United States: Recent Ruling Against Puerto Rico Revenue Bondholders Causes Waves In U.S.

Douglas I. Youngman is a Partner in New York office.

Peter Baumgaertner is a Partner in New York office.

Phillip W. Nelson is a Senior Counsel in our Chicago office.


  • The U.S. Court of Appeals for the First Circuit has upheld a controversial ruling by a U.S. District Court in a case involving special revenue bonds issued by the Puerto Rico Highway Transportation Authority (PRHTA).
  • The District Court ruled in January 2018 that the Authority was permitted, but not required, by the U.S. Bankruptcy Code to apply special revenues to pay the bonds during adjustment proceedings under the Puerto Rico Oversight, Management and Economic Stability Act of 2016 (PROMESA).
  • The District Court's ruling contradicted long-held conventional wisdom regarding a municipal debtor's obligation to apply special revenues after commencing a bankruptcy proceeding.
  • The First Circuit's affirmation may have widespread impact on the municipal revenue bond market.

The U.S. Court of Appeals for the First Circuit has affirmed a controversial ruling regarding the treatment of municipal revenue debt, leaving investors with lingering questions about the value and significance of a revenue pledge in a municipal bankruptcy.

The original U.S. District Court decision roiled the municipal markets in January 2018, when Judge Laura Taylor Swain, the judge overseeing Puerto Rico's debt restructuring, ruled that municipal debtors were permitted, but not required, to apply special revenues to pay related bonds. Judge Swain's ruling reversed long-held conventional wisdom regarding the mandatory application of special revenues following municipal bankruptcy.

Background and District Court Decision

The case involved several series of bonds (the Bonds) issued by the Puerto Rico Highway and Transportation Authority (PRHTA), a public corporation of the Commonwealth of Puerto Rico. By statute, the Bonds were secured by a gross lien on revenues derived from certain highway tolls and excise taxes (collectively, the Pledged Special Revenues). The Bonds were also insured by a number of financial insurers (the Insurers), who were subrogated to the bondholders' rights upon payment of a covered default of the Bonds.

In March and April 2017, each of the Commonwealth and PRHTA adopted fiscal plans purporting to modify the application of the Pledged Special Revenues. Under the Commonwealth's fiscal plan, certain of the Pledged Special Revenues would be diverted to the Commonwealth for its general revenue purposes, and under the PRHTA fiscal plan, PRHTA would be authorized to apply Pledged Special Revenues to pay operating expenses ahead of debt payments, in contravention of the gross lien granted to holders of the Bonds.

On May 21, 2017, the Financial Oversight and Management Board for Puerto Rico (the Board) commenced debt adjustment proceedings for the PRHTA under Title III of the Puerto Rico Oversight, Management and Economic Stability Act of 2016 (PROMESA), which under Section 301 thereof incorporates and makes applicable to it portions of the U.S. Bankruptcy Code. Shortly thereafter, the trustee for the Bonds was instructed by the Puerto Rico Fiscal Agency and Financial Advisory Authority, on behalf of PRHTA, to cease making scheduled payments, based on the rationale that such payments violated the automatic stay under Section 362(a) of the U.S. Bankruptcy Code (as incorporated into PROMESA by Section 301 thereof). On July 3, 2017, PRHTA defaulted on a scheduled payment of $219 million.

The Insurers filed suit against the Commonwealth, the PRHTA, the Board and various other entities and individuals, seeking declaratory and injunctive relief. The Insurers asked the court to declare, among other things, that the Bonds were secured by special revenues exempt from the automatic stay and to grant an injunction requiring PRHTA to resume remittance of the Pledged Special Revenues. The Insurers' arguments hinged on the interpretation of Sections 922(d)1 and 9282 of Chapter 9 of the U.S. Bankruptcy Code (each incorporated into PROMESA by Section 301 thereof), which address the treatment of special revenues in municipal bankruptcy.

Judge Swain granted the defendants' motion to dismiss the Insurers' claims, holding, in effect, that while Section 928 extended the Bonds' statutory lien to cover post-filing special revenues and Section 922(d) indeed permitted the municipality to apply those special revenues to make the secured payments, neither Bankruptcy Code section affirmatively required such payments.

