Puerto Rico Loses High Court Bid to Restructure Debt

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By Diane Davis

June 13 — Puerto Rico suffered a loss June 13 at the U.S. Supreme Court when five justices concluded that federal bankruptcy law precludes the territory from restructuring its massive debt ( Puerto Rico v. Franklin Cal. Tax-Free Trust, U.S., No. 15-233, 6/13/16 ); ( Acosta-Febo v. Franklin Cal. Tax-Free Tr. , U.S., No. 15-255, 6/13/16 ).

Writing for the majority, Justice Clarence Thomas affirmed the First Circuit's decision which struck down Puerto Rico's restructuring law. The court concluded that Puerto Rico is a “state” for the purposes of Chapter 9 of the Bankruptcy Code, and therefore its municipal bankruptcy scheme to restructure the debt of its insolvent public utilities is preempted by Bankruptcy Code Section 903(1). The Puerto Rico Public Corporation Debt Enforcement and Recovery Act was designed to allow public utilities to restructure their debts and continue to provide essential public services like electricity and water.

Justice Sonia Sotomayor wrote a dissenting opinion in which Justice Ruth Bader Ginsberg joined.

Justice Samuel A. Alito Jr. recused himself from the case.

Majority View ‘Makes No Sense.'

“The dissent's view that ‘Congress excluded Puerto Rico from Chapter 9 for all purposes' makes much more sense,” Prof. Charles J. Tabb, of counsel, Foley & Lardner LLP and Mildred Van Voorhis Jones Chair in Law, University of Illinois, Champaign, Ill., told Bloomberg BNA June 13.

“While a possible reading, the only problem with the Court’s decision is that in context it makes absolutely no sense,” Tabb said.

“Section 903 is entitled ‘Reservation of State power to control municipalities,'” Tabb said. “The initial part of Section 903 provides that ‘This chapter does not limit or impair the power of a State to control, by legislation or otherwise, a municipality of or in such state in the exercise of the political or governmental powers of such municipality, including expenditures for such exercise,' with the pre-emption proviso then following as an exception,” he said. “This careful balancing of state versus federal powers is necessitated by the constitutional constraints on imposing federal bankruptcy on the states. But if no federal bankruptcy power at all is allowed for a state (here, Puerto Rico), there is no federal intrusion to be reserved from,” Tabb said. “Thus, none of Section 903 — or the rest of Chapter 9 — logically should apply to Puerto Rico,” he said.

“As Justice Sotomayor points out in her dissent,” Tabb said, “‘this distribution of power between the State and the bankruptcy court is irrelevant to Puerto Rico,'” and “‘[i]n context, … § 903 is directed to states that can approve their municipalities for chapter 9 bankruptcy.'” Sotomayor explains that “‘because Puerto Rico’s municipalities cannot pass through the § 109(c) gateway to Chapter 9, nothing in the operation of a Chapter 9 case affects Puerto Rico’s control over its municipalities. The ‘reservation’ preamble is therefore meaningless to Puerto Rico — there is no power to reserve from Chapter 9’s operation,'” Tabb said.

“The majority’s response does little more than fall back on its myopic reading of the definitional limitation in Section 101(52),” which defines a “state,” Tabb, who is an editor of , told Bloomberg BNA.

Legislation in the Works

When Congress revised the Bankruptcy Code in 1984, it changed the definition of “state” so that Puerto Rico could no longer authorize its municipalities to file Chapter 9 bankruptcy — reserved for municipalities — but there is no legislative history as to why Congress changed this provision. Thus, under Section 109(c), the Commonwealth of Puerto Rico's municipalities don't meet the requirements for filing bankruptcy under Chapter 9.

While the court acknowledged that Puerto Rico and its municipalities are in the middle of a financial crisis with the debt of its three main public utilities exceeding $20 billion, Puerto Rico will now need to get its help from Congress following the court's decision.

The House June 9 passed a bill, The Puerto Rico Oversight, Management and Economic Stability Act (PROMESA), H.R. 5728, which will allow Puerto Rico to restructure its debts, and the measure now heads to the Senate. (See related article in this issue.)

Plain Text Reading

Puerto Rico remains a “state,” however, for other purposes related to Chapter 9, the court said, including the preemption provision. Section 903(1) expressly bars Puerto Rico from enacting its own municipal bankruptcy scheme to restructure its debt, the majority said.

According to Thomas, a plain text reading of the preemption provision supports the respondent bondholders' reading of the statute.

The court specifically looked at three bankruptcy provisions: (1) the “gateway provision, Section 109(c), which requires a Chapter 9 debtor to be an insolvent municipality that is “specifically authorized” by a state “to be a debtor;” (2) the preemption provision of Section 903(1); and (3) the definition of “state” in Section 101(52), which includes Puerto Rico “except for purposes of defining who may be a debtor under chapter 9.”

If Congress “[h]ad intended to exclude Puerto Rico from Chapter 9 bankruptcy altogether, including Chapter 9's pre-emption provision, Congress would have said so,” Thomas said.

Dissent: Only Existing Legal Option

According to Sotomayor's dissent, the structure of the Bankruptcy Code and the language and purpose of Section 903 “demonstrate that Puerto Rico's municipal debt restructuring law should not be read to be prohibited by Chapter 9.”

Because Puerto Rican municipalities can't access Chapter 9's bankruptcy process, “a nonfederal bankruptcy solution is not merely a parallel option; it is the only existing legal option for Puerto Rico to restructure debts that could cripple its citizens,” Sotomayor said.

