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Legal Analysis: Puerto Rico Appeals to Supreme Court to Consider Territory’s Bankruptcy Law

Breaking News:  On November 9, 2015, the United States Supreme Court added Puerto Rico’s Recovery Act appeal to the list of cases it will discuss in a private conference on November 24, 2015.  A decision on Puerto Rico’s petition for a writ of certiorari is expected on November 30, 2015.

Following the decision of the United States Court of Appeals for the First Circuit affirming the lower court’s rejection of Puerto Rico’s bankruptcy law, Puerto Rico and its officials filed a petition with the United States Supreme Court for a writ of certiorari on August 21, 2015.

The Supreme Court does not hear every case that is appealed to it; it will grant certiorari “only for compelling reasons.”  Puerto Rico is hoping that the highest court will find the issue of Puerto Rico’s ability to authorize its municipalities to restructure their debt sufficiently “compelling” to take the case and, ultimately, to overturn the lower court’s decisions finding that the Recovery Act is preempted by chapter 9 of the Bankruptcy Code.

On October 23, 2015, the two bondholder groups who successfully challenged the Recovery Act filed briefs in opposition to Puerto Rico’s petition for certiorari.

The gist of Puerto Rico’s argument is that chapter 9 of the Bankruptcy Code does not apply to Puerto Rico and, as a result, cannot preempt a Puerto Rico statute that provides a mechanism for its municipalities to restructure their debt, especially in the context of “the most acute fiscal crisis in [Puerto Rico’s] history.”  Puerto Rico contends that the First Circuit’s decision leaves it in a “’no man’s land,’” without “access to any legal mechanism to restructure the debts of its public utilities,” which could not have been Congress’s intent.  Puerto Rico seeks immediate review of the lower court’s decision given Puerto Rico’s impending “financial meltdown” and the wellbeing of its public utilities, as well as “the 3.5 million American citizens who depend on them.”

The petition describes the background leading up to enactment of the Recovery Act, including the current financial crisis faced by the Puerto Rico Electric Power Authority (“PREPA”) which has far-reaching implications for Puerto Rico’s economy.  “When faced with similar crisis conditions,” the Puerto Rico petitioners note, “the fifty States may authorize their public utilities to restructure under Chapter 9 of the Bankruptcy Code.”  Puerto Rico enacted the Recovery Act to offer the same opportunity to its municipalities.  Significantly—and unlike chapter 9—the Recovery Act permits the municipalities to bind creditors who have not consented to the restructuring.

In February 2015, the federal district court held that the Recovery Act is preempted by section 903(1) of the Bankruptcy Code and enjoined implementation of the law.  The First Circuit affirmed the district court’s decision in July 2015.  Bankruptcy Code section 903(1) prohibits a “State law prescribing a method of composition of indebtedness” that binds “any creditor that does not consent to such composition.”

Puerto Rico advances two primary reasons that the Supreme Court should accept its petition and hear its appeal.

First, “Section 903(1) is a proviso to a clause that does not apply to Puerto Rico, located within a chapter of the Bankruptcy Code that does not apply to Puerto Rico.”  The petitioners essentially argue that if Puerto Rico is excluded from authorizing its municipalities to seek relief under chapter 9, it must follow that chapter 9 as a whole, including section 903(1), does not apply to Puerto Rico.  “The Recovery Act,” therefore, “represents Puerto Rico’s considered decision to fill the gap left by the inapplicability of Chapter 9” to Puerto Rico’s municipalities and does not conflict with chapter 9 in violation of Congress’s powers under the Bankruptcy Clause.

Puerto Rico contends that the First Circuit’s ruling “flouts background preemption principles that apply with full force to Puerto Rico.”  The petitioners argue that if Congress had intended to leave Puerto Rico in “no man’s land” without access under any law to restructure its municipalities’ debts, it “surely could and would have said so.”  Like concurring First Circuit Judge Juan Torruella, Puerto Rico also rejects as “pure fiction” the First Circuit’s suggestion that Congress sought to reserve for itself the option of authorizing Puerto Rico’s municipalities to restructure their debts.

