Supreme Court Rules Against Puerto Rico Debt Recovery Act
SAN JUAN – The U.S. Supreme Court upheld Monday a lower court ruling that declared unconstitutional the 2014 Public Corporation Debt Enforcement and Recovery Act, which allowed certain public corporations to restructure their debts, arguing that the U.S. Bankruptcy Code bars the island from writing its own bankruptcy law.
In a 5-2 vote, the top court ruled that the language of the Bankruptcy Code states that Puerto Rico is a state for purposes of the code except for the purpose of defining who may be a debtor under Chapter 9, a section that allows financially distressed municipalities to seek debt restructuring. In other words, Puerto Rico does not have the power to authorize municipalities, which in the code includes agencies or public corporations, from seeking bankruptcy.
The ruling on Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust, et al, is a blow to the island, which had hoped for a favorable ruling at a time when it must come up with a more than $1.5 billion payment by the end of the month. The government is operating with limited resources with a weak healthcare system and a pension system at the verge of becoming insolvent.
The Supreme Court, ironically, ruled last week that Puerto Rico was a territory without sovereignty separate from the U.S. Congress and, for that reason, could not prosecute individuals for the same crimes for which they were convicted by a federal court because it would violate the U.S. Constitution’s double-jeopardy clause.
The new ruling, delivered by Justice Clarence Thomas and in which four other justices joined, also comes after a bill that would establish a federal oversight board for Puerto Rico was approved by the U.S. House and was on its way to the Senate.
“After the parties briefed and argued these cases [in February], members of Congress introduced a bill in the House of Representatives to establish an oversight board to assist Puerto Rico and its instrumentalities…. The bill does not amend the Federal Bankruptcy Code; it instead proposes adding a chapter to Title 48, governing the Territories,” according to the top court.
In response to an ongoing fiscal crisis, Puerto Rico enacted the Public Corporation Debt Enforcement and Recovery Act, of which portions mirror Chapters 9 and 11 of the Federal Bankruptcy Code and enable public corporations to restructure their climbing debt.
A group of investment funds, including the Franklin California Tax-Free Trust and Blue Mountain Capital Management LLC, brought separate suits against Puerto Rico and various government officials, including the Government Development Bank, to enjoin the enforcement of the Recovery Act.
Collectively, the plaintiffs hold nearly $2 billion in bonds issued by the Puerto Rico Electric Power Authority, one of the distressed public utilities, which has already restructured its debt. Two lower courts ruled that the bankruptcy law preempted the local Recovery Act.
The Federal Bankruptcy Code preempts state bankruptcy laws that enable insolvent municipalities to restructure their debts over the objections of creditors and instead requires municipalities to restructure such debts under Chapter 9 of the code. According to the top court, Puerto Rico is a “State” for purposes of this preemption provision.
“The Bankruptcy Code has long included Puerto Rico as a ‘State,’ but in 1984 Congress amended the definition of ‘State’ to exclude Puerto Rico ‘for the purpose of defining who may be a debtor under chapter 9,’” the top court ruled.
By excluding Puerto Rico “for the purpose of defining who may be a debtor under chapter 9,” the code prevents Puerto Rico from authorizing its municipalities to seek Chapter 9 relief. Without that authorization, the island’s municipalities cannot qualify as Chapter 9 debtors. But Puerto Rico remains a “State” for other purposes related to Chapter 9, including that chapter’s preemption provision. “That provision bars Puerto Rico from enacting its own municipal bankruptcy scheme to restructure the debt of its insolvent public utilities companies,” the top court said.
In resolving the question, the U.S. Supreme Court analyzed the language of the statute itself.
“And because the statute ‘contains an express preemption clause,’ we do not invoke any presumption against preemption but instead ‘focus on the plain wording of the clause, which necessarily contains the best evidence of Congress’ pre-emptive intent,’” the top court said.
Justice Sonia Sotomayor, who wrote a dissenting opinion along with Justice Ruth Bader Ginsburg, noted that the structure of the code and the language and purpose of its Section 903, the preemption provision, demonstrate that Puerto Rico’s municipal debt restructuring law should not be read to be prohibited by Chapter 9.
To understand why Section 903 does not preempt the Recovery Act, it is important to consider that statutory provision in context, she said. “Section 903, titled ‘Reservation of State power to control municipalities,’ reads in full: ‘This chapter [Chapter 9] 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, but— ‘(1) a State law prescribing a method of composition of indebtedness of such municipality may not bind any creditor that does not consent to such composition’; and ‘(2) a judgment entered under such a law may not bind a creditor that does not consent to such composition,’” she said.
This “reservation” of power to the states was added to the code in response to the Supreme Court’s earlier recognition that states possess plenary control over their municipalities, particularly in fiscal matters, she said. For example, even if a municipality is in Chapter 9 bankruptcy, a state could still revoke its charter.
The majority argues that, in light of the longstanding nature of the Section 903 preemption provision to preclude state municipal bankruptcy laws, “[h]ad Congress intended to ‘alter this fundamental detail’ of municipal bankruptcy” to not apply to Puerto Rico, “we would expect the text of the amended definition to say so,” she said.
The court ignores that the U.S. Congress already altered the fundamental details of municipal bankruptcy when it amended the definition of “State” to exclude Puerto Rico from authorizing its municipalities to take advantage of Chapter 9. “Nobody has presented a compelling reason for why Congress would have done so, and the legislative history of the amendment is unhelpful. Under either interpretation the scheme has been fundamentally altered by Congress. And, in context, 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 Section 903,” Sotomayor said.
Preemption cases may seem like abstract discussions of the appropriate balance between state and federal power. “But they have 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…. Congress could step in to resolve Puerto Rico’s crisis. But, in the interim, the government and people of Puerto Rico should not have to wait for possible congressional action to avert the consequences of unreliable electricity, transportation, and safe water—consequences that members of the Executive and Legislature have described as a looming ‘humanitarian crisis,’” she added.