Brief historical context of Puerto Rico's current legal ... · Juan Ponce de León organized the first European settlement fifteen ... bill of rights, instituted a republican form

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American Bar Association Section of State and Local Government

2016 Spring Meeting

A Tale of Two “Municipalities” (Detroit and Puerto Rico): Legal and Practical Issues Facing a Financially Distressed “Municipality”

Brief historical context of Puerto Rico's current legal and economic reality: How are we different? How are we similar? What is going on?

Carlos A. Rodriguez Vidal, Esq.

Managing Member and Chair, Litigation and Trial

Practice

Goldman Antonetti & Córdova, LLC

San Juan, Puerto Rico

April 7-10, 2016

Intercontinental Hotel


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Brief historical context of Puerto Rico's current legal reality:

How are we different? How are we similar? What is going on?1

Carlos A. Rodriguez Vidal, Esq.


'Discovery," Conquest and Rule by Spain

In 1493, in his second voyage to the continent later named América, Christopher Columbus discovered an island known as Boriquén, inhabited by an estimated 20,000 to 40,000 Taínos in about twenty villages. Juan Ponce de León organized the first European settlement fifteen years later in the island that was initially named San Juan Bautista by Spain. In short time, a school was founded; another settlement, San Germán, was founded in the southwest part of the island; the Catholic Church divided the island into two dioceses; and the application of Spanish law was extended, too. In less than half a century, Taínos fled or were absorbed (some say exterminated). Slavery was extended to the region, and the island was renamed Puerto Rico. The island remained a colony of Spain for nearly four centuries and underwent changes in its relationship with Spain as changes occurred in Spain itself. It was not until the beginning of the nineteenth century, after Napoleon invaded Spain, that Puerto Rico and other overseas territories were recognized as provinces with the right to representation in the Spanish Cortes. In 1812, Spain adopted the Cádiz Constitution and in 1815, issued the Royal Decree of Graces, which allowed foreigners to enter Puerto Rico and opened its ports to trade with other nations. By then, other Spanish colonies in America had begun their liberation movements. Despite this reality, or perhaps because of it, Spain appointed governors to Puerto Rico with virtually limitless powers. Nonetheless, during the last three decades of the nineteenth century, the Spanish Constitution of 1876 framed the judicial system of the Overseas Province of Puerto Rico. The Spanish Civil Code of 1889 was extended to Puerto Rico. Smaller inhabited islands, islets and cays became part of Puerto Rico. Essential principles of the period's judicial system and specific laws such as a penal code, a code of commerce, codes of civil and criminal procedure, and a civil code all were applied in Puerto Rico. The system had 71 municipal courts, eleven courts of first instance where civil appeals and matters beyond the jurisdiction of municipal courts would be heard, and one Real Audiencia Territorial, where these judges' decisions could be appealed. Arguments were generally submitted in writing with little or no questioning of witnesses by both parties. Civil and human rights, however, were not a hallmark of Spanish rule in Puerto Rico. There was no right to trial by jury, no habeas corpus, and no right to post bail. 1 Submitted on March 1, 2016.

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A short-lived autonomous group of islands become war booty

Under the Autonomic Charter of 1897, Puerto Rico became an autonomous entity from Spain for nearly one year. Before it could obtain its formal independence, and without consulting it, however, Spain agreed to include it as one of several ceded territories under the Treaty of Paris that ended the Spanish-American War in 1898. At the time of the Treaty of Paris, a judiciary existed in Puerto Rico, and a body of laws had emerged since the Spanish Constitution of 1876 was in place. Consideration over the determination of judicial proceedings pending in all ceded territories at the end of the Spanish-American War was drafted into an article of the Treaty of Paris, recognition of the relative maturity of the legal systems involved. Rights to property, including intellectual property such as copyrights and patents, were also the subject of that treaty. After 1898, Puerto Rico became a possession of the United States under military rule. Upon assuming sovereignty over Puerto Rico, General John R. Brooke issued General Order No. 1 which provided that "all judges and other officials involved in the administration of justice who accepted the United States' sovereignty and pledge their allegiance," would remain in place, and renamed the Audiencia Territorial as the Supreme Court of Justice of Puerto Rico. The military government also organized a Provisional Court to follow the same law and equity principles as United States courts, and to follow as close as possible procedures, rules and case management of the federal courts, including the use of the English language.

Transition to and from United States military rule: the Foraker Act and the Insular

Cases

In 1900, a federal statute known as the Foraker Act, 31 Stat. 77 (Apr. 12, 1900), formally established the relationship between the United States and Puerto Rico. The Foraker Act provided that the federal laws "not locally inapplicable" would have the same force and effect in Puerto Rico as in the United States, except for internal revenue laws, where Puerto Rico would be entitled to establish its own system of taxation. The laws and ordinances of Puerto Rico continued in force and effect as far as they would not be in conflict with the laws of the United States. Among the various statutes that remained in force under the Act were the Civil Code, Olivieri v. Biaggi, 17 P.R.R. 676 (1911); Mortgage Law and its regulations, Giménez

v. Brenes, 10 P.R.R. 124 (1903); and regulations and schedules for the assessment and collection of industrial insular taxes, Guillermety v. Treasurer, 3 P.R.R. 157 (1903). Under the Foraker Act, the judicial power was vested in the courts and tribunals then existing in Puerto Rico, including insular bodies such as the municipal courts and police courts. To succeed the Provisional Court, the Foraker Act created a federal judicial district for a court called the United States District Court for the District of Puerto Rico. The Act provided for the appointment of one judge for a four-year term under Article I of the U.S. Constitution. In addition, the Act granted the Court jurisdiction over civil cases involving controversies where

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the parties, or either of them, are citizens of the United States, or citizens or subjects of a foreign State, where the matter in dispute exceeded one thousand dollars. The right of trial by jury was adopted, although it became nearly impossible to convene a pool of 300 citizens with sufficient knowledge of the English language to serve as jurors. Writs of error and appeals from the final decisions of the Supreme Court of Puerto Rico and the District Court of the United States were allowed to be taken - in the English language - to the United States Supreme Court in the same manner and under the same regulations as from the supreme courts of the territories of the United States. Unlike federal courts in state jurisdictions, however, federal court fees and expenses in Puerto Rico, as well as salaries for its officers, were payable out of the Puerto Rico Treasury. The Foraker Act also created a commission appointed by the President of the United States to compile and revise the laws of Puerto Rico, the codes of procedure and systems of municipal government and to frame and report legislation to establish an efficient and economical government that would provide a general system of education, provide buildings and funds, and establish an equitable and simple method of taxation. The Commission issued a report recommending the implementation of changes to Puerto Rico's laws including, among others, the Civil Code, and the Codes of Civil and Criminal Procedure. The application of the U.S. Constitution and statutes, and specifically of provisions of the Foraker Act, was called into question often. The U.S. Supreme Court agreed to hear five cases collectively called the "Insular Cases" in 1901.2 In Downes v. Bidwell, 182 U.S. 244 (1901), considered by scholars to be the most important of the five, the specific question at issue was whether the Foraker Act, which imposed a tariff on goods shipped from Puerto Rico to the United States, violated either the uniformity clause of the Constitution (Article I, § 8), the no preference clause (Article I, § 9, clause 6), or the no export duty clause (Article I, § 9, clause 5). In effect, however, the Court was being called upon to decide the larger question whether Puerto Rico was, or was not, a part of the United States. By a vote of 5-4, the Court ruled for the U. S. Government and sustained the tariff, but no rationale commanded a majority of the Court. Although there were five separate opinions in Downes, there were effectively three distinct outlooks. In one, Justice Brown held that the United States, properly speaking, consisted only of the federated States, and that the Constitution applied, of its own force, only in the United States thus understood. The Congress having, with respect to other peoples, the same sovereign powers belonging to any nation in the international system, it also had plenary authority to rule its territories as it saw fit. The Congress could elect to extend United States law and constitutional protections to its territories, but without an act thus extending the Constitution's reach, it would not apply

2 De Lima v. Bidwell, 182 U.S. 1 (1901); Goetze v. United States, 182 U.S. 221 (1901); Armstrong v. United States, 182 U.S. 243 (1901); Downes v. Bidwell, 182 U.S. 244 (1901); and Huus v. New York and Puerto Rico Steamship Co., 182 U.S. 392 (1901).

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outside the states. Because Puerto Rico, in his view, belonged to but was not a constituent part of the United States, the tariff was valid. In their dissenting opinions, Chief Justice Fuller and Justice Harlan argued that the United States consisted of both the States and the territories, and that the Constitution necessarily applied of its own force in the whole United States, including the territories. Puerto Rico having become a part of the United States by the Treaty of Paris, ratified in 1899, the tariff manifestly violated the uniformity clause. Justice White articulated a middle position, positing that although the Constitution applied throughout the states and territories, the full set of constitutional protections applied only in the states and in territories that Congress had "incorporated"; in the other, "unincorporated" territories, only a limited and unspecified set of fundamental constitutional protections would apply. The continental territories of the United States had all been incorporated, in White's view, but the insular possessions had not. Because Puerto Rico remained an unincorporated territory, Congress remained at liberty to impose the tariff. Thus, while the United States could colonize, it could also deny its new possessions rights that would apply to states and territories under the Constitution.

