Puerto Rico v. Franklin California Tax-Free Trust (15-233)

Issues 

Does Chapter 9 of the federal Bankruptcy Code prohibit Puerto Rico from providing distressed municipalities with debt restricting mechanisms?

Oral argument: 
March 22, 2016

Many of Puerto Rico’s municipalities are in financial crisis, and public utility companies are facing insolvency. In this consolidated case, the Supreme Court will determine whether Chapter 9 of the federal Bankruptcy Code preempts Puerto Rican laws permitting distressed municipalities to restructure their debt. Puerto Rico and its Government Development Bank assert that Puerto Rico is not prevented from passing local bankruptcy laws because Congress has not directly addressed territorial law in this area. But public utility creditors Franklin California Tax-Free Trust and BlueMountain Capital Management, LLC, argue that Congress preempted any state or territorial municipal bankruptcy legislation in an effort to ensure a uniform federal bankruptcy standard. The Court’s ruling will impact Puerto Rican municipalities’ ability to provide essential services to their residents, and the rights of creditors to collect on their debt. 

Questions as Framed for the Court by the Parties 

Does Chapter 9 of the Federal Bankruptcy Code, which does not apply to Puerto Rico, nonetheless preempt a Puerto Rico statute creating a mechanism for Puerto Rico’s public utilities to restructure their debts?

Facts 

The Commonwealth of Puerto Rico isfacing a severe financial crisis, and several public utility companies are on the verge of insolvency. See Franklin California Tax-Free Trust, et al. v. Commonwealth of Puerto Rico, 805 F.3d 322, 324 (1st Cir. 2015). In federal Bankruptcy Law, 11 U.S.C. § 109(c) (“section 109(c)”) requires state authorization for a municipality to constitute a debtor under Chapter 9, which governs municipal debt. See id. at 328. The Bankruptcy Amendments and Federal Judgeship Act of 1984 altered the section 101(52) definition of “state” to include Puerto Rico “except for the purpose of defining who may be a debtor under Chapter 9 of [the U.S. Bankruptcy Code].” See id. at 330-31. Therefore, Puerto Rico is currently barred from authorizing its municipalities to declare bankruptcy and restructure their debt under Chapter 9, because the amended definition prevents Puerto Rico from meeting the state-authorization requirement of section 109(c). See id. at 324.

In response to this restriction, Puerto Rico enacted the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (the “Recovery Act”) in June 2014. See Franklin California, 805 F.3d at 331. The Recovery Act, modeled in part after Chapter 9, “establish[ed] a debt enforcement, recovery, and restructuring regime for the public corporations and other instrumentalities of the Commonwealth [] during an economic emergency.” See id. The Recovery Act provides municipalities with two mechanisms to restructure debt: Chapter 2, a contractual debt modification process, and Chapter 3, a court-supervised process. See id.

Franklin California Tax-Free Trust, et al. (“Franklin California”)—a group of investors who hold almost two billion dollars in bonds issued by the distressed public utility company Puerto Rico Electric Power Authority (“PREPA”)—challenged the legitimacy of the Recovery Act and sought declaratory relief under 28 U.S.C. §§ 2201–02. See Franklin California, 805 F.3d at 325–26. Less than a month later, BlueMountain Capital Management, LLC (“BlueMountain”), another PERPA creditor, filed a similar suit in district court. See id. Franklin California and BlueMountain sued several defendants, including Puerto Rico, Governor Alejandro Garcia-Padilla, and Melba Acosta-Febo, president of the Government Development Bank for Puerto Rico (“GDB”). See id. The district court consolidated the cases for briefing purposes without merging the suits. See id.

Franklin California and BlueMountain each argued that section 903(1) of the Bankruptcy Code, in order to promote the uniform application of federal bankruptcy laws, prohibits states from enacting municipal debt restructuring laws that change creditors’ contractual rights without their consent. See Franklin California, 805 F.3d at 325–26. The district court granted summary judgment to Franklin California, holding that section 903(1) preempted the Recovery Act, and permanently enjoined Puerto Rico from implementing it.  See id. at 326.

