Thursday, August 27, 2015

Puerto Rico Seeks Supreme Court Review in Bankruptcy Preemption Case

By Kevin Kulling, J.D.

The government of Puerto Rico has filed a petition for a writ of certiorari with the United States Supreme Court in an effort to overturn a federal appeals court decision holding that the bankruptcy code preempted Puerto Rico’s own statute that created a mechanism for the commonwealth’s public utilities to restructure their debt (Puerto Rico v. Franklin California Tax-Free Trust, August 21, 2015).

Meanwhile, separate bills that would revise the bankruptcy code to allow Puerto Rico to authorize its municipalities to seek bankruptcy protection and revise its debt remain pending in Congress.

Case history. Plaintiffs are investors who hold nearly $2 billion of bonds issued by one of Puerto Rico’s distressed public utilities. Under the federal bankruptcy laws, Puerto Rico is not included in the definition of a state for purposes of authorizing its municipalities, including its public utilities, to seek federal bankruptcy relief under Chapter 9 of the U.S. Bankruptcy Code. In June 2014, Puerto Rico attempted to allow its utilities to restructure their debt by enacting its own municipal bankruptcy law, the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (“Recovery Act”), which expressly provides different protections for creditors than does the federal Chapter 9.

The bond investor plaintiffs brought suit to challenge the Recovery Act’s validity and sought to enjoin its implementation. The district court ruled in their favor, finding that the Recovery Act was preempted by the federal bankruptcy law. On appeal, Puerto Rico argued that the definition of “State” in the federal bankruptcy code rendered the bankruptcy code inapplicable.

The First Circuit Court of Appeals affirmed the district court’s holding that the bankruptcy code preempted the Recovery Act.

Supreme Court appeal. In its petition seeking to have its Recovery Act declared constitutional, Puerto Rico observed that that law as it stands provides Puerto Rico with “the worst of both worlds: it is not entitled to the benefits of Chapter 9 but remains subject to the burdens of Chapter 9” by preempting Puerto Rico’s attempt to restructure its debts beyond the scope of the chapter.

In seeking Supreme Court review, Puerto Rico claims that its dire financial situation is “the most acute fiscal crisis in its history.” The petition asserts that Puerto Rico’s three major public utilities, which provide electricity, water, and roads for its citizens have a combined debt of some $20 billion, which they cannot pay. The petition further asserts that this is “one of the rare cases that calls for [the Supreme Court’s] immediate review” based partly on the fact that the “Commonwealth is in the midst of a financial meltdown that threatens the island’s future.”

Congressional relief. Congressional action to amend the bankruptcy code to provide Puerto Rico with the same relief afforded the states has been the subject of prior testimony before Congressional committees. There are bills pending in both the Senate and the House that would grant Puerto Rico relief by including it in the definition of a state covered by Chapter 9 of the bankruptcy code.