The Jones Act and its direct effects on Puerto Rico

The Jones Act of 1917, 39 Stat. 951 (Mar. 2, 1917) defined Puerto Rico expressly as "an organized but unincorporated territory" of the United States, and extended to its inhabitants a bill of rights, instituted a republican form of government with three branches, maintaining the judicial power already vested in the Puerto Rico courts and maintained the federal court as the United States District Court for the District of Puerto Rico. The Jones Act also provided that the writs of error and appeals from final judgments and decrees of the Supreme Court of Puerto Rico could be taken and prosecuted to the United States Circuit Court of Appeals for the First Circuit and to the Supreme Court of the United States. Section 3 of the Act also exempted Puerto Rican bonds from federal, state, and local taxes regardless of where the bond holder resides:

"[...] all bonds issued by the government of Porto Rico, or by its authority, shall be exempt from taxation by the government of the United States, or by the government of Porto Rico or of any political or municipal subdivision thereof, or by any state, or by any county, municipality, or other municipal subdivision of any state or territory of the United States, or by the District of Columbia."

The Jones Act also granted statutory, not constitutional, United States citizenship that would make Puerto Ricans, among other things, eligible for the military draft. Nearly 20,000 Puerto

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Ricans were drafted to participate in World War I a few months after the enactment of the Jones Act. Justice White's incorporation doctrine seemed controversial at first, but in the end, it received the unanimous endorsement of the U.S. Supreme Court when, in 1922, in Balzac v. Puerto

Rico, 258 U.S. 298 (1922), a criminal libel case, the Court considered the issue whether the First Amendment protections extended to Puerto Rico, and whether that part of the Sixth Amendment to the U.S. Constitution, which required that, in all criminal prosecutions, the accused shall enjoy the right to a speedy and public trial by an impartial jury of the State and district wherein the crime shall have been committed, applied to Puerto Rico. The questions, in turn, revolved around the issue of whether Congress, since the Foraker Act, had enacted legislation incorporating Puerto Rico into the Union. With respect to the question of the First Amendment, the Court considered that the rights involved were sufficiently fundamental to answer it affirmatively. 258 U.S. at 314. However, the Court held that the Sixth Amendment did not require extending that right because Puerto Rico was an unincorporated territory, that the constitutional power extended to Congress does not require that body to enact for all ceded territories, not made a part of the United States by Congressional action, a system of laws which includes the right of trial by jury, and that the Constitution does not, without legislation and of its own force, carries such right to a territory so situated. Puerto Rico did eventually legislate to provide for jury trial in criminal cases where the sentence could result in incarceration longer than six months. To this day, no right to jury trial exists in the Puerto Rico courts in civil cases. From 1915 to 1961, decisions of the Puerto Rico Supreme Court could be appealed to the United States Court of Appeals for the First Circuit. In earlier years, the First Circuit frequently reversed the Puerto Rico Supreme Court, sometimes imposing its own interpretation of Puerto Rico's civil law legal norms despite the circuit's lack of familiarity with Puerto Rico law or jurisprudence, until a series of opinions by the United States Supreme Court instructed that the Puerto Rico Supreme Court's interpretations were not to be overturned by the federal appeals court unless they were "manifestly wrong," see, e.g., People

v. Rubert, 315 U.S. 637, 646 (1942); Bonet v. Yabucoa Sugar Co., 306 U.S. 505, 509-510 (1939); Bonet v. Texas Company (P.R.), Inc., 308 U.S. 463, 470-472 (1940); and De Castro

v. Board of Commissioners, 322 U.S. 451 (1944). In one such case, the U.S. Supreme Court, in Diaz v. González y Lugo, 261 U.S. 102 (1923), a suit brought by the plaintiffs to establish the nullity of a sale of their land while they were all minors, extended a rule of deference to interpretations of Puerto Rico law to Puerto Rico courts, given the unique cultural and legal history of Puerto Rico. The Court considered and discussed the Puerto Rico Civil Code and interpretations of Spanish treatises on equivalent sections of the Spanish Civil Code. It concluded its opinion as follows:

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This Court has stated many times the deference due to the understanding of the local courts upon matters of purely local concern. It is enough to cite De

Villanueva v. Villanueva, 239 U.S. 293, 299. Nadal v. May, 233 U.S. 447, 454. This is especially true in dealing with the decisions of a Court inheriting and brought up in a different system from that which prevails here. When we contemplate such a system from the outside it seems like a wall of stone, every part even with all the others, except so far as our own local education may lead us to see subordinations to which we are accustomed. But to one brought up within it, varying emphasis, tacit assumptions, unwritten practices, a thousand influences gained only from life, may give to the different parts wholly new values that logic and grammar never could have got from the books. In this case a slight difference in the caution felt in dealing with the interest of minors (Baerga v. Registrar of Humacao, 29 P.R. 440, 442,) and a slight change of emphasis in the reading of statutes, explain the divergence between the Supreme Court and the Circuit Court of Appeals. Our appellate jurisdiction is not given for the purpose of remodeling the Spanish American law according to common law conceptions except so far as that law has to bend to the expressed will of the United States. The importance that we attribute to these considerations led to our granting the writ of certiorari and requires us to reverse the judgment below. 261 U.S. at 105-106.

An "act in the nature of a compact" allows for the approval of a Constitution

In 1950, after the end of the Second World War and the creation of the United Nations, in what was termed "an act in the nature of a compact" between Puerto Rico and the United States, the U.S. Congress allowed the People of Puerto Rico to organize a government pursuant to a constitution of their own adoption under the Puerto Rican Federal Relations Act, 64 Stat. 319 (July 3, 1950). A Constitutional Convention was held in Puerto Rico, and it created a body politic whose name was not literally translated from its original Spanish version, Estado Libre Asociado, but translated by the Act as Commonwealth of Puerto Rico. Free Associated State, as it would have been literally translated, was felt to be misleading because the term "state" in the United States ordinary speech would have meant one of the States of the Union. See Resolution No. 22 of Constitutional Convention, February 4, 1952. The Commonwealth was officially constituted on July 25, 1952. A short time later, the United States asked the United Nations to take Puerto Rico off the United Nations Decolonization Committee's list of possessions over which its owner had to provide annual reports on efforts to decolonize. The Constitution included Article VI, §8, on the priority of disbursements when resources are insufficient. The section provides that when available resources in a fiscal year are insufficient to cover the approved expenditures for that year, payment of interest and amortization of public debt shall be paid first, and then other disbursements shall be paid in the order of

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priority established by law. The Puerto Rico Office of Management and Budget enabling statute provides the guidelines for such disbursements:

(1) Order the payment of interest and amortizations corresponding to the public debt. (2) Order that the commitments entered into by virtue of legal contracts in force, judgments of the courts in cases of condemnation under eminent domain, and binding obligations to safeguard the credit, reputation and good name of the Government of the Commonwealth of Puerto Rico, be attended to. (3) Order that preference be given to disbursements charged to appropriations for regular expenses connected with the: (A) Conservation of public health. (B) Protection of persons and property. (C) Public education programs. (D) Public welfare programs. (E) Payment of employer contributions to retirement systems and payment of pensions to individuals granted under special statutes; and then, the remaining public services in the order of priority determined by the Governor; Provided, That the disbursements related to the services listed hereunder shall not have preference among themselves but shall be handled simultaneously; Provided, further, That any adjustments due to reductions may be made in any of the appropriations for regular expenses, including the service areas indicated in this subparagraph. (4) Order the construction of capital works or improvements with duly executed contracts; Provided, That priority shall be given to emergency works caused by catastrophes or acts of nature, acts of God; and then, to those works that are most responsive to the development of the normal and economic life of Puerto Rico. (5) Order that the payment of contracts and commitments contracted under special appropriations for operations be honored, and then, that special preference be given to those phases of the programs that are in the process of development or in a stage of planning which, if postponed, would affect the interests of the clients served by the program, directly or indirectly.