Many commentators expressed surprise at Judge Swain's ruling, which upset the widely held view in the municipal market that the protections afforded special revenues in municipal bankruptcy were, in fact, intended to provide bondholders with the certainty of payment during the adjustment proceeding, resulting from not only the continuing lien on special revenues, but a statutory obligation to apply those special revenues to pay the secured debt notwithstanding the automatic stay. Fitch Ratings, in a statement issued following Judge Swain's original ruling, warned that "If the ruling is upheld on appeal, credit ratings that could be negatively affected include utility, transportation and tax revenue bonds rated higher than a municipality's Issuer Default Rating," echoing the sentiment of others in the market.

First Circuit Decision and Potential Effects

The First Circuit heard the Insurers' appeal and, on March 26, 2019, affirmed Judge Swain's ruling, dismissing the Insurers' claims. In its opinion, written by Judge Juan Torruella, the First Circuit found that "In sum, Sections 928(a) and 922(d) permit, but do not require, continued payment during the pendency of the bankruptcy proceedings. The two provisions stand for the premise that any consensual prepetition lien secured by special revenues will survive the period of municipal bankruptcy, and, accordingly, municipalities can elect to voluntary [sic] continue payment on these debts during the course of the bankruptcy proceedings so as to not fall behind and thus be at risk of being unable to secure financing in the future."

Although the First Circuit's ruling covers only Maine, Massachusetts, New Hampshire, Puerto Rico and Rhode Island, commentators and rating agencies have expressed concern that the ruling will have a broader impact on holders of municipal revenue debt, particularly given the relative scarcity of case law interpreting issues of municipal bankruptcy. The First Circuit's affirmation raises serious concerns about the value of a municipal revenue pledge and creditors' ability to enforce any lien on such revenues post-bankruptcy or to otherwise protect the revenue stream.

As the First Circuit noted, like its analog in Section 904 of the U.S. Bankruptcy Code that applies in Chapter 9 municipal bankruptcies, Section 305 of PROMESA denies the court presiding over the Commonwealth and the PRHTA's debt adjustment proceedings the power and jurisdiction to "interfere with ... any of the property or revenues of the debtor; or ... the use or enjoyment by the debtor of any income-producing property." Thus, in a situation where some portion of the pledged revenues is being expressly diverted away from the issuer and the remainder of the pledged revenues are being applied, on an ongoing basis, to operating expenses in violation of the applicable bond documents, the courts' dismissal of the Insurers' claims appears to leave bondholders exposed as the stream of revenues continues to be depleted, without any recourse in the adjustment proceeding itself. If this is the case, it appears that the Insurers' only remedy, then, would be to persuade the court to grant relief from the automatic stay imposed by PROMESA on the grounds that the property interest embodied by the lien was not being adequately protected, and seek a remedy from some other competent court of more general jurisdiction to enforce their contractual and statutory rights (although the First Circuit's opinion does not comment on this).

Because the First Circuit's decision rests entirely upon the interpretation of provisions of Chapter 9 that are incorporated into (but not otherwise modified by) PROMESA, the court's ruling could be viewed as equally applicable to all special revenues in municipal bankruptcies. Accordingly, while the First Circuit's decision stands, municipal revenue bond ratings may be negatively impacted by the weakened bondholder protections; Fitch Ratings has already indicated that it will continue to monitor the case to determine whether ratings action is warranted. As a function of perceived credit risk, the price and valuation of new and existing municipal revenue debt may also be impacted, regardless of whether the rating agencies take action. Issuers of revenue bonds may consider taking additional steps to assure the market that they intend to honor their obligations, although the relative value of such an assurance may also be negatively impacted by the First Circuit's decision. In addition, new debt issues may benefit from structures that provide greater protection for pledged revenue streams. Market participants will need to consider whether new disclosure is warranted in light of the ruling's reversal of long-established market views regarding special revenues.

Assured Guaranty, one of the Insurers, has indicated that it is considering its legal options, including an appeal to the U.S. Supreme Court, or a challenge that the effective destruction of the lien constitutes an unconstitutional taking. Assured had previously been unsuccessful in its attempt to lift the automatic stay. In light of the facts surrounding the diversion of the pledged revenues and the subsequent actual default, however, perhaps another attempt will be better received, giving Assured another opportunity to seek protection of its lien. Regardless of the actions to be taken by Assured and the other Insurers, the market will continue to watch this case closely, considering its potentially wide-ranging ramifications.


1 Section 922(d) states that "Notwithstanding section 362 of this title and subsection (a) of this section, 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."

2 Section 928 states, in relevant part, that "Notwithstanding section 552(a) of this title and subject to subsection (b) of this section, special revenues acquired by the debtor after the commencement of the case shall remain subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions