WASHINGTON – The Supreme Court will hear oral arguments Tuesday on whether Chapter 9 of the federal bankruptcy code, which does not apply to Puerto Rico, nevertheless preempts or makes illegal a law adopted by the commonwealth that would allow its utilities to restructure their debts.
Seven of the high court's members will hear arguments for one hour. The group will not include Justice Samuel Alito who is recusing himself over a potential conflict or a ninth member because the late Justice Antonin Scalia's seat remains vacant.
The two consolidated cases -- Puerto Rico v. Franklin California Tax-Free Trust and Melba Acosta-Febo v. Franklin Tax-Free Trust – pit Puerto Rico, its Gov. Alejandro Garcia-Padilla and other commonwealth officials against hedge BlueMountain Capital Management and of two sets of mutual funds advised by OppenheimerFunds and Franklin Advisors. All of the funds together hold roughly $2 billion of the Puerto Rico Electric Power Authority's bonds.
The commonwealth, in the midst of a downward spiral from a fiscal and $70 billion debt crisis, want the high court to overturn a ruling last July by a three-judge panel on the U.S. Court of Appeals for the First Circuit in Boston. That ruling concluded the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (DERA) adopted by the commonwealth in June 2014 was illegal.
The appeals court panel ruling, which upheld the decision of the U.S. District Court of Puerto Rico, found the recovery law violated a section of federal bankruptcy law that prohibits states from passing laws that would allow their public entities to restructure without approval of those entities' creditors.
In its petition asking the Supreme Court to reconsider the appeals court ruling, Puerto Rico said, "This case involves Puerto Rico's ability to respond to the most acute fiscal crisis in its history."
The commonwealth said the appeals court ruling has left it "in a 'no man's land' where its public utilities cannot restructure their debts under either federal law or its own law." The appeals court decision, it said, "held that Puerto Rico has the worst of both worlds: it is not entitled to the benefits of Chapter 9, but remains subject to the burdens of Chapter 9."
Puerto Rico argues that if the bankruptcy law does not treat it like a state under Chapter 9, then it should not be subject to Chapter 9 in determining whether DERA is legal.
The commonwealth said its three major utilities have a combined total of $20 billion of debt. Without restructuring of their debt, the utilities and the 3.5 million residents, American citizens, who depend on them are "at the mercy of [the utilities' creditors]," the commonwealth told the high court.
The funds want the high court to uphold the appeals court and lower court rulings that DERA is illegal. They do not want any statutory law that might force them, as creditors, to accept concessions on their PREPA debt holdings. They want to be allowed to negotiate with PREPA, which has held off making certain debt service payments under forbearance agreements with some creditors, on how best to handle the crisis.
In their filings with the court, BlueMountain and the funds argued that Section 903(1) of the U.S. Bankruptcy Code prohibits state laws providing for the adjustment of municipal debts over the objection of nonconsenting creditors and preempts 'state' laws authorizing the non-consensual restructuring of municipal debts.
The U.S. Chamber of Commerce and the Association of Financial Guaranty Insurers, which filed friend-of-the-court briefs with the Supreme Court, also argued DERA is illegal. The Chamber said DERA favors Puerto Rico authorities "at the expense of" creditors and worries it "could serve as a model for other states."
AFGI warned that upholding DERA "would have significant negative consequences on the $4 trillion municipal bond industry … which finances many of the most important projects and services provided by the nation's municipalities, including those of Puerto Rico."
The case is expected to hinge on the U.S. Bankruptcy Code's definition of state and Section 901(3) as well as on the territory, supremacy and bankruptcy clauses of the U.S. Constitution, according to municipal bankruptcy expert Jim Spiotto, managing director of Chapman Strategic Advisors in Chicago.
Section 101(52) of the bankruptcy code says in part that the definition of state "includes the District of Columbia and Puerto Rico" except for the purpose of defining who may be a debtor under Chapter 9."
Section 903(1) of the code says "a state law prescribing a method of composition of indebtedness ... may not bind any creditor that does not consent to such composition." A composition details a legal agreement between the debtor and their creditors, where the creditors agree to receive installments of what is owed by the debtor until full settlement, according to the Dictionary of Legal Terms.
Spiotto said Puerto Rico's DERA doesn't work under these bankruptcy code provisions because the territory is included in the definition of state and states cannot prescribe a group of creditors that binds creditors without the creditors' consent.
Apart from that, the "territorial clause" in Article IV, section 3 of the U.S. Constitution says Congress shall make the laws for territories. Specifically it says in part: "The Congress shall have power to dispose of and make all needful rules and regulations respecting the territory or other property belonging to the United States."
"Puerto Rico is a territory owned by the United States and its part of the land. That's why [Puerto Ricans] are U.S. citizens when they're born," Spiotto said. "It must adhere to general principles of the U.S. laws and Constitution."
The supremacy clause in Article VI, clause 2 of the Constitution says, "This constitution, and the laws of the United States … and all treaties made … shall be the supreme law of the land."
"The supremacy clause says federal laws are supreme," said Spiotto. "If Puerto Rico is a state, it can't voluntarily composite or restructure debt without the consent of the creditors unless it's in bankruptcy," said Spiotto, adding DERA isn't a bankruptcy law and Puerto Rico isn't authorized to do bankruptcy.
The bankruptcy clause in Article I, section 8, clause 4 of the Constitution says "Congress shall have power … to establish … uniform laws on the subject of bankruptcies throughout the United States." Spiotto said this clause means Puerto Rico "can't create its own bankruptcy law, only Congress can."
"Puerto Rico is a sovereign, as permitted by its Constitution, with regard to its local government and affairs. But it is a sub-sovereign to the United States because it's a territory and is subject to the principles of the U.S. Constitution, including the supremacy clause, the territorial clause and the bankruptcy clause. For these reasons DERA is unconstitutional as the First Circuit stated."
The oral arguments will take place against a backdrop of controversy over whether the U.S. Congress will act on legislation to provide relief to Puerto Rico. Bills pending in the Senate would provide for territory-wide restructuring outside of Chapter 9 or under Chapter 9. Another bill pending in the House would allow Puerto Rico's authorities, but not the territory itself, to file for bankruptcy under Chapter 9. Other bills would place a temporary moratorium on certain litigation filed over Puerto Rico's debt.
House Speaker Paul Ryan, R-Wis., had said set a March 31 deadline for House members to come up with a legislative package for Puerto Rico. But Senate Finance Committee chair Orrin Hatch, R-Utah, indicated on Thursday that Republicans and Democrats in the Senate are still at loggerheads and far from coming up with a bipartisan relief package.
If Congress does approve a relief package for Puerto Rico that allows it or its authorities to restructure their debt, that would become the law of the land and it could render moot any Supreme Court ruling to the contrary, Spiotto and other lawyers said.