As Judge José Cabranes of the U.S. Court of Appeals for the Second Circuit has noted, whether, in fact, the essential nature of the relationship between Puerto Rico and the United States was somehow altered by the enactment of the Federal Relations Act or the promulgation of the Puerto Rico Constitution is a matter of continuing and somewhat abstract partisan controversy. Puerto Rico and the Constitution, Remarks of the Hon. José A. Cabranes, First Circuit Judicial Conference, 110 F.R.D. 475, 480 (1985). Former Dean of the University of Puerto Rico Law School, David M. Helfeld, has written on the subject of how much of the U.S. Constitution and statutes are applicable to Puerto Rico. How Much of the United States Constitution and Statutes Are Applicable to the Commonwealth of Puerto

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Rico?, Remarks of Dr. David M. Helfeld, First Circuit Judicial Conference, 110 F.R.D. 452 (1985). He posits that, generally speaking, in the field of individual rights, if a state can do something constitutionally, Puerto Rico can do it, and vice versa. However, Congress can legislate for Puerto Rico without constitutional limits when funding federal programs. If Congress can discriminate with respect to funds against Puerto Rico, then it can also discriminate in all legislation in the field of economic regulation, against or in favor of Puerto Rico, or to opt for equal treatment. Less than one year after the comments of Dean Helfeld and Judge Cabranes, in a case involving restrictions to advertising of casino gambling in Puerto Rico, a majority of the U.S. Supreme Court in Posadas de Puerto Rico Associates v. Tourism Co. of P.R., 478 U.S. 328 (1986), held that it had jurisdiction to review a decision of the Supreme Court of Puerto Rico on the grounds that a federal statute, 28 U. S. C. § 1258(2), specifically authorizes an appeal to the U.S. Supreme Court from a decision of the Supreme Court of Puerto Rico "where is drawn in question the validity of a statute of the Commonwealth of Puerto Rico on the ground of its being repugnant to the Constitution, treaties, or laws of the United States, and the decision is in favor of its validity." On the case's merits, the Court refused to give casino advertising substantial First Amendment protection, asserting that the Commonwealth has a legitimate and substantial interest in discouraging its residents from engaging in casino gambling. In an article titled The Commonwealth Before the Courts 1952-1994, the late Puerto Rico Supreme Court Chief Justice José Trias Monge, a member of the 1950-1952 Constitutional Convention, summarized his analysis of the most important principles Puerto Rico's legal system:

1) Puerto Rico is sovereign over matters that are not governed by the U.S. Constitution. 2) The relationship between Puerto Rico and the United States is unparalleled in U.S. history. 3) The purpose of the creation of the Commonwealth of Puerto Rico was to grant it the degree of autonomy and independence normally associated with states. 4) Puerto Rico, like a state, is an autonomous political entity. 5) In summary, Puerto Rico's status has evolved from a mere territory to the unique status of Commonwealth of Puerto Rico. 6) The Constitution of the Commonwealth of Puerto Rico is not merely another Congressional statute. 7) The Commonwealth of Puerto Rico is subject to the applicable provisions of the U. S. Constitution. 8) Congress may treat Puerto Rico differently as long as there is a rational basis for its actions. 9) Federal laws apply to Puerto Rico as they do in states of the United States, except when they are locally inapplicable, or when Congress decides not to extend

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their application to Puerto Rico; and Congress cannot legislate for Puerto Rico in a way that exceeds its constitutional powers with respect to states. 10) Federal laws are superior in rank over the Constitution of the Commonwealth of Puerto Rico 11) The authority exercised by the federal government emanates, since the foundation of the Commonwealth status, from the Federal Relations Act itself, but Congress maintains over Puerto Rico similar power that it has over states. 12) There is a tendency to economically integrate Puerto Rico more into the United States, and to treat it more like other states, except when it comes to the distribution of wealth and welfare.

Trias Monge, J., El Estado Libre Asociado Ante los Tribunales 1952-1994, 64 Rev.Jur.U.P.R. 1, 3941 (1995).

This view, which had been expressed by Justice Trías in other articles and books is, of course, subject to much debate in Puerto Rico, from both advocates for independence for the island, Berríos, R. La independencia de Puerto Rico: Razón y lucha, México, Edit. Linea, (1983), and more recently, Delgado Cintrón, C., Imperialismo juridico norteamericano en Puerto

Rico (1898-2015) (“North American Legal Imperialism in Puerto Rico (1898-2015)”), and from advocates for admission of Puerto Rico into statehood in the United States, see Torruella, J. The Supreme Court and Puerto Rico: The Doctrine of Separate and Unequal, Edit. Universidad de Puerto Rico, 1985; Gelpí, G., The Insular Cases: A Comparative

Historical Study of Puerto Rico, Hawai’i and the Philippines (2011).

The Merchant Marine Act’s application to Puerto Rico

A different Jones Act, the Merchant Marine Act of 1920, Pub. L. No. 66-261, 41 Stat. 988, 989 (1920), codified as amended at 46 U.S.C. § 55102, requires that maritime transport of cargo between points in the United States be carried by vessels that are (1) owned by U.S. citizens and registered in the United States, (2) built in the United States, and (3) operated with predominantly U.S.-citizen crews. Puerto Rico is subject to all Jones Act requirements. Shippers and others engaged in shipping between the United States and Puerto Rico have expressed concerns that, as a result of this Jones Act, freight rates between the United States and Puerto Rico are higher than they would otherwise be. Higher rates increase prices of goods and have a negative effect on the Puerto Rico economy.3 Of the total volume of trade between the United States and Puerto Rico in 2011, 85% was shipped from the United States to Puerto Rico. Goods imported into Puerto Rico from the United States are primarily consumer goods. Puerto Rico imports from foreign countries are also a significant volume,

3 A GAO Report to requesters from Guam and Puerto Rico, GAO 13-260, dated March, 2013, investigated the characteristics of Puerto Rico’s maritime trade and the potential effects of modifying the Act’s application to Puerto Rico. It concluded that modifying the Jones Act in Puerto Rico “would have uncertain effects and may result in difficult trade-offs.”

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primarily due to imports of petroleum products, on which Puerto Rico relies most heavily for the production of electricity.

The Current Practice of Law in Puerto Rico

As this brief, surely incomplete and, perhaps, simplistic summary shows, the legal history and traditions of Puerto Rico are heavily influenced by Spanish law and traditions and, more recently, by United States constitutional, statutory, and procedural law. Puerto Rico has its own republican form of government with an independent judiciary, all of whom are appointed by the governor and confirmed by the Senate of Puerto Rico. The Puerto Rico Supreme Court has a Chief Justice and, currently, eight associate justices. Puerto Rico also has a Court of Appeals composed of thirty-seven appellate judges, and a Court of First Instance divided into thirteen judicial regions with nearly two hundred judges. Puerto Rico trial courts, as state courts do, have concurrent jurisdiction to entertain suits on a myriad of issues, including those that may require the interpretation of federal law where exclusive jurisdiction has not been placed in federal courts. Most cases brought before the Puerto Rico court system are completely devoid of any issues that may require the analysis of Puerto Rico's relationship to the United States. Disputes related to all walks of life are resolved or handled in the Spanish language in those courts. The Puerto Rico Civil Code of 1930, subdivided into four titles, Persons, Property, Modes of Acquiring Ownership, and Obligations and Contracts continues to apply to matters related to family law, property law, trusts and estates, contracts, and torts. Puerto Rico maintains the same type of mortgage and registry law system it had when it was a Spanish colony. As a result, for example, all notaries must be attorneys. At the same time, even after 1952, the federal judicial district court remains active and present in Puerto Rico. While the number of district judgeships at times has been insufficient to handle the caseload, and visiting judges from other jurisdictions continue to preside over cases in Puerto Rico, all active district judges appointed by the President of the United States since 1952 have been Puerto Rican attorneys. Since 1966, they have been Article Ill judges with lifetime tenure. A total of 20 such appointments have been made over the last fifty-five years. The federal district court sitting in Puerto Rico is currently composed of seven district judges, four senior district judges, four magistrate judges, and four bankruptcy judges. It conducts its trials and hearings in English, although a significant amount of litigation off the record takes place in Spanish. It has the same type of jurisdiction over admiralty, criminal and civil cases as other federal district courts do. It is based on federal questions, admiralty, or on questions involving disputes where the citizenship of the parties is completely diverse and the amount in controversy exceeds $75,000.00. Because there is a right to trial by jury in civil cases in federal court, plaintiffs aspire to obtain - or in some cases create - federal diversity jurisdiction in tort or contract cases to avail themselves of the perception that juries in federal civil cases are more generous than judges presiding over bench trials in the Puerto Rico courts.

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The current fiscal crisis of the Puerto Rico government, litigation and

Congressional efforts

Puerto Rico is currently facing a singularly debilitating fiscal crisis. This crisis is centered on a public debt of more than $70 billion, an amount that exceeds that of all but two States of the United States and almost equal to its annual Gross National Product.

