Puerto Rico Electric Power Authority (Prepa) bondholders could move to take control of the bankrupt government utility as early as next month by petitioning the U.S. District Court to place it under receivership.

The move would mark the first «takeover» of a commonwealth public corporation by bondholders and employ a rarely used federal court remedy.

However, with the federal court having invalidated a local bankruptcy law and Puerto Rico currently barred from taking advantage of Chapter 9 of the U.S. Bankruptcy Code, a court-ordered receivership could represent the cleanest path to restructuring Prepa, according to legal and financial experts.

«To do a proper restructuring, it could be in everybody’s interest to get a receiver. The official would have all the necessary powers to do it,» said legal analyst John Mudd.

«Prepa’s creditors are empowered by contract to enforce a lien on revenues and seek the appointment of a receiver for Prepa if revenues are insufficient,» added Height Securities analyst Daniel Hanson. «Bondholders now have a strong incentive…to force Prepa to make managerial and operational changes that could be politically challenging. The legal structure appears to be robust enough to handle the burden of a negotiated restructuring.»

A majority of Prepa creditors have been in discussions with the utility since last August under terms of a forbearance agreement. Those talks were made possible by the enactment of the Puerto Rico Public Corporation Debt Compliance & Recovery Act, which provided a bankruptcy-like process for Prepa and other troubled public corporations to restructure, because it gave the government leverage to negotiate, Government Development Bank President Melba Acosta told CARIBBEAN BUSINESS earlier this month.

However, most analysts see the government having lost negotiating leverage after U.S. District Court Judge Francisco Besosa recently declared the law unconstitutional. Acosta described the decision as a «temporary setback» and said the commonwealth will appeal, but Mudd predicted the process would take about a year, while many experts believe the appeal will be unsuccessful because the Besosa decision «wasn’t even close.»

A key requirement under the accord is the delivery of a restructuring plan next month (see related story on page 22). While Prepa Chief Restructuring Officer Lisa Donahue is talking to bondholders about pushing back the deadline until June, it isn’t clear if they will agree to the extension, especially after the Besosa decision. That may push Prepa to stick to the original dates, with the delivery of a restructuring plan acceptable to bondholders the only issue preventing them from calling for a court-ordered receivership, Mudd said. Hanson predicted bondholders would bolt from the agreement even before the Besosa decision.

Prepa bond covenants empower bondholders to seek a court-ordered receivership in the event of a utility default. Bondholders who live in the U.S. have standing to sue in federal court for the appointment of a receiver.

Mudd said that under federal court rules, a receiver would have «very broad powers, and in some cases, it is the power of a trustee in bankruptcy.»

Hanson said the court would seek to ensure «a stable, reliable and affordable electricity grid,» but said there was no reason why it wouldn’t conclude that Prepa could make «significant operational changes that could materially decrease the cost of generating power while simultaneously holding power rates steady.»

The analyst believes under the court-ordered receivership process, Prepa could be forced to cut staff, close inefficient plants, eliminate subsidies and aggressively collect $1.75 billion in outstanding receivables, with a large chunk of that owed by government agencies.

However, Mudd said the receivership route wouldn’t give complete power to bondholders. The federal court receiver would have to abide by commonwealth rules protecting retired workers’ pensions and forbidding the cutting of benefits spelled out in labor contracts, while a federal bankruptcy court could. The federal court receiver would also have to work with the recently created Puerto Rico Energy Commission to review rates.

In a recent interview, former U.S. Bankruptcy Chief Judge Gerardo Carlo said the receivership procedures laid out in Prepa bond documents are geared more toward liquidating assets than turning around and improving the entity.

However, he said the parties could ask a federal judge to appoint a receiver using the federal Bankruptcy Code to operate Prepa through a receivership at the federal court. It could be a good option, but would require the initiative of the parties involved.

Puerto Rico has a long experience with federal court monitors, which have played vital roles in reforming overcrowded prisons, cleaning up environmental crimes at the Puerto Rico Aqueduct & Sewer Authority, stomping out air-quality violations and straightening out federal-funds management at the Education Department. The model is now being employed to oversee a reform of the Puerto Rico Police Department.

Besides Prepa, Carlo believes the federal court monitors could also serve a key function in turning around the commonwealth’s other financially battered public corporations.

Resident Commissioner Pedro Pierluisi refiled legislation to extend the provisions of Chapter 9 to Puerto Rico last week. Hearings are expected and the measure has support from investors and the commonwealth government.

While Prepa and other Puerto Rico public corporations are barred from Chapter 9 provisions, Carlo said Prepa might have a case to file under Chapter 11 bankruptcy protection because it functions more as a private entity rather than a public operation. He pointed to precedent in sovereign immunity cases at the U.S. Court of Appeals at the federal circuit level that found Prepa and the Highways & Transportation Authority were considered private entities—by their actions—and couldn’t use the shield of sovereign immunity.