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Puerto Rico: Further Supreme Court Thoughts

posted by Stephen Lubben

So Noah Feldman has a column up on Bloomberg that suggests that section 903(1) of the Code should clearly apply to the Commonwealth. It's a sensible argument, if you read that section entirely in isolation and know nothing about the overall structure of the Bankruptcy Code.

And while I say that intending a bit of the obvious snark – what else could be expected, he’s suggesting that my analysis is essentially daft – it is important to remember that the Supreme Court is not made up of bankruptcy experts. Thus, his column provides a fairly clear analysis of how Puerto Rico might still lose, despite the apparent leanings of the Justices in yesterday’s oral argument.

So if there is a non-frivolous argument for preemption of the Recovery Act, why do I think the Court might still overturn the First Circuit? It could happen one of two ways.

First, the Court could look at the overall structure of the Code. Section 109 governs who gets into what chapters of the Code. Only municipalities that have been authorized by their states get into chapter 9. Puerto Rico counts as a state for most purposes under the Code, save for this one point.  Under section 109, it is not a “state” that can authorize a chapter 9 filing by its municipalities.

The argument is then that all of chapter 9 is now irrelevant to Puerto Rico, because its municipalities can’t ever get in. Sure 903(1) in isolation looks like it applies, but its in chapter 9, which can never be invoked by a Puerto Rican municipality.

After all, 903(1) was essentially tacked on to a provision that otherwise is all about preserving the power of the states over their municipalities, despite the fact that they are now in front of a federal bankruptcy judge. That provision, taken as a whole, does not really make any sense when applied to a “state” that can’t ever put its municipalities in that position.

The second approach is to argue that 903(1), at least when read as broadly as the bondholders want to read it, is itself unconstitutional.  The argument is essentially that Congress can’t say “it's chapter 9 or nothing” to the states.  The viability of this argument depends on whether you think the Court still worries about the Tenth Amendment implications of chapter 9.  Clearly in the Warren Court days, that would have been doubtful – not quite clear where things stand today.

In my article, I suggest that this potential constitutional problem is a reason to read 903(1) as instead part of a Congressionally imposed bargain: if the states want to use chapter 9, they have to give up their oddball state laws. That arguably saves 903(1), because it makes 903(1) a bit more voluntary, but again it depends on whether you think there are Tenth Amendment concerns still lurking out there with regard to chapter 9.

Maybe you say “but wait, Puerto Rico does not have Tenth Amendment rights.”  Maybe, but they might have some other form of sovereignty that gives them a general police power, and an ability to control their sub-units, which Congress is bound to respect. If the Court uses the “other” Puerto Rico case to overturn the odious “Insular Cases,” this argument gets even stronger.

Which one will the Court adopt – assuming it overrules the First Circuit?  My guess is the first approach, because its easier, and avoids the constitutional issues entirely. But Justice Sotomayor was clearly attuned to the second issue in yesterday’s argument.  So there is still a chance, however slight, that 903(1) is either struck down, or read along the lines I suggest above to “save” it.


My prediction is 4-3 overturn. Huge for PR that Alito isn't in there.

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