Puerto Rico further takes issue with the First Circuit’s finding that the legal presumption against preemption is “’weak, if present at all’ in this case,” since the Supreme Court has long recognized that states and territories of the United States retain control over their fiscal affairs.

Second, Puerto Rico asserts that the First Circuit decision, which has the “unprecedented and anomalous result” of “leav[ing] Puerto Rico powerless to restructure the debts of its public utilities under any law,” presents an important question of federal law that the Supreme Court should review.  Puerto Rico contends that the issue is ripe for review, because “there is no realistic prospect of further percolation of this issue among the lower courts” and “no circuit split is realistically possible.”  Moreover, the issue is critical “to the future of Puerto Rico and its people.”  Puerto Rico laments its inability to get relief from Congress in face of “furious opposition of certain bondholders” and criticizes Congress’s failure to treat Puerto Rico with “the dignity due the millions of American citizens who live there by arbitrarily excluding [Puerto Rico] from Chapter 9.”

Two groups of bondholder respondents—Blue Mountain Capital, LLC and the Franklin Plaintiffs (which include the “Franklin Funds” and the “Oppenheimer Rochester Funds”)—filed briefs opposing the Puerto Rico petitioners’ petition for a writ of certiorari.

The respondent bondholders contend that, as an initial matter, Puerto Rico’s petition does not meet the Supreme Court’s exacting criteria for granting certiorari.  Since Puerto Rico concedes there is no circuit conflict on the question presented and the question is unlikely to recur, the bondholders argue that there is no basis for Supreme Court review.  Puerto Rico’s “shrill predictions” and argument regarding the exigency of its fiscal crisis is “a policy argument properly directed to Congress.” And, the Franklin Plaintiffs assert, “[t]he reality is entirely different.”  Both groups of bondholders point to the subsequent agreement in principle between PREPA and its creditors, including the respondents, as proof that Puerto Rico does not need a statutory debt restructuring mechanism for its municipalities.  (The PREPA settlement was announced approximately one week after Puerto Rico filed its petition for certiorari.)  The Franklin Plaintiffs also rely on the fact there has not been a bondholder lawsuit or shutdown of public services in the eight months since the district court struck down the Recovery Act.

Next, the bondholder respondents argue that the First Circuit correctly applied settled law in holding that the Bankruptcy Code preempts the Recovery Act (and, as the Franklin Plaintiffs assert, mere error correction “is not typically a sufficient basis for certiorari”).

The respondents argue that section Bankruptcy Code 903(1) has always applied to Puerto Rico, and the 1984 amendments to the Bankruptcy Code, characterizing Puerto Rico as a “State . . . except for the purpose of defining who may be a debtor under chapter 9,” had no effect on the separate statutory provision (section 903(1)) prohibiting State laws providing for the adjustment of municipal debts over the objection of nonconsenting creditors.  Bankruptcy Code section 109(c) is the statutory provision that defines who may be a debtor under chapter 9.  The Franklin Plaintiffs succinctly summarize the respondents’ argument as follows:   Puerto Rico is a “State” under the Bankruptcy Code, “except for the purpose of defining who may be a debtor under chapter 9.”  “Section 903(1), in turn, prohibits all ‘State’ laws that authorize non-consensual municipal debt restructurings.  Because Section 903(1) has nothing to do with ‘defining who may be a debtor under chapter 9,’ the ‘State’ laws that Section 903(1) prohibits include those of Puerto Rico.”