Over the last eight years, the Government of the Commonwealth of Puerto Rico has been facing a most serious fiscal crisis, and some of its public utilities are in imminent risk of becoming insolvent. The U.S. Bankruptcy Code, a federal statute that applies in all fifty states and most of the U.S. territories, does not extend in all respects to Puerto Rico. Unlike states, Puerto Rico may not authorize its “municipalities,” including its public utilities providing energy, water, and sewer services to its population, to seek federal bankruptcy relief under Chapter 9 of the U.S. Bankruptcy Code. 11 U.S.C. §§ 101(40), 101(52), 109(c). In June 2014, Puerto Rico attempted to allow its utilities to restructure their debt by enacting its own municipal bankruptcy law, the Puerto Rico Public Corporation Debt Enforcement and Recovery Act ("Recovery Act"), which expressly provides different protections for creditors than does the federal Chapter 9. Investors who collectively hold nearly two billion dollars of bonds issued by one of the distressed public utilities, the Puerto Rico Electric Power Authority ("PREPA"), fearing that a PREPA filing under the Recovery Act was imminent, brought suit in the summer of 2014 to challenge the Recovery Act's validity and enjoin its implementation. The U.S. District Court for the District of Puerto Rico ruled in their favor and permanently enjoined the Recovery Act on the ground that it is preempted under 11 U.S.C. § 903(1). That provision, § 903(1), ensures the uniformity of federal bankruptcy laws by prohibiting state municipal debt restructuring laws that bind creditors without their consent. 11 U.S.C. § 903(1). The defendants in that case, the Commonwealth of Puerto Rico, its Governor, its Secretary of Justice, and the Government Development Bank ("GDB"), appealed the decision to the U.S. Court of Appeals for the First Circuit. On July 6, 2015, the First Circuit affirmed the decision of the district court. The primary legal issue on appeal was whether § 903(1) preempted Puerto Rico's Recovery Act. That question turned on whether the definition of "State" in the federal Bankruptcy Code -- as it had been amended in 1984 -- rendered § 903(1)'s preemptive effect inapplicable to Puerto Rico. When Congress completely revised the code in 1984, it included a section on acquisition of debts and how they would be treated legally. It includes Puerto Rico as the equivalent of the states, territories, and the District of Columbia. However, a special provision said that Puerto Rico and the District of Columbia could not be classified as debtors under Chapter 9.

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Chapter 9 allows municipal government to be treated as debtors, and file for relief under the bankruptcy code. Detroit, for example, was an important illustration of Chapter 9’s usefulness to local governments that have run up heavy debt. Prior to the 1984 revision, Puerto Rico had been eligible to file for bankruptcy under prior provisions.

The post-1984 definition of "State" includes Puerto Rico, "except" for the purpose of "defining" a municipal debtor under § 109(c). 11 U.S.C. §§ 101(52), 109(c). Puerto Rico now lacks the power it once had been granted by Congress to authorize its municipalities to file for Chapter 9 relief. The First Circuit held that § 903(1) preempts the Recovery Act. The prohibition now codified at § 903(1) has applied to Puerto Rico since the predecessor of that section's enactment in 1946. The First Circuit stated that the statute does not currently read, nor does anything about the 1984 amendment suggest, that Puerto Rico is outside the reach of § 903(1)'s prohibitions. Puerto Rico, its Governor, its Secretary of Justice, and the GDB argued that this result would leave Puerto Rico without relief. The First Circuit was unmoved, however, and stated that, although §101(52) denies to Puerto Rico the power to authorize its municipalities to pursue federal Chapter 9 relief, Puerto Rico may turn to Congress for recourse. Indeed, it said, Congress preserved to itself that power to authorize Puerto Rican municipalities to seek Chapter 9 relief. Puerto Rico, its Governor, its Secretary of Justice, and the GDB filed a petition for certiorari to the U.S. Supreme Court. Certiorari was granted and the case will be argued on March 22, 2016, just two weeks before this Conference takes place. At the same time, Puerto Rico is seeking authorization or other relief directly from the U.S. Congress. See Puerto Rico Chapter 9 Uniformity Act of 2015, H.R. 870, 114th Cong. (2015). Legislation to open chapter 9 of the U.S. Bankruptcy Code to Puerto Rico was filed in the U. S. Senate on July 8, 2015, with New York Sen. Charles Schumer and Connecticut Sen. Richard Blumenthal making a joint statement after the bill was unveiled on Capitol Hill. “Creditors, investors, ordinary citizens, all will be harmed if the Congress fails to act. This measure is not a bailout - involving not a dime of federal funds. It enables an orderly, rational restructuring of debt, instead of a financial free-for-all and potential free fall.” The bill mirrors H.R. 870, the Puerto Rico Chapter 9 Uniformity Act, legislation that was filed in the U.S. House of Representatives by Puerto Rico’s Resident Commissioner Pedro Pierluisi in February of 2015. The Puerto Rico Chapter 9 Uniformity Act would provide Puerto Rico with the same authority granted to all U.S. states that enables its municipalities and public utilities to restructure their debt. The bill was co-sponsored by the junior senators of both New York and Connecticut, states that are home to vital financial services hubs, including hundreds of hedge funds, and large Puerto Rican populations. Joining Senators Schumer and Blumenthal, Sen. Kirsten Gillibrand of New York and Connecticut Sen. Christopher Murphy as original co-sponsors of the bill are Democratic Sens. Harry Reid of Nevada, Bill Nelson of Florida,

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Robert Menéndez of New Jersey, Cory Booker of New Jersey, Elizabeth Warren of Massachusetts, Martin Heinrich of New Mexico, Mazie Hirono of Hawaii and Bernie Sanders, a Vermont independent. New Jersey and Massachusetts both have long-established Puerto Rican populations, and Florida, a key swing state, is the focal point of the latest and ongoing exodus of islanders to the mainland. Senate Judiciary Committee Chairman Charles Grassley, R-Iowa, has said there is “no clear path forward” for the legislation in the upper chamber. Grassley and his counterpart in the lower chamber, House Judiciary Committee Chairman Bob Goodlatte, R-Va., have said that opening Chapter 9 is not going to solve all of the U.S. territory’s fiscal problems, signaling that any hopes of getting the bills past their panels would require the Puerto Rico government to tackle underlying structural, economic and fiscal problems. At a hearing held on February 25, 2016 before the U.S. House Committee on Natural Resources, Antonio Weiss, Counselor to Secretary of Treasury Kevin Lew, testified that the Obama administration proposes a restructuring authority, pursuant to the territorial clause of the U.S. Constitution, which would apply to all of the Puerto Rico’s liabilities. This, he said, would give Puerto Rico the tools it needs to reach a resolution with creditors and adjust its debts to a sustainable level. Mr. Weiss also chose to emphasize that this authority would expressly not apply to states, “who have an entirely different relationship with the federal government under the 10th Amendment.” Accessing this “territorial restructuring authority” would be conditioned on acceptance of strong, independent federal oversight in the form of a financial and fiscal board. On that same date, the U.S. House Financial Services Subcommittee on Oversight and Investigations held a parallel session. At that hearing, financial services representatives testified, among other things, that some have concerns over the Treasury Department's proposal for "Super Chapter 9" bankruptcy, as it could raise the cost of borrowing for areas of the United States, and that long-term financial stability for Puerto Rico's government requires continued access to the financial markets, which could be more difficult and expensive should the Treasury's plan be enacted. Others opined that additional tools are necessary, perhaps a framework allowing for restructuring of all the island's problems, adding that it may the only way to put Puerto Rico on a sustainable path without fallout on the bond market and financial system. One witness from Puerto Rico, an employee of a real estate developer, felt compelled to tell subcommittee chairman Rep. Sean Duffy, (R-WI), that there would be “strong support” in Puerto Rico for an oversight board. It is unclear from the testimony at the hearing who he consulted before expressing that opinion. Rep. Mick Mulvaney (R-S.C.) noted his discontent over Treasury's Puerto Rico plan and asked how it is fair for United States pensioners and retirees. Krueger called the situation "dire," adding that it will be a "messy, long, drawn-out process" as Puerto Rico will not be able to make its payments. The list of sovereign defaults in the world over the last two centuries is long. Most European countries, including currently strong economies such as Germany, France, and the United

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Kingdom, have at one point or another failed to meet their liabilities as they became due. More recently, Portugal, Spain, and Greece have been in the brink of default, and requiring bailouts. In the Americas, even the United States, whose national debt exceeds 17 trillion dollars, narrowly avoided default in 2011 and 2013. One distinction is that Puerto Rico, as can be seen, cannot act on its own to manage its impending difficulties. Because of its relationship with the United States, it is subject to the ebbs and flows of attention and inattention of the United States to its affairs and to the limitations U.S. laws impose on its ability to cope with them. Economic indicators reveal that the unemployment rate stood at 12.2 percent in January 2016, and even worse, the labor participation rate, the measure of people actively involved in the workforce, is 40 percent, more than 20 points lower than the United States and one of the world's weakest. Growth is stagnant — in fact the economy is shrinking — and manufacturing is in a decade-long decline.

The human toll for the island's 3.6 million residents has been profound. Median household income is one-third that of the United States; over 45 percent of Puerto Ricans live below the poverty line and more than a third are on government assistance. Approximately 1.9 million potential clients qualify financially for legal services under LSC guidelines (approximately 54% of the total population).