Puerto Rico appealed the district court’s decision to the U.S. Court of Appeals for the First Circuit. See Franklin California, 805 F.3d at 327. The First Circuit affirmed the district court’s preemption ruling, and also held that Congress intended section 903(1) to block every state municipal-bankruptcy law, including those laws passed by jurisdictions that did not receive federal bankruptcy law protection. Congress wanted the power to determine the best course of action in these circumstances. See id. at 345.

Puerto Rico and GDB petitioned the U.S. Supreme Court for writ of certiorari, which the Court granted on December 4, 2015. See Brief for the Petitioner, the Commonwealth of Puerto Rico at 11; see also Brief for the Petitioner, Melba Acosta-Febo and John Doe at 15. The Court consolidated Puerto Rico’s and GDB’s cases due to their similar legal issue.

Discussion 

The Court will consider whether Puerto Rico can provide bankruptcy procedures to struggling municipalities. The decision will have widespread economic and social effects on Puerto Rico’s residents.

FINANCIAL AND SOCIAL IMPLICATIONS ON PUERTO RICO RESIDENTS

Law professors Clayton Gillette and David A. Skeel, Jr. (the “Professors”) assert that prohibiting Puerto Rico from utilizing restructuring mechanisms will prevent municipalities from providing the public with access to critical resources, such as police, fire and utilities. See Brief of the Professors at 22-23. The Professors contend that, unlike the failure of a private firm in a competitive market, the fiscal incapacity of a struggling municipality leaves the public without suitable alternatives for key goods and services. See id. at 24-25. As a result, the residents of Puerto Rico will be forced to either move out of failing municipalities, pay an extremely high cost to receive these services, or live without these resources. See id. at 25. Furthermore, PREPA asserts that the preemption of the Recovery Act will lead creditors to “race to the courthouse,” leaving municipalities unable to handle the resulting humanitarian crisis. See Brief of PREPA, in Support of Petitioner at 12-13.

However, the Association of Financial Guaranty Insurers (“AFGI”) contends that these alleged harms are patently inaccurate, given the behavior of Puerto Rico and its creditors, governing law, the parties’ contractual obligations, and basic reasoning. See Brief for the AFGI, in Support of Respondent at 20. AFGI contends that public utility companies’ financial difficulties prompted good faith negotiations between PREPRA and its creditors, resulting in the more efficient operation of PREPA. This benefits both creditors and the public as a whole. See id. at 29. Finally, AFGI contends that the current statutory and contractual framework provide for PREPA’s continued operation under the guidance of a receiver. The receive will ensure that Puerto Rican residents receive critical utilities, and also ensure that creditors are paid back in a timely manner. See id. at 32.

PUBLIC INTEREST IN ACCESS TO AND APPLICATION OF BANKRUPTCY LAW

PREPA argues that Congress passed municipal bankruptcy laws to provide for orderly municipal restructurings, and to address holdout problems by providing creditors with fair and equitable relief. See Brief of PREPA at 17. PREPA maintains that denying Puerto Rico access to Chapter 9 and invalidating the Recovery Act leaves Puerto Rico’s municipalities exposed to the same issues that Congress strove to avoid through the Bankruptcy Code. See id.

But the Chamber of Commerce of the United States (the “Chamber of Commerce”) contends that a functioning economy requires the uniform application of bankruptcy laws and thus precludes states and territories from enacting local bankruptcy laws. See Brief of the Chamber of Commerce, in Support of Respondents at 20–21. The Chamber of Commerce explains that Congress retained the power to enforce uniform bankruptcy laws so it could regulate and preserve the national market for the extension of credit—without interference from conflicting state laws. See id. at 21. Furthermore, Scotiabank de Puerto Rico (“Scotiabank”) asserts that the Recovery Act allows municipalities, who previously acquired favorable terms in the credit market due to their legal status, to skirt obligations during financial difficulties while depriving creditors of their bargained-for rights. See Brief of Scotiabank, in Support of Respondents at 12.