The respondents further argue that a state cannot simply invent its own municipal bankruptcy regime if chapter 9 is not available to it.  Taking this a step further, they suggest that a state that has denied its municipalities authorization to seek chapter 9 relief—as approximately half of the states have—could then create its own state-law municipal bankruptcy regime, because the Bankruptcy Code does not distinguish between states declining to authorize their municipalities and “states” forbidden from granting such authorization.  As a result, argues Blue Mountain, Puerto Rico’s reasoning effectively “convert[s] Section 903(1)’s categorical prohibition on state municipal-bankruptcy laws into an ‘opt-in’ system under which state laws are preempted only to the extent that the State has authorized its municipalities to file for Chapter 9 bankruptcy.”  The Franklin Plaintiffs describe Puerto Rico’s argument and its effects more colorfully:  “[B]y excluding [Puerto Rico’s] municipalities from Chapter 9, Congress licensed [Puerto Rico] to Xerox Chapter 9, make it worse, and then enact it as Puerto Rican law—a result that would nullify the effect of Puerto Rico’s exclusion from Chapter 9 and gut Congress’ goal of preempting state municipal restructuring laws.”

The respondents note that Puerto Rico also raised definitional arguments in support of its interpretation of Bankruptcy Code section 903(1) in its lower court pleadings but did not include them in its petition.  Nonetheless, both respondents’ briefs refute those arguments in detail.

The bondholder respondents contend that the Recovery Act is also preempted because it frustrates Congressional objectives and trespasses on a field—which the Franklin Plaintiffs characterize not as “’restructuring’ or ‘debt relief’ statutes, generally, but municipal bankruptcy laws”—that Congress has occupied.  Therefore, the Recovery Act “stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress” with respect to chapter 9, regardless of whether section 903(1) applies.  Moreover, the framework of regulation in this area is “so pervasive” that federal bankruptcy law “occupies the entire field”; it precludes state laws on the same subject.

Finally, the bondholder respondents assert that even if the Court were to grant certiorari, it would not resolve the matter, because the bondholders’ claims for injunctive relief under the Contract Clause remain.  The Contract Clause prohibits the states from enacting laws which discharge a debtor from its contractual obligations.  The Franklin Plaintiffs describe the Recovery Act, “which imposes a permanent injunction on the collection of debt,” as “such a statute,” and the district court was receptive to this argument.

Puerto Rico may choose to file a reply brief addressing the respondent bondholders’ arguments.  A reply brief is usually filed approximately ten days after the opposition briefing (which would have been November 2, 2015), but there is no strict deadline.  Thereafter, the case will be added to the “cert. pool” and the Court will decide whether to grant certiorari.  Four out of the nine Justices must vote to accept a case.  The Court accepts only approximately 2% of the cases that it is asked to review each year.

Puerto Rico contends that this case has the kind of national significance and precedential value to merit a writ of certiorari, but it is impossible to know now whether at least four Supreme Court Justices will agree.  The Court announced on October 1, 2015, that it would be hearing Puerto Rico vs. Valle, which specifically addresses the issue of whether Puerto Rico would be considered a seperate sovereign entity from the United States under the Constitution’s Double Jeopardy clause.  This case could impact the debate over Puerto Rico’s status as well.

UPDATE:  On November 9, 2015, Puerto Rico and the representatives of the Government Development Bank for Puerto Rico filed two reply briefs in support of their petition for a writ of certiorari.  The briefs refute the respondent bondholders’ arguments, including the respondents’ attempts to rely on their nascent Contract Clause claims as a basis for denying certiorari, and reiterate the petitioners’ arguments related to Bankruptcy Code section 903(1) and the “unique” and important nature of the appeal.  The key themes in the reply briefs are that:

  • The Puerto Rican debt crisis is real:  neither the highly contingent agreement between PREPA and a minority of its bondholders, nor the fact that “the lights are on,” nor the fact that bondholder lawsuits have not been commenced to date, supports the respondents’ arguments to the contrary;
  • Puerto Rico has an “enormous collective-action problem” that requires a legislative solution, and the lower court’s decision completely forecloses such a solution at both the local and federal levels; and
  • The lower court’s decision misconstrues the Bankruptcy Code in a way that Congress never intended and undercuts established principles of federalism. 


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