Puerto Rico is also apparently undergoing accelerating outward migration, but the census data itself is unreliable. Manipulation, carelessness, and sheer negligence in government have created a lack of transparency that severely disrupted the ability to discuss matters constructively with the United States. While the miscommunication may be partly culturally -driven, stemming from a much lower obsession with metrics and the overzealous quantification of subjective reality that permeates the United States and its public policy formulation, some of it is the fault of petty, misguided Puerto Rican politics. A report to the U.S. Census Bureau that 80.5% of the Puerto Rico population was of the White race is just one example of why skepticism abounds when Puerto Rican political parties in power choose to communicate equivocating messages. Puerto Rico's fiscal crisis has grown more acute in recent months. The inability of the Executive and Legislative branches of government to agree on tax reform that would generate more revenue resulted in a budget proposal for fiscal year 2015-16 that reduced the budget of the Judicial branch by an additional 20% over reductions that had been implemented already in 2013. Total or partial court closings were underway in 2015. To save on rent, electricity and water and related costs, thirteen Municipal courts closed in the last year, forcing the consolidation of their operations into regional judicial centers that often are not accessible to remote and rural communities. Employees are asked not to come to work, and courts do not receive the public on days such as the day after Thanksgiving, the days before and after Christmas and New Year's and other similar holidays to reduce the Judiciary's exposure to vacation and compensatory leaves. Innovative programs such as Drug Courts and specialized

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domestic violence courts are at risk because they depend on the provisions of services by government agencies with diminishing budgets of their own for the provision of rehabilitation services to drug court participants or for protection of domestic violence victims. The Judiciary has also discontinued the payment of professional and other membership fees paid to judges and other professionals. In the context of funding legal services for disadvantaged communities, for example, charitable foundations have shared in the common misconception of the island's status: United States foundations do not treat Puerto Rico as if it were part of the United States, while international foundations do. Puerto Rican foundations have traditionally shown a disinterest or a distaste to fund legal services organizations. In the end, the people of Puerto Rico lose.

A new paradigm has surfaced to strengthen democratic participation that allows the population to have better access to information and to participate more effectively in aspects of government with a direct effect on their lives. Through its Open Places Initiatives, the Open Society Foundations have begun to make substantial investments in Puerto Rico, one of which involves one of the law schools' clinical programs in a broader initiative. The Center for a New Economy, a Puerto Rican public policy think-tank, the Puerto Rico chapter of the ACLU, the Puerto Rico Center for Investigative Journalism, and the University of Puerto Rico Law School Clinic joined together to form Espacios Abiertos, an initiative that aims to strengthen civic capacity in Puerto Rico. With funding awarded by OSF, it has developed projects in the areas of transparency, access to justice, and socioeconomic development. It is in the process of galvanizing different sectors of society to generate and sustain an agenda of community leadership and development to form alliances that will allow them to advance democratic participation.

In the meantime, some residents of Puerto Rico have left, seeking other horizons, mainly in the United States. The larger portion of the population that remains in Puerto Rico, over 3.5 million, are bracing for the probability of additional taxes and a smaller government with reduced services. Yet, the private sector in Puerto Rico attempts to forge ahead. Uncertainty may reign, but life must go on, and does. But we can and should do much more. As Alex Soros recently said in an Editorial Page opinion column in the Miami Herald, for example, concerted, coordinated and focused effort by Puerto Rico, United States and international foundations similar to one that took place in Detroit, Michigan could bolster Puerto Rico's efforts to address its crisis.

PANEL: A Tale of Two “Municipalities” (Detroit and Puerto Rico): Legal and PracticalIssues Facing a Financially Distressed Municipality

American Bar AssociationSection of State and Local Government2016 Spring Meeting

April 8, 2016Intercontinental HotelSan Juan, Puerto Rico

PRESENTATION: Chapter 9 Bankruptcy and the Detroit Experience

Robert D. Gordon151 S. Old Woodward Ave., Suite 200Birmingham, MI 48009(248) [email protected]

These materials are for educational purposes only and do notconstitute legal advice, nor do they necessarily reflect theopinions of the speaker, Clark Hill, or the American BarAssociation.

TABLE OF CONTENTS

Speaker Biography 3

Detroit’s Long Road to Bankruptcy 4

Chapter 9 Bankruptcy — Overview 12

The Eighth Amended Plan for the Adjustment of Debts of the City ofDetroit, Michigan — Overview

30

The Speed of the Bankruptcy Case 39

Mediation 41

Goals Achieved Via Chapter 9 Bankruptcy 43

2

SPEAKER BIOGRAPHY

3

Detroit’s Long Road to Bankruptcy

Deteriorating Macroeconomic Conditions: During the past several decades, the City of Detroit (the “City”) experienced changes that adversely

affected the economic circumstances of the city and its residents.

Declining Population: the City’s population declined 63% since its postwar peak, including a 26%decline since 2000: June 1950: 1,849,600 June 1990: 1,028,000 June 2000: 951,270 June 2010: 713,777 December 2012: 684,799

High Unemployment: The City’s unemployment rate nearly tripled between 2000 and 2012: June 2000: 6.3% June 2010: 23.4% June 2012: 18.3%

DETROIT’S DETERIORATING FINANCIAL CONDITION

5 Information on this slide provided by Conway MacKenzie, Inc.


Eroding Tax Base and Reductions in State Revenue Sharing

Property Taxes. Property tax revenues decreased by approximately 19.7% over the prior five years asa result of declining assessed values ($1.6 billion from 2008 to 2012) and lower collection rates(from 76.6% in 2008 to 68.3% in 2012).

Income Taxes. Income tax revenues decreased by $91 million since 2002 (approximately 30%) andby $44 million (approximately 15%) since 2008. The primary cause of these decreases was highunemployment.

The city was levying all taxes at or near statutory maximum rates and had the highest taxes in theState of Michigan.

Information on this slide provided by Conway MacKenzie, Inc.6


The City’s Debt and Legacy Liabilities Grew Considerably Over Time.

Balance Sheet Liabilities

The City estimated that, as of the close of its 2013 fiscal year, the City had liabilities reflected on itsbalance sheet of approximately $9.05 billion, including:

$5.85 billion in special revenue obligations;

$1.43 billion in pension-related Certificates of Participation (“COPs”) liabilities;

$343.6 million in marked-to-market swap liabilities related to COPs (as of May 31, 2013 valuation);

$1.13 billion in unlimited and limited tax general obligation bond liabilities and notes and loanspayable; and

$300 million in other liabilities.

Legacy costs were 42.5% of annual revenues in FY 2012 -- and projected to grow to 64.6% of revenuesby FY 2017.


DETROIT’S DETERIORATING FINANCIAL CONDITION (1)

$91$142

$267

$91

$197

$327$245

$75

$75

$75

$75

$75

$75$250

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$130

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2007A 2008A 2009A 2010A 2011A 2012A 2013P

($ in millions)

Accumulated Deficit LTGO Series 2008ALTGO Series 2010 LTGO Series 2012C

The City’s deficits continued to grow as legacy expenditures absorbed additional amounts of resources

0%

10%

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2008 2010 2012 2014 2016

Total Legacy Expenditures

Total Revenues (excl. financing proceeds)

Total Legacy Expenditures as a %of Total Revenues

($ in millions) (Legacy as % of Revenues)

8 Information on this slide provided by Conway MacKenzie, Inc.


Off-Balance Sheet Liabilities

OPEB Liabilities

– Unfunded other post-employment benefit (“OPEB”) retiree pre-petition liability claims were inexcess of $4.3 billion

– As of June 30, 2011, there were 19,389 retirees eligible to receive benefits under the City’sOPEB plans. The number of retirees eligible to receive benefits from the City was expected toincrease over time

Pension Liabilities

– Pre-petition unfunded pension liabilities were over $3.1 billion

– There were approximately 2 retirees for every active employee


DETROIT’S DETERIORATING OPERATIONAL CONDITION

40% of street lights were inoperable.

High crime: 5x national average in 2012.

Every single City department was fundamentally broken in terms of operations, fiscal controls, and IT.

Infrastructure and equipment were completely outdated, including: public safety forces, IT, andtransportation.


THE CITY’S RESTRUCTURING GOALS

Fiscal stability and sustainability

Stabilize key revenue streams and forecast revenues that the City could reasonably achieve

Reduce burden of debt, pension and healthcare related (OPEB) liabilities, while providing restructured benefits to

actives and retirees

Improve controls and management of daily operations

Revitalization of City of Detroit / Improvement of services for citizens and businesses

Provide City with resources in order to reinvest, reinvent and grow within its own means

Improve infrastructure

Eliminate residential blight

Public safety – reduce crime and improve response times

Essential services – reinvest in street lighting and other City services

Create the foundation to allow for a sustainable outcome for the City, residents and stakeholders


Chapter 9 Bankruptcy - Overview

CHAPTER 9 ADVANTAGES: SIMILARITIES TO CHAPTER 11

Section 901 of the Bankruptcy Code incorporates many sections of the Code applicable to private-sectorChapter 11 cases.

Sections 362 and 922 of the Bankruptcy Code provide for a stay, applicable to all individuals and entities, ofactions to recover prepetition claims, enforce pre-petition judgments, obtain or control any property of thedebtor, and of “action(s) or proceedings against an officer or inhabitant of debtor that seeks to enforce a claimagainst the debtor” (section 922(a)(1)).

Section 922(a)(2) also stays the enforcement of a lien on or arising out of taxes or assessments owed tothe debtor.

This is the “automatic stay” because it is in effect from the moment the petition is filed.