Analysis 

Puerto Rico and GDB argue that Puerto Rico can pass its own bankruptcy laws, because Congress has not passed laws that directly conflict with Puerto Rico’s laws.  See Brief for Petitioner, Puerto Rico at 17; Brief for Petitioner, GDB at 19.  But Blue Mountain and Franklin California contend that section 903(1), which bars states from legislating municipal bankruptcy laws, also prohibits federal territories from passing such laws.  See Brief for Respondent, Blue Mountain at 18; Brief for Respondent, Franklin California at 14.

DO THE BANKRUPTCY CLAUSE AND FEDERAL BANKRUPTCY CODE CATEGORICALLY PREEMPT ALL STATE AND TERRITORY RESTRUCTURING LAWS?

Puerto Rico and GDB contend that the Bankruptcy Clause of the Constitution and the federal Bankruptcy Code do not preempt all state and territorial restructuring laws.  See Brief for Petitioner, Puerto Rico at 15; See Brief for Petitioner, GDB at 19.  While the Bankruptcy Clause permits Congress to regulate bankruptcy on a national scale, states and territories may still pass laws to regulate the restructuring of debts when Congress has chosen not to.  See Brief for Petitioner, Puerto Rico at 21; Brief for Petitioner, GDB at 35.  Puerto Rico contends that there have been long periods in history when there was no federal bankruptcy law in place, during which states and territories enacted their own bankruptcy litigation.  See Brief for Petitioner, Puerto Rico at 16.  Puerto Rico concedes that once federal bankruptcy laws were in place, they displaced conflicting state laws under the Supremacy Clause.  See id. at 17.  Nonetheless, the lack of a federal bankruptcy law does not in itself preclude states’ from legislating on the issue.  See id. at 17.   Accordingly, Puerto Rico and GDB conclude that the lack of municipal bankruptcy regulations for territories such as Puerto Rico means the territories may legally create bankruptcy regimes.  See id. at 17-19, Brief for Petitioner, GDB at 21-22. 

Blue Mountain and Franklin California disagree. They argue that Congress has retained authority over the field of municipal-debt restructuring.  See Brief for Respondent, Blue Mountain at 54; Brief for Respondent, Franklin California at 25. Municipal bankruptcy regulation is comprehensive, so Blue Mountain maintains that Congress intended for the federal regulation to be exclusive.  See Brief for Respondent, Blue Mountain at 55.  Accordingly, Blue Mountain and Franklin California maintain that the Recovery Act conflicts with the congressional objectives of section 903(1) and is therefore preempted.  See Brief for Respondent, See Blue Mountain at 57-59; Brief for Respondent, Franklin California at 12. 

IS PUERTO RICO CONSIDERED A STATE UNDER SECTION 903(1)?

Puerto Rico and GDB argue that Puerto Rico falls outside of the limitations on states imposed by section 903(1), and thus Puerto Rico was free to pass its own laws.  See Brief for Petitioner, Puerto Rico at 23–24; Brief for Petitioner, GDB at 27.  Section 903(1) bars states from legislating their own municipal bankruptcy laws.  See Brief for Petitioner, Puerto Rico at 22.  Puerto Rico contends that it is excluded generally from Chapter 9 of the Bankruptcy Code, the broader chapter in which Section 903(1) lies.  See id. at 26–27.  Moreover, Puerto Rico contends that section 903 explicitly states that it should not affect the ability of a state to control its municipalities, which Blue Mountain’s reading of the statute would require.  See id. at 25.  Under Blue Mountain’s reading, Puerto Rico would nonsensically be forced to bear the burden of prohibiting state municipal bankruptcy laws, without receiving the benefit of coverage from federal municipal bankruptcy laws.  See id. at 27.  In the alternative, GDB argues that Puerto Rico is not a debtor under Chapter 9 and therefore it cannot have creditors, as referenced in section 903(1). See Brief for Petitioner, GDB at 31–32.  Consequently, GDB argues, Puerto Rico would not be bound by the restrictions of section 903(1), which only prohibits municipal bankruptcy laws that bind creditors without their consent. See id. at 32.

