Supreme Court Appears Receptive to Puerto Rico's Argument

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By Diane Davis

March 22 — The U.S. Supreme Court March 22 considered what Congress meant when it revised the Bankruptcy Code so that Puerto Rico could no longer authorize its municipalities to file bankruptcy under Chapter 9.

The case arose out of the “most acute fiscal crisis in Puerto Rico history,” according to the Commonwealth of Puerto Rico's petition filed with the court. The island, which is an unincorporated territory of the U.S., is facing an economic recession, high unemployment, a declining population, and significant long-term debt. According to Puerto Rico, it is on the brink of insolvency.

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 Bankruptcy Code Section 109(c), the Commonwealth of Puerto Rico's municipalities don't meet the requirements for filing bankruptcy under Chapter 9.

`Never-Never Land' Situation

Justice Ruth Bader Ginsburg asked the key question in this case: Why would Congress put Puerto Rico in this “never-never land” situation? “What explains Congress wanting to put Puerto Rico in this anomalous position of not being able to restructure its debt?” she asked.

In the absence of legislative history, Congress has micromanaged Puerto Rico's debt for a long time, Matthew D. McGill of Gibson, Dunn & Crutcher LLP, Washington, who argued for respondents Franklin California Tax-Free trust and BlueMountain Capital Management, LLC, said. By 1984, “Puerto Rico and the District of Columbia are the most indebted territories by a lot,” McGill said.

At oral argument, four justices appeared to at least be favorably considering Puerto Rico's argument. Justice Elena Kagan, who in the beginning of oral argument said that “it isn't clear which of you is right,” acknowledged later when respondent was arguing that the petitioners' view of the text is “just as good if not better than yours.” Kagan also noted several times that “I came in here not thinking that at all.”

Justice Stephen G. Breyer also seemed to come around to the petitioners' argument, which Breyer initially said “doesn't make sense.” Later during respondent's argument he said that he had a “better understanding” of the petitioners' argument now.

`Flesh and Blood' Situation

With Justice Antonin Scalia's seat still vacant, and Justice Samuel A. Alito Jr.'s recusal in the case, those four votes would be enough as petitioners' counsel Christopher Landau of Kirkland & Ellis LLP, Washington, said, to ensure that “people in a village in Puerto Rico will be able to get clean water.”

Landau urged the justices in his rebuttal not to lose sight of the fact that this is a “flesh-and-blood situation in Puerto Rico.”

Puerto Rico enacted the Public Corporation Debt Enforcement and Recovery Act in 2014 because it is “facing a crisis in providing essential services to its citizens. It is implausible at best to think that Congress” meant to take Puerto Rico out of Chapter 9, he said.

Challenge to Law's Validity

The day the governor signed the Recovery Act into law, Franklin—mutual funds that hold more than $1.7 billion in Puerto Rico Electric Power Authority bonds—filed a lawsuit challenging the act's validity and seeking declaratory and injunctive relief. Shortly thereafter, BlueMountain brought a similar lawsuit alleging that the Recovery Act is preempted by Section 903(1) of the Bankruptcy Code.

The district court granted the respondents summary judgment without hearing oral argument and permanently enjoyed the petitioners from enforcing the Recovery Act.

The U.S. Court of Appeals for the First Circuit struck down the law, concluding that Bankruptcy Code Section 903(1) expressly preempts it (, 805 F.3d 322 (1st Cir. 2015) .

The Supreme Court agreed to hear the case Dec. 4, 2015 .

No Remedy for Puerto Rico?

On behalf of the petitioners, Landau argued that this case presents the question of “whether Congress has stripped Puerto Rico of access to any legal mechanism to restructure the debts of its public utilities which provide essential services to its citizens, like electricity and water.”

According to the petitioners, the respondents contend that “Congress denied Puerto Rico access to Chapter 9 altogether, but left Puerto Rico subject to Chapter 9's preemption provision. That anomalous result can't be squared with the statute's text and structure,” Landau said. He called the respondent's approach “selective textualism.”

Landau explained that in 1984, Congress defined the word “state” in the Bankruptcy Code to include Puerto Rico and the District of Columbia except for the purposes of determining who may be a debtor under Chapter 9. Chapter 9 can't apply to Puerto Rico in light of the 1984 amendment, which “categorically precludes Puerto Rico from passing through the gateway into Chapter 9, which is located in Section 109(c)(2),” Landau argued.