A Chapter 9 plan for adjustment of debts can bind non-consenting creditors to impaired treatment by classvoting or “cram-down” of non-consenting class and can extend maturities on debt, lower interest rates, replaceexisting debt with new borrowings, and provide for only partial payment of unsecured claims.

Debtor can reject/modify contracts.

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CHAPTER 9 ADVANTAGES: DIFFERENCES FROM CHAPTER 11

Limited Court Supervision/Control Over Governmental Functions

A. 10th Amendment and federalism concepts, as recognized by the Supreme Court, have beenincorporated via sections 903 and 904 of the Bankruptcy Code:

1. Section 903: Chapter 9 does not limit a State’s power to control its municipalities, but “(1) aState law prescribing a method of composition of indebtedness of such municipality may notbind any creditor that does not consent to such composition; and (2) a judgment enteredunder such a law may not bind a creditor that does not consent to such composition.”

2. Section 904: “Notwithstanding any power of the court, unless the debtor consents or theplan so provides, the court may not, by any stay, order, or decree, in the case or otherwise,interfere with – (1) any of the political or governmental powers of the debtor; (2) any of theproperty or revenues of the debtor; or (3) the debtor’s use or enjoyment of any income-producing property.”

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CHAPTER 9 ADVANTAGES: DIFFERENCES FROM CHAPTER 11 (CONT’D)

B. No official financial reporting obligations to the Court.

C. No judicial supervision of employment of professionals, sale of unencumbered property, orincurring of unsecured borrowings.

D. No removal of the Debtor’s agent or representative: no Chapter 7 liquidation or trustee, no Chapter11 trustee or examiner (except possibly the appointment of a trustee to pursue avoidance actionsunder section 926(a) of the Code).

E. Only the Debtor can file a plan of adjustment, and there is no statutory time limit in which to do so.

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REJECTION OF EXECUTORY CONTRACTS AND UNEXPIRED LEASES

A. Under section 365 of the Bankruptcy Code (applicable to Chapter 9 under section 901), the debtormay assume or reject any executory contract or unexpired lease (with certain exceptions), includingreal and personal property leases, service contracts, supply contracts, and collective bargainingagreements. The Court reviews such requests under the deferential “business judgment”standard. Nonresidential real property leases may be assumed/rejected within 120 days afterorder for relief, or 210 days if court extends. Other executory contracts and leases can beassumed/rejected up to the time of plan confirmation.

B. Per section 365(b), assumption requires (i) payment of a “cure” (or provision of adequateassurance of prompt cure) of all monetary defaults, (ii) compensation (or adequate assurance ofprompt compensation) for all pecuniary loss resulting from default, and (iii) adequate assurance offuture performance.

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REJECTION OF EXECUTORY CONTRACTS AND UNEXPIRED LEASES (CONT’D)

C. Rejection constitutes a breach of the contract as of the moment before the Chapter 9 petition wasfiled (see section 365(g), which renders any claim on the rejected contract arising specifically fromrejection a pre-petition claim not entitled to administrative expense); if the rejection is of a realproperty lease or employment contract, the damage claim is capped under section 502(b)(6) or(7), respectively.

D. Note: municipal leases may be executory contracts subject to assumption/rejection under section365 or may be financial leases/debt instruments not subject to section 365 (see section 929).

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REJECTION OF EXECUTORY CONTRACTS AND UNEXPIRED LEASES (CONT’D)

E. Collective Bargaining Agreements can be rejected under section 365 (section 1113 does not apply).

1. NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984): a labor agreement can be rejected if it burdens theestate, the equities favor rejection, and the debtor made “reasonable efforts to negotiate a voluntarymodification” but such efforts “are not likely to produce a prompt and satisfactory solution.”

2. In re City of Vallejo, 403 B.R. 72 (Bankr. E.D. Cal. 2009): Bildisco standard applies -- any state lawpurporting to superimpose state labor laws on section 365 would violate U.S. Constitution (BankruptcyClause, Art. 1 §8, cl. 2, Supremacy Clause, Art. VI, cl. 2, and Contracts Clause, Art. VI).

3. In re County of Orange, 179 B.R. 177 (Bankr. C.D. Cal. 1995): unilateral acts by municipality to impair alabor contract must satisfy both Bildisco and state law governing such acts, including under “emergency”conditions.

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SPECIAL REVENUE BONDS AND GENERAL OBLIGATION BONDS

A. General Rule: Section 552(a) (incorporated into Chapter 9) provides that property acquired by the debtor afterthe bankruptcy filing is not subject to a lien resulting from a security agreement entered into by the debtor prior tothe petition date. Section 552(a) “should be viewed broadly, given the goal of facilitating a fresh start for thedebtor.” Alliance Capital Mgmt. L.P. v. County of Orange (In re County of Orange), 179 B.R. 185, 191 (Bankr. C.D.Cal. 1995) (citations omitted).

B. Section 552(a) applies only to liens arising out of “any security agreements,” and not to other liens, such asstatutory liens. Alliance Capital Mgmt. L.P. v. County of Orange (In re County of Orange), 189 B.R. 499, 502 (C.D.Cal. 1995) (citations omitted).

1. A “statutory lien” is defined as a “lien arising solely by force of a statute on specified circumstances orconditions, . . . but does not include security interest or judicial lien, whether or not such interest or lien isprovided by or is dependent on a statute and whether or not such interest or lien is made fully effective bystatute.” 11 U.S.C. § 101(53) (emphasis added).

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SPECIAL REVENUE BONDS AND GENERAL OBLIGATION BONDS (CONT’D)

C. Special Revenue Bonds – Protections Under Section 928.

1. Section 928(a) of the Bankruptcy Code states that “[n]otwithstanding section552(a) . . . special revenues acquired by the debtor after the commencement ofthe case shall remain subject to any lien resulting from any security agreemententered into by the debtor before the commencement of the case.”

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2. “Special revenues” are defined in section 902 as:

a. “receipts derived from the ownership, operation, or disposition of projects or systems of the debtorthat are primarily used or intended to be used primarily to provide transportation, utility, or otherservices, including the proceeds of borrowings to finance the projects or systems;

b. special excise taxes imposed on particular activities or transactions;

c. incremental tax receipts from the benefited area in the case of tax-increment financing;

d. other revenue or receipts derived from particular functions of the debtor whether or not the debtorhas other functions; or

e. taxes specifically levied to finance one or more projects or systems, excluding receipts from generalproperty, sales, or income taxes (other than tax-increment financing) levied to finance the generalpurposes of the debtor.”

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3. In 1988, Chapter 9 was amended to incorporate section 928 to protect holders of specialrevenue bonds. A “primary purpose of the legislation is to eliminate the possibility of avoidinga lien on post-petition special revenues under section 552(a) of [the Code].” (H. Rept. No. 100-1011 (1988) pp. 6, 7).

4. A leading treatise indicates that section 928(a) should only apply to liens on special revenuesthat secure revenue bonds that financed the project from which the revenues derive. See 6-928 Collier on Bankruptcy, ¶ 928.02.

5. Section 928(a) recognizes the difference between industrial or revenue bonds, on the onehand, and general municipal bond financing, on the other hand. In re Las Vegas Monorail Co.,429 B.R. 770, 782 (Bankr. D. Nev. 2010).

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6. The goal was to remove the risk that revenue bondholders would be stripped of their liens on revenueacquired by the debtor after the commencement of a municipality’s Chapter 9 case pursuant to 11 U.S.C. §552(a). In re County of Orange, 179 B.R. 185, 191-92 (Bankr. C.D. Cal. 1995).

7. The “effect is to prevent special revenues that secure an issue of revenue bonds from being diverted to beavailable for the municipality’s general expenses or obligations.” 6-928 Collier on Bankruptcy, ¶ 928.01.

8. Section 928(b) of the Bankruptcy Code provides that liens on special revenues, other than municipalbetterment assessments, derived from a project or system shall be subject to the necessary operatingexpenses of the underlying project.

9. Under section 922(d), the automatic stay does not prevent the application of pledged special revenues topayment of indebtedness secured by such revenues.

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D. General Obligation Bonds. General obligation bonds are not so protected under the BankruptcyCode. Except to the extent that a bond statute provides a statutory lien or trust interest in an asset,unlimited tax general obligation bonds and limited tax general obligation bonds are generallytreated as unsecured debt under Chapter 9. See, e.g., In re County of Orange, 179 B.R. 185(Bankr. C.D. Cal. 1995); In re Sanitary & Improv. Dist. #7, 98 B.R. 970, 973-974 (Bankr. D. Neb.1989) (bondholders and warrantholders are holders of unsecured claims in bankruptcy); In reColumbia Falls, Special Improv. Dist. No. 25, 143 B.R. 750, 760-61 (Bankr. D. Mont. 1992)(prepetition general obligation bond debt is subject to modification and impairment under Chapter9).

Note: The Constitution of Puerto Rico purports to provide certain protections to the holders ofgeneral obligation bonds. Whether those protections are enforceable under Chapter 9 isuncertain.