Nobody has presented a compelling reason as to why Congress would have amended the definition of “state” to exclude Puerto Rico from authorizing its municipalities to take advantage of Chapter 9, and the legislative history of the amendment isn't helpful, she said. The “proper understanding of that alteration is that Puerto Rico and its municipalities have been removed entirely from Chapter 9 — both from the benefits it provides and from the burden of the preemption clause in § 903(1),” Sotomayor said.

‘Real-World Consequences.'

Sotomayor pointed out that the majority's decision here has “real-world consequences.” “Finding preemption here means that a government is left powerless and with no legal process to help its 3.5 million citizens,” she said, noting that Congress could “step in to resolve Puerto's crisis.”

“The only immediate options we have to deal with Puerto Rico's financial crisis is Congressional action or direct negotiations between the island's government and creditors,” Eric LeCompte, executive director of the religious development coalition Jubilee USA, said June 13 in a statement.

“This decision demonstrates how important it is that the Senate passes Puerto Rico debt legislation as soon as possible. The longer it takes to reach a solution, the worse it gets for Puerto Rico's people,” LeCompte said.

Ignores Contextual Basis for Preemption

“The Court’s reasoning ignores the contextual basis for the preemption provision in Section 903, as Justice Sotomayor cogently explains,” Tabb said. “There is no reason to think that Congress intended that Puerto Rico (and DC) alone would have no legal means, either federal or local, for empowering their municipalities to restructure their debts,” he said.

“The Court’s reasoning reminds us why Charles Dickens’ barb in Oliver Twist that “‘the law is a ass' resonates today, close to two centuries later,” Tabb said.

Oral Argument Not a Predictor

“The case is a good reminder that oral argument impressions don't always carry over to the written opinion,” Prof. Stephen J. Lubben, Harvey Washington Wiley Chair in Corporate Governance & Business Ethics at Seton Hall University School of Law, Newark, N.J., told Bloomberg BNA June 13.

Based on the justices' questions and comments at oral argument, the court appeared to be receptive to Puerto Rico's argument, which would have meant a reversal of the First Circuit's opinion (28 BBLR 365, 3/24/16).

“The case ultimately boiled down to a straight statutory construction matter,” Lubben, who is a contributing author of , told Bloomberg BNA. “Despite the awkward placement of the 1946 amendments to Section 903, the majority was willing to straighten that out and hold that all of the states, including Puerto Rico for these purposes, have lost their ability to enact municipal restructuring laws,” he said.

Decision a ‘Surprise?'

Prof. David Skeel of the University of Pennsylvia Law School, Philadelphia, Pa., told Bloomberg BNA that he was “surprised by the decision,” as well.

“Because of Justice Scalia’s death and Justice Alito’s recusal, the case was heard by the four liberal justices and the three remaining conservative justices, which appeared to increase the likelihood that Puerto Rico would prevail,” Skeel, who is an editor of , told Bloomberg BNA. “Based on the justices’ comments at oral argument, Puerto Rico seemed even more likely to win,” he said.

“Justice Kagan seemed swayed by Puerto Rico’s lawyer’s argument that the preemption provision in Chapter 9 didn’t apply to Puerto Rico because Puerto Rico’s municipalities are excluded from Chapter 9,” he said. “In the end, both she and Justice Breyer joined the majority opinion holding the Recovery Act preempted.”

“I had predicted quite confidently that Puerto Rico would win,” Skeel said, “but my prediction was wrong, as often seems to be the case with Supreme Court decisions.”

According to Skeel, “Justice Thomas’s opinion is a no nonsense plain meaning analysis.” “ It is the most recent in a series of cases — which include Nobelman and Caulkett — in which Justice Thomas has cast cold water on creative arguments that would provide relief for debtors,” Skeel said.

“The opinion seems to me to make it even more important that Congress pass the pending PROMESA legislation, which would finally give Puerto Rico a restructuring option,” Skeel said.

Focus on the Future

The majority opinion upheld a “very strict interpretation of the provisions,” bankruptcy attorney Maria Mercedes Figueroa y Morgade told Bloomberg BNA. She's been in private practice in Puerto Rico since 2007, and is a former attorney for the Puerto Rico Department of Justice Bankruptcy Division.

“The dissenting opinion focuses on the economic and financial tragedy Puerto Rico is undergoing and how a holistic interpretation of these sections would allow Puerto Rico to use the Recovery Act as a vehicle towards its financial recovery,” Mercedes Figueroa y Morgade said. “But, at this juncture, Chapter 9, Sections 109(c) (2) and 903 and the applicability to Puerto Rico have been defined by the majority opinion in Franklin,” she said.

“Whether you agree or not, the focus has shifted to another scenario. We must now concentrate on the impending reality of the oversight board created by the House of Representatives Natural Resources Committee to assist Puerto Rico and its instrumentalities that was recently approved by the House of Representatives,” Mercedes Figueroa y Morgade said. “We must now center attention on the implementation of PROMESA, the Board, and how it will be construed to manage and stabilize and develop Puerto Rico’s economy and the impact it may have on maintaining the essential and vital services for all Puertoricans,” she said.

The Supreme Court agreed to hear the case Dec. 4, 2015(27 BBLR 1622, 12/10/15), and heard oral argument March 22 (28 BBLR 365, 3/24/16).

Christopher Landau of Kirkland & Ellis LLP, Washington, represented Puerto Rico and the other petitioners. Matthew D. McGill of Gibson, Dunn & Crutcher LLP, Washington, represented the respondents.

To contact the reporter on this story: Diane Davis in Washington at ddavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at jhorowitz@bna.com