in a manner consistent with section 927 of this title to payment of indebtedness secured by such revenues.” The insurers argued that section 922(d) is an exception to the automatic stay that required PRHTA to remit the special revenues into the reserve accounts. They also argued that the statute allowed bondholders to enforce their rights to those revenues. The First Circuit disagreed, finding that section 922(d) was adopted only to make clear that a creditor holding pledged special revenues as security may apply those revenues to outstanding debt, notwithstanding the automatic stay.

In seeking Supreme Court review, Ambac Assurance Corporation argued that the First Circuit ruling had departed from prior law and would rattle the municipal bond market. Assured Guaranty Corporation also argued that there is unlikely to be a corrective ruling from another court in the near future because municipal bankruptcy cases usually “moot out” before reaching the court of appeals.

The Securities Industry and Financial Markets Association (SIFMA) filed an amicus brief arguing that the First Circuit’s decisions upset the settled expectations of the municipal bond markets and that the opinion undermined the 1988 amendments to the Bankruptcy Code. According to SIFMA, the 1988 amendments were intended to ensure that a lien on special revenues would prevent the diversion of investors’ security and source of repayment during a municipal bankruptcy. SIFMA said that municipal bond investors have relied on the special revenue provisions in the Bankruptcy Code and that the First Circuit’s opinions contradicted those assurances and undercut Congress’s express intent.

In opposing certiorari, the Financial Oversight and Management Board for Puerto Rico argued that the First Circuit’s opinions were correct and supported by precedent. Notably, the brief opined that the petitioners vastly exaggerated the market impact of the First Circuit’s opinion, citing the “near-total absence of economic data” to support the petitioners’ assertions.


The First Circuit’s opinions with respect to special revenue municipal bonds and the Supreme Court’s denial of certiorari presents a problem for bondholders and bond issuers. Bondholders had previously regarded special revenue bonds as the most secure and least risky class of municipal bonds. Whether the market reaction will be as disastrous as some have predicted remains to be seen, but it seems evident that the First Circuit’s opinions will raise the risk profile for these issues, which will likely lead to higher interest rates for issuers.

Stephen B. Selbst at +1 212 592 1405 or [email protected]

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