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ACCRUED PENSION BENEFITS

A. No specific provision under Chapter 9 regarding pension liabilities. The protection of pension benefitsdepends upon the particular Constitutional, statutory, contractual, and economic environment of themunicipality and its pension system.

B. In Detroit, the Retirement Systems argued, among other things, that the protection of accrued pensionbenefits under the Pensions Clause of Michigan’s Constitution could not be abrogated in a Chapter 9bankruptcy.

C. After a 9-day trial, the Court in Detroit determined that the Pensions Clause did not protect accruedpension benefits from impairment in bankruptcy. The Court equated the Pensions Clause with theContracts Clause, which does not bar the State from authorizing a bankruptcy to impair contractual debtobligations.

D. The Detroit Retirement Systems and others appealed this determination and requested direct certificationto the Sixth Circuit Court of Appeals, which was granted. The appeals were consensually dismissed inconnection with the confirmed Plan of Adjustment.

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PLAN CONFIRMATION AND DISCHARGE

A. Section 901 incorporates many features of Chapter 11 plan confirmation – plan is proposed,creditor votes are solicited and counted, and dissenting impaired classes of creditors can bebound if “cramdown” standards of section 1129(b)(1) of the Bankruptcy Code are met (includingwhether the Plan is “fair and equitable” and “does not discriminate unfairly” with respect todissenting classes).

B. Difference from Chapter 11: in Chapter 9, only debtor may propose plan, and there is no statutorytime limit for filing and obtaining confirmation of a plan.

26

PLAN CONFIRMATION AND DISCHARGE (CONT’D)

C. Under section 943(b) of the Bankruptcy Code – adding to incorporated Chapter 11 confirmationstandards– “[a] court shall confirm a plan if —

1. the plan complies with the provisions of [the Code] made applicable by sections 103(e) and 901 of [theCode];

2. the plan complies with the provisions of [Chapter 9];

3. all amounts to be paid by the debtor or by any person for services or expenses in the case or incident tothe plan have been fully disclosed and are reasonable;

4. the debtor is not prohibited by law from taking any action necessary to carry out the plan;

5. except to the extent that the holder of a particular claim has agreed to a different treatment of such claim,the plan provides that on the effective date of the plan each holder of a claim of a kind specified in section507(a)(2) of [the Code] will receive on account of such claim cash equal to the allowed amount of suchclaim;

6. any regulatory or electoral approval necessary under applicable non-bankruptcy law in order to carry outany provision of the plan has been obtained, or such provision is expressly conditioned on such approval;and

7. the plan is in the best interests of creditors and is feasible.”

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D. “Best interests of creditors” test refers to plan being a reasonable effort by the municipal debtor andsuperior to dismissal of case (see Collier on Bankruptcy § 943.03[7]); not as stringent of a standardas in Chapter 11. See, e.g., In re City of Detroit, 524 B.R. 147, 213 (Bankr. E.D. Mich. 2014) (“Courtsgenerally agree that the best interests of creditors test in § 943(b)(7) requires ‘that a proposed planprovide a better alternative for creditors than what they already have.’”) (citations omitted); Matter ofSanitary & Imp. Dist., No. 7, 98 B.R. 970 (Bankr. D. Neb. 1989).

E. “Feasibility” requires reasonable assumptions about future revenues and expenses; success neednot be certain or guaranteed, but more is required than mere hopes and speculation. See, e.g., In reMount Carbon Metropolitan Dist., 242 B.R. 18, 41 (Bankr. D. Colo. 1999) (citations omitted); seealso, In re City of Detroit, 524 B.R. 147, 222 (Bankr. E.D. Mich. 2014) (articulating feasibilitystandard as whether it is likely that, after confirmation of the plan, the municipality will be able tosustainably provide basic municipal services to its citizens and meet the obligations in the planwithout significant probability of default).

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F. Section 1129(b) “cram-down” provisions: can confirm plan over objections of dissenting classes ofcreditors if the plan is “fair and equitable” and does not “discriminate unfairly.”

G. Section 1129(a)(3) requires that plan have been “proposed in good faith and not by any meansforbidden by law.”

H. Effect of confirmation is set forth at section 944 of the Code, and includes discharge of allobligations except those excepted by the plan and those owed to parties that did not receive noticeof the case. Court retains continuing jurisdiction over the case as necessary for the successfulimplementation of the plan (see section 945).

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The Eighth Amended Plan for theAdjustment of Debts of the City ofDetroit, Michigan - Overview

OVERVIEW OF THE PLAN OF ADJUSTMENT

The Plan of Adjustment permanently eliminated billions of dollars of debt and unfunded liabilities andpositioned the City for growth through significant capital investment and increased oversight

Extinguished $1.8 billion of funded debt, obligations and payables

Debt backed by distributable state aid, Detroit Water and Sewerage Dept. (“DWSD”) revenues, and Cityincome taxes unimpaired

Majority of new General Fund debt issued to creditors is LTGO

Eliminated $5.5 billion in unfunded pension and OPEB obligations

General Fund’s pension contribution obligations deferred through FY 2023 – trusts funded primarily bythe “Grand Bargain” and DWSD in the interim

Pension actuarial rate of return assumptions reduced to 6.75%; mechanisms introduced to shareinvestment performance

Established and capitalized VEBAs to address retiree health care, removing $3.8 billion of unfundedOPEB obligation


OVERVIEW OF THE PLAN OF ADJUSTMENT (CONT’D)

Provided $1.4 billion of investment for infrastructure and other revitalization initiatives throughFY 2023

Blight Removal: $440 million

Public Safety: $411 million

Services Infrastructure: $403 million

Transportation & Other Resident Services: $106 million

Resolved disputes and preserved key civic assets and operations (e.g., DWSD, Detroit Institute ofArts, Belle Isle)

Established a Financial Review Commission to provide ongoing financial/strategic guidance andsupervision for the City


THE FOUNDATION FOR THE PLAN OF ADJUSTMENT

The “Grand Bargain” and settlements negotiated with respect to the City’s pension obligations andthe City’s financial creditors created the foundation for the Plan of Adjustment.

The “Grand Bargain”: Charitable foundations, the Detroit Institute of Arts, and the State of Michiganagreed to contribute an aggregate of approximately $816 Million over 20 years to support accruedpension benefits and preserve the art collection of the DIA. The Grand Bargain contains conditions,including the release of litigation claims against the City and the State of Michigan.

Proceeds of the Grand Bargain, along with revenues from DWSD, enabled the City to suspendmaking contributions to the Retirement Systems from the General Fund until 2023 and to devotecertain resources to the Restructuring and Reinvestment Initiatives.

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DIFFERING ASSERTED LEGAL RIGHTS AND DEFENSES TO IMPAIRMENT

•Section 922(d) and 928 of the Bankruptcy Code provide special protections.Special Revenue Bonds

(Class 1A – 1C – Sewer and Water)

•Holders argued the liabilities were secured by Casino tax revenue.Swap Agreements(Class 5)

•Unlimited Tax General Obligation Bond Debt — holders alleged the liabilities were secured in certain taxrevenue.

• Limited Tax General Obligation Bonds – holders alleged certain series of these bonds were secured by lien ondistributable state aid and that City was obligated to use general tax revenues collected to service these bonds.

General Obligation Bond Debt(Classes 7 and 8)

•No statutory or contractual lien or trust beneficiary rights; City challenged validity andenforceability of claims.

Certificates of Participation(Class 9)

•Holders asserted protection of accrued pension benefits under Article IX, Section 24 of MichiganConstitution (the “Pensions Clause”).

•Holders challenged the City’s eligibility under section 109(c) of the Bankruptcy Code to be a debtor.

Pensions(Classes 10 and 11)

•In Detroit, no statutory protections. May vary by state or territory.OPEB

(Class 12)

•In Detroit, the City’s collective bargaining agreements had expired prior to the Petition Date.Generally, collective bargaining agreements can be rejected under Chapter 9. Negotiations areprimarily economic.