Petitioners Use ‘Decision Tree' Analysis

Landau asked the justices to look at this as a “decision tree.” The “decision tree” starts with Bankruptcy Code Section 101(52), the definitions, he said. It says that Puerto Rico isn't a state for purposes of determining who may be a debtor under Chapter 9. “That sends us to Chapter 1, to [Section] 109(c)(2),” which states that in order to get into Chapter 9, you must have that authorization from a state. Then you go to the third step, he said, which says that Chapter 9 doesn't limit or impair the power of a state to control.

“[I]t's a big deal to assume that Congress categorically precluded Puerto Rico from access to anything,” Landau said.

Chief Justice John G. Roberts Jr., queried why Congress would treat the District of Columbia and Puerto Rico differently than Guam and the Virgin Islands.

According to Landau, “everyone agrees that Puerto Rico operates in that very unique situation which is really almost the opposite extreme of the spectrum from D.C. where D.C. has to have its laws submitted to Congress, and they can veto it.”

“[W]e don't know why Congress chose to lump these two jurisdictions which are kind of at opposite ends of congressional oversight,” Landau said. He called this lack of legislative history directly on point either way the “black box.”

Range of Options Being Considered

Respondent's counsel McGill began by saying that everyone agreed that in 1984, Congress withdrew Puerto Rico and the District of Columbia the power to put their municipalities into Chapter 9 bankruptcy. “Petitioner's position is that by the same enactment, Congress impliedly gave Puerto Rico and the District a much greater power that no state has possessed since 1946, the power to write its own municipal laws,” he argued.

According to McGill, Section 903 applies to every state in the sense that it “demarcates where Congress is not entering and where Congress is. That is the role that [Section] 903 plays in this statutory scheme.”

The choice for Puerto Rico and the District of Columbia is to “come to Congress,” McGill said.

McGill noted that at this very moment, Congress is addressing how to deal with Puerto Rico's fiscal crisis, and is considering a range of options for Puerto Rico, including Chapter 9, “just as Congress considered a range of options for the District of Columbia during its own financial crisis in the 1990s, which resulted in a financial control board rather than Chapter 9.”

Stakes Are High for Puerto Rico

No matter what happens with the Supreme Court's decision, in order for Puerto Rico to move forward, its political status issue has to be resolved, Osvaldo M. Medina Hernandez, executive director of the Joint Committee for the Penal Code and Criminal Law Reform and legal advisor to the Judiciary Committee of the House of Representatives of Puerto Rico, said March 21. Hernandez was moderating a panel of speakers on Puerto Rico's public debt and status at American University Washington College of Law in Washington.

Neil Weare, founder of We the People project, a nonprofit organization fighting for equal rights for people living in the U.S. territories and the District of Columbia, agreed that Puerto Rico needs “clarity for a new path forward.”

“The stakes couldn't be higher in court now and in Congress,” Weare said.

According to Rep. Louis Vega Ramos, a member of the House of Representatives of Puerto Rico, the issue with Puerto Rico isn't merely a financial crisis, but a “humanitarian crisis.” “It's a moral and ethical crisis, he said, with Puerto Rico $69 billion in debt and Congress has yet to provide any process to reasonably allow Puerto Rico to restructure their debt.”

Will Problems Be Resolved?

According to Carlos I. Gorrin Peralta, professor of constitutional law at the Interamerican Univeristy of Puerto Rico School of Law, no matter what the Supreme Court decides in this case, it won't resolve Puerto Rico's problem because it is a “structural problem” and Puerto Rico is in an “unsustainable position.” Offering statehood is one option that Peralta discussed, as well as a treaty of free association, or recognizing Puerto Rico as fully independent.

If the Supreme Court rules in favor of Puerto Rico, “we'll have some additional tools to address some of the debt in an orderly way,” Eric LeCompte, a United Nations sovereign debt expert and Executive Director of the religious development group Jubilee USA,” said in a statement March 22.

“While this could be positive, it still doesn't offer a comprehensive solution,” LeCompte said. LeCompte testified before Congress in February on possible legislative solutions to Puerto Rico's debt crisis.

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

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