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Puerto Rico Preemption

posted by Melissa Jacoby

PRholdingLast summer, PREPA bondholders filed actions challenging the constitutionality of Puerto Rico's recently enacted, but as yet unused, Public Corporation Debt Enforcement and Recovery Act. Last night, the district court filed a seventy-five page opinion. It did not dispose of the actions in full (e.g., the contract clause challenges remain alive but not decided), but did hold the Recovery Act is preempted. Given that the judge's order permanently enjoins Puerto Rico from enforcing the Recovery Act, I believe it is immediately appealable under 28 USC 1292(a)(1).

Applying First Circuit law, the court notes that "[f]or preemption purposes, the laws of Puerto Rico are the functional equivalent of state laws" (p. 30). Although the plaintiffs, and particularly Blue Mountain, raised a variety of preemption arguments, the court justified its decision on express preemption, and, even more specifically, on section 903(1) of the Bankruptcy Code. Here's the language of that provision, as printed in the opinion (the introductory reference to "[t]his chapter" is chapter 9, the type of bankruptcy that municipalities file if authorized):


The district court analyzed section 903's text, history, purpose, and context and concluded that "this is not a close case" (p. 42).  It does not matter that the Bankruptcy Code currently precludes Puerto Rico municipalities from using chapter 9 for debt adjustment; "Congress's decision not to permit Puerto Rico municipalities to be Chapter 9 debtors... reflects its considered judgment to retain control over any restructuring of municipal debt in Puerto Rico. Congress, of course, has the power to treat Puerto Rico differently than it treats the fifty states" (p. 39). The district court was likewise unpersuaded by the statutory interpretation argument that provisions of chapter 9 apply only in the context of an actual chapter 9 case (p. 41).

My own assessment continues to be that preemption should not rise or fall on section 903(1); the Recovery Act could be preempted independent of section 903(1).  Thus, I wish that the court had more fully addressed and decided the other preemption arguments. 

Although not fully resolved, the contract clause discussion in last night's opinion warrants reading, particularly as states and municipalities seek to justify, on financial emergency grounds, unilateral changes to public employee obligations. The court "easily concludes" that the Recovery Act causes a substantial impairment of bondholders' rights (p. 60). The more fact-intensive second prong of contract clause analysis, whether the impairment was reasonable and necessary to serve an important government purpose, survived a motion to dismiss (p. 65).

Last night's Puerto Rico decision did not discuss City of Pontiac v. Schimmel, an unusual en banc per curiam decision of the U.S. Court of Appeals for the Sixth Circuit that the parties cited in their papers.  The 6th Circuit decision arose out of actions taken by an emergency manager to reduce and eliminate health care benefits for city retirees. Among many arguments retirees invoked to contest the changes was that section 903(1) of the Bankruptcy Code prohibited them. The en banc 6th Circuit decision stated, with no analysis, that the "plain language" of [section 903(1)] is not limited to bankruptcy proceedings" but it was not clear whether the actions of the Emergency Manager otherwise fit the statutory language. The remand to the district court instructed the development of a factual record and "carefully considered legal arguments" about section 903(1), among many other important issues.  But then, a two-judge concurring opinion is dedicated solely to clarifying that the decision only scratched the surface of a section 903(1) analysis; it still is possible for a court to conclude that section 903 does NOT apply because chapter 9 has not been invoked. In any event, City of Pontiac illustrates why last night's decision on Puerto Rico's Recovery Act should be of interest to a much broader audience than one would initially suspect. And that section 903(1) needs to be reworked.

Back to financial difficulties in Puerto Rico. PREPA has been trying to restructure pursuant to a forbearance agreement with creditors but now the legal backdrop has changed. In the last Congress, Rep. Pierluisi introduced legislation, endorsed by the National Bankruptcy Conference, giving Puerto Rico the ability to authorize its municipalities to use chapter 9. H.R. 5305 is among the shortest clearest bills in bankruptcy history. Let's count the days between last night's district court decision and reintroduction of this bill in the new Congress.


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