Active Employees

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TREATMENT OF CREDITORS UNDER DETROIT PLAN OF ADJUSTMENT

Class(es) Type of Debt Recovery

1, 2, 3, 4 and 6 DWSD Bonds, Secured GO Bonds, Other SecuredDebt, HUD Notes, Parking Bonds (Secured)

100%

5 Settled COP Swap 30%

7 Settled LTGO 47%

8 Settled UTGO 74%

9 Settled COPs 13%

10 Settled PFRS Pension 39-59%

11 Settled GRS Pension 48-60%

12 Settled OPEB 11%

13 DDA Notes 10-13%

14 Other Unsecured 10-13%

15 Convenience Claims 25%

16 Subordinated Claims 0%

17 36th District Court Claims 33%


EIGHTH AMENDED PLAN OF ADJUSTMENT SUMMARY

Sewer andWater Claims ($5,273)

(Class 1A – 1C)

Select Major Claims Summary

Claim(Est. Size $ Million)

Treatment

Sewer and Water Claims

($5,273)

(Class 1A - 1C)

COP Swap Claims ($290)

(Class 5)

UTGOs ($388)

(Class 8)

Unimpaired; all non-tendered bonds reinstated on the effective date

Tender resulted in $1.64 billion of bonds voluntarily tendered for $113.5M of NPV savings

All state revolving fund loans are unimpaired and reinstated in full

Deemed Allowed as Secured Claim in the amount of $85.0M plus accrued interest after October 15,2014 (30% Recovery) (Reflects settlement between the City and COP Swap banks)

Claim shall be paid either (1) in full in cash 30 days following Effective Date or (2) 180 days followingthe effective date in the case the City is not able to secure sufficient exit financing

Pro rata share of either (1) $55.0M in cash or (2) $55.0M of New LTGO Bonds at the City’s option

Pro rata share of Excess New B Notes in an amount of $17.3M

The City will issue $287,560,790 of MFA-backed UTGO bonds (74.1% Recovery), of which $279,618,950 will beissued to the current holders of the UTGO bonds on a pro-rata basis and $7,941,840 will be issued to the UTGOinsurers

• Confirmed lien on UTGO levy and fourth lien on DSA

• Other terms consistent with outstanding UTGO bonds

MFN clause

Information on this slide provided by Conway MacKenzie, Inc.

COP Swap Claims ($290)

(Class 5)

36

EIGHTH AMENDED PLAN OF ADJUSTMENT SUMMARY (CONT’D.)


COPs ($1,473)

(Class 9)

Syncora: $354

FGIC: $1,119

PFRS Pension Claims($1,250)

(Class 10)

GRS Pension Claims($1,879)

(Class 11)

GRS & PFRS

OPEB ($4,303)

(Class 12)

Plan freeze, COLA increases reduced 55% (no reduction in current pension levels)

Contributions until 2023 to be fixed and funded solely by (i) DIA proceeds and (ii) State funding (PV of $203M)

General Fund funding to recommence starting in 2023 for remaining unfunded amount supplemented by certainadditional DIA proceeds (PV of $362M)

FGIC Holders:$74.2M New B Notes, $67.2M New C Notes and $19.75M Settlement Credits

• FGIC Insurance Settlement: $4.5M New B Notes

• FGIC Litigation Settlement: Joe Louis Arena development agreement

Syncora Holders: $23.5M New B Notes, $20.8M New C Notes and $5.25M Settlement Credits

• Syncora Insurance Settlement: $5 million cash payment

• Syncora Litigation Settlement: Detroit-Windsor Tunnel lease extension and Grand Circus Parking lease

Plan freeze, COLA eliminated and 4.5% reduction in current pension levels

Exclusive source for funding until 2023 shall be payments from the DWSD equal to approximately $428.5M and aportion of State Contribution and certain DIA proceeds (PV of ~$203M)

General Fund funding to recommence starting in 2023 for remaining unfunded amount supplemented by certainadditional DIA proceeds (PV of ~$345M)

Creation of General and Police / Fire VEBA to satisfy OPEB claims

• General VEBA to be funded with $218M New B Notes, $20.8M of Excess New B Notes, and $11M cash

• Police and Fire VEBA to be funded with $232M New B Notes, $21.9M of Excess New B Notes, and $9M cash

Information on this slide provided by Conway MacKenzie, Inc.


Treatment

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OPEB $4,303

Pension $3,129

Pension $1,447

COPS $1,473

$543

$1,100

UTGO $488

UTGO $388

$290

$275

Other $280

Other $90

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

Pre-Petition Pro Forma

LTGO

Exit Financing

Total: $10,506

Total: $3,300

2010-A DSA: $100Non DSA: $388

2010 & 2012-C DSA: $379Non DSA: $164

2010 & 2012-C DSA: $379New B Notes: $632New C Notes $88

2010-A DSA: $1002014 DSA: $288

LTGO1

The Plan of Adjustment reduces the City’s General Fund obligations by $7.2 billion

COPS Swap

GENERAL FUND PRO FORMA CAPITALIZATION

1. Assumes $55 million of New LTGO Bonds representing recoveries for prepetition Unsecured LTGO Bonds is paid off at exit2. Information on this slide provided by Conway MacKenzie, Inc.

38

The Speed of the Bankruptcy Case

ALL SYSTEMS GO — THE CHAPTER 9 PROCESS

July 18, 2013 – PetitionDate

August 2013 – FirstMediation Order

December 2013 –Eligibility

Determination/Order forRelief

February 2014 – PlanFiled

April 2014 – PensionSettlement

October 2014 – EighthAmended Plan Filed

November 2014 – EighthAmended Plan

Confirmed

December 10, 2014 –Effective Date

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Mediation

MEDIATION

Twenty-six days after the Petition Date, Bankruptcy Court issued Mediation Order appointing JudgeGerald Rosen as judicial mediator.

Judge Rosen announced five-person mediation team.

Mediation was privileged and confidential.

Numerous, intensive mediation sessions between the City, the Retirement Systems, the financialcreditors, the Retiree Committee, the unions, as well as the State.

Mediation culminated in settlements with the City’s unions, retirees, and financial creditors. Thesesettlements formed the foundation for the Plan of Adjustment.

42

Goals Achieved Via Chapter 9Bankruptcy

GOALS ACHIEVED VIA CHAPTER 9 BANKRUPTCY

In Detroit’s Chapter 9 bankruptcy case, the Court determined that the City was insolvent because theCity (a) was generally not paying its debt as they became due and (b) was unable to pay its debts as theybecame due.

In assessing the City’s insolvency, the concept of “service delivery insolvency” took center stage.

“Service delivery insolvency focuses on the municipality’s inability to pay for all costs of providingservices at the level and quality that are required for the health, safety, and welfare of thecommunity.” December 3, 2013 Transcript Bench Opinion Regarding Eligibility, p. 38.

Legal tensions impacting a municipality’s ability to remedy service delivery insolvency:

Creditors’ inability to compel the municipality to liquidate assets to pay debts

Creditors’ rights to repayment of their claims under the Bankruptcy Code

Municipality must propose a plan of adjustment in good faith, that is fair and equitable, and that is inthe best interests of creditors

Municipality must propose a plan of adjustment that is feasible

44

GOALS ACHIEVED VIA CHAPTER 9 BANKRUPTCY (CONT’D)

Repay CreditorsUnder Court-

Approved Plan ofAdjustment

Remedy Service DeliveryInsolvency

There is an inherent tension created by the municipality’s goals of remedying servicedelivery insolvency, repaying creditors, and proposing a feasible plan that is fair andequitable and in the best interests of creditors.

45


The City balanced and addressedthe competing Chapter 9 interests via: (i) a reasonably tailored Restructuring and ReinvestmentPlan (the “RRP”) and (ii) settlements with creditors that accommodatedthe City’s near-term need to fund the RRP by addressing theCity’s debt obligations on a long-term basis.

The Restructuring and ReinvestmentInitiatives include:

Systematicallyand comprehensivelyaddress and remediate residential urban blight (“Blight Initiatives”)

Improve operating performance and infrastructure of public safety operations (“Public Safety Initiatives”)

Improve services that the City provides to its citizens, including transportation (“ResidentService Initiatives”)

Includes Department of Transportation, Department of Health and Wellness Promotion, Ombudsperson, Department ofPublic Works and Recreation

Enhance the attractiveness of the City as a place to invest in and do business (“Business Service Initiatives”)

Includes Airport, Building Safety Engineering & Environmental Department (“BSEED”), Board of Zoning Appeals,Department of Administrative Hearings, Municipal Parking Department, and Planning & Development Department

Modernize the City’s information technology systemsto enhance management tools and information, and invest in supportdepartments to enable greater efficiencies in operations throughout the City (“Organizational Efficiency Initiatives”)

Includes Auditor General, Elections Department, Finance Department, General Services Department, Human ResourcesDepartment, Human Rights Department, Inspector General, Information Technology Services Department and LawDepartment

Increase executive support, while reducing redundancy (“Management Initiatives”)

Reduce the burden on the City’s general fund from non-departmental operations (“Non-Departmental Initiatives”)



The detailed10-year financial plan (Restructuring and ReinvestmentPlan) underlying the Plan of Adjustment:

Provides$1.7 billion of reinvestment into the City’s operations and infrastructure, including:

$715.7million toward operating expenditures

$151.7million in information technology infrastructure

$225.4million of capital expenditures

$167.4million of fleet reinvestment and replacement

$37.7million of reorganization implementation costs

$420.0million toward Blight remediation

Identifies $482.9million of revenue enhancements opportunities, without increasing taxes, which will improve revenueavailable for City services and partially offset reinvestment initiatives

Identifies $358.2million of efficiency and cost savings opportunities which will streamline the City’s existing cost structure andpartially offset reinvestment initiatives

The 40-year financial plan underlying the Plan of Adjustmentprovides for long-term payments to creditors, including:

$3.8 billion to GRS/PFRS

$1.2 billion pursuant to Note B (including reserves) to OPEB, LTGO, POC, notes & other unsecured creditors

$120 million pursuant to Note C to Syncora & FGIC


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