However, Blue Mountain and Franklin California contend that Puerto Rico is considered a state throughout the Bankruptcy Code, and therefore it is precluded, like a state, from passing its own municipal bankruptcy laws under section 903(1).  See Brief for Respondent, Blue Mountain at 18-19; Brief for Respondent, Franklin California at 25.  Blue Mountain and Franklin California assert that “state” under section 903(1) is defined in section 101(52) of the Bankruptcy Code as including Puerto Rico.  See Brief for Respondent, Blue Mountain at 18-19; Brief for Respondent, Franklin California at 24-25. Puerto Rico’s exclusion as a “state” is limited solely to the definition of debtor in Chapter 9 of the Bankruptcy Code.  See Brief for Respondent, Blue Mountain at 18-19; Brief for Respondent, Franklin California at 15. 

IF SECTION 903(1) IS AMBIGUOUS, WHAT INTERPRETATION CONTROLS?

Puerto Rico and GDB argue that there is a strong presumption against finding that state law is preempted when a federal statute’s preemptive effect is ambiguous.  See Brief for Petitioner, Puerto Rico at 28; Brief for Petitioner, GDB at 19.  They contend that this presumption also applies to Puerto Rico in the valid exercise of its powers as a territory.  See Brief for Petitioner, Puerto Rico at 28; Brief for Petitioner, GDB at 20.  GDB and Puerto Rico assert that the Recovery Act was a valid use of the territory’s police powers: the Act was a necessary action to protect Puerto Rico’s depressed economy and promote the public welfare.  See Brief for Petitioner, Puerto Rico at 36; Brief for Petitioner, GDB at 20.  Moreover, GDB argues that the presumption against preemption extends, in particular, to instances in which a subject would be immune from both federal and state law, a so-called “no man’s land.”  See Brief for Petitioner, GDB at 28. Puerto Rico also contends that the doctrine of constitutional avoidance counsels against construing section 903(1) to preempt Puerto Rican law. Holding that section 903(1) preempts the Recovery Act might implicate states’ rights to control their fiscal affairs, even if it doesn’t implicate Puerto Rico directly.  See Brief for Petitioner, Puerto Rico at 41.

Blue Mountain argues that Puerto Rico and GDB’s reliance on preemption-avoiding doctrines is misguided.  See Brief for Respondent, Blue Mountain at 44. Blue Mountain argues that regardless of how section 903(1) is interpreted, the Court’s decision will skirt constitutional issues and thus the doctrine of constitutional avoidance does not necessarily favor Puerto Rico.  See id. at 41-42.  Moreover, Blue Mountain asserts that the presumption against preemption is not applicable.  See id. at 45. The presumption does not apply when Congress has made its intention to preempt apparent.  See id. at 46.  Blue Mountain argues that there is clear evidence of congressional intent for section 903(1) to preempt state law. Most significantly, after the Court found the first version of the Chapter 9 municipal-bankruptcy law was unconstitutional, Congress passed the current version of Section 9 to ensure there was a constitutionally-valid means to preempt states’ laws.  See id. at 47.   Furthermore, Blue Mountain contends that the law does not create a “no man’s land”.  See id. at 49.  Instead, Congress chose to reserve the right to legislate municipal bankruptcy laws for territories such as Puerto Rico.  See id.

Conclusion 

The Court will determine whether Puerto Rico can pass its own bankruptcy procedures for restructuring municipal debt.  See Brief for Petitioner, Puerto Rico at 1.   Puerto Rico and GDB argue that Puerto Rico has the authority to legislate restructuring laws for municipalities because it is not within the scope of section 903(1) and therefore not preempted by the bankruptcy code.  See Brief for Petitioner, Puerto Rico at 17; Brief for Petitioner, GDB at 19.  But Franklin California and Blue Mountain argue that section 903(1) preempts Puerto Rico’s bankruptcy regime, even though Puerto Rican municipalities cannot seek relief under section 9.  See Brief for Respondent, Blue Mountain at 18; Brief for Respondent, Franklin California at 14.  

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Acknowledgments