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Puerto Rico: The Recovery Act's Potential Second Wind

posted by Melissa Jacoby


This post continues the long-running Credit Slips discussion of Puerto Rico's Recovery Act, now the subject of U.S. Supreme Court review in Puerto Rico v. Franklin California Tax-Free Trust, 15-233, as indicated in Lubben's recent post and in last week's preview. In the video above, posted with permission of the American Bankruptcy Institute, I interview Bill Rochelle, who was at the Supreme Court for oral argument and makes some intriguing predictions on the vote, timing of issuing the opinion, judicial selection, and other matters. A few more reflections below the break.

  1. Express preemption and the rise and fall of section 903(1): Although other preemption theories seemed viable, I never could wrap my head around what many consider the central express preemption evidence, namely 11 U.S.C. 903(1). Many readers and colleagues have heard me say "preemption should not rise or fall on section 903(1)." So at least on this issue, that position left me roughly in Lubben's camp, who has studied and written on the issue in detail. Clay Gillette and David Skeel get to a similar place in their amicus brief: that section 903(1) cannot reasonably apply to Puerto Rico. Most recently, Drew Dawson has weighed in in a working paper (p. 49: "Understood within its broader context, section 903(1) can have no impact on state laws unless and until the state has authorized a municipal bankruptcy filing"). Tuesday's oral argument doubled down on express preemption. To the extent the Supreme Court does not engage with alternative theories, that alone should improve the odds it will reverse the First Circuit. As an aside, the composition proscription in section 903(1), supposedly added to overrule the Supreme Court's ruling in Faitoute, wouldn't have even applied to Faitoute because it didn't involve a composition (check out Dawson's discussion on pp. 31-32). Can this odd provision really be the barrier to Puerto Rico's attempt to build its own toolkit that is claimed? As Mitu Galati notes in this interview, surely Puerto Rico has some legal capacity to tackle its debt problems, which takes us to the second point below.  
  2. Contract impairment: The justices really wanted to talk about Contracts Clause issues, which technically are still pending in the district court in Puerto Rico. As a recap, the bondholders' Contracts Clause challenge to the Recovery Act survived a motion to dismiss, even without a specific use of the Recovery Act. My prior posts have stressed the fact-intensive nature of the analysis necessary for Contracts Clause litigation without articulating a more fundamental problem with the district court's approach: how can a court determine whether the potential impairment is the least intrusive means if we don't know if the plan proposes to cut 5% or 50% and the circumstances? (For more on the Contracts Clause, check out this interview with Amy Monahan on underfunded public pensions). If the district court makes such a ruling, shouldn't Puerto Rico have a very strong appeal? And, upon reversal, they would put forth a specific proposal, prompting a challenge, and around we go.  

And to think that Congress could stop the madness and give chapter 9 access to some of Puerto Rico's debt issuers. Sure, some parties might raise legal challenges to that as well, but restructuring probably could charge ahead in the meantime and ultimately moot out those fights.  


I loved the dichotomy of interpretations of the meaning of Chapter 9 disclosed in the video when Bill Rochelle challenged Puerto Rico’s reliance on Chapter 9 to exclude the prohibition against Puerto Rico writing its own insolvency law and Melissa’s retorted by asking how could the subject of Chapter 9, which empowers what municipalities may do in bankruptcy, also be interpreted to exclude Puerto Rico from writing insolvency law if Puerto Rico’s municipalities can’t be debtors in bankruptcy for which Chapter 9 even applies.

That is, how can something you are excluded from also apply to you.

I think the argument goes that this is not the way Congress preempts sovereigns.

An interesting place to look for a corollary is in how the Supreme Court has upheld Tribal gaming and land rights in recent years, and in this term.

Hi Melissa, thank you for the video. Very insightful! I'm not a lawyer but have invested a significant part of my retirement money in Puerto Rico bonds because of the triple exception - local,state and federal taxes.

As I read the applicable sections of the Bankruptcy Code, it seems clear to me that Congress realized the risks of giving the territories the ability to declare municipalities and instrumentalities bankrupt.

It seems clear that the Congress "intend" was to have a say as to who is a "debtor" for dept "composition" purposes. I was taken aback by the fact that 7 SCOTUS did not see it that way. OK, maybe the Chief Justice did by the structure of his question - BTW, I truly believe that Justice Soto Mayor is alo in conflict in this case and should recuse herself like Justice Alito did.

The Washington D.C., and now the Puerto Rico Commonwealth situation, has proven Congress right in the cautionary approach to "Territories" and the District of Colombia. As a territory, the powers of Puerto Rico ultimately emanate from the People of the United States of America via the U.S. Constitution and via the powers granted to Congress via the 'Territorial Clause" of the U.S. Constitution. Therefore, the U.S. Congress has absolute power over Puerto Rico with the exception of "basic" constitutionally guarantee rights such as "live, liberty and the pursue of happiness." the
"Contract Clause" and the "Taking Clause."

What say you?

BTW, I'm a Puerto Rican. I'm retiring soon and may seek a law degree specializing in constitutional law - Chapel Hill would be great.



BTW Melissa, if you dwell deep into the "Territorial Clause" you may find that by Congress having ultimate powers over Puerto Rico, the Commonwealth is not a "sovereign" power like Argentina or Greece; and therefore, the ultimate sovereign of the Commonwealth is the United States of America - as such, had ultimate responsibility over the governance (good or bad) Puerto Rico - with all that that entails in a court of law or the SCOTUS.

My point in the above post was that Obama was right when they presented in front of the SCOTUS that Puerto Rico is neither a "sovereign" or a "state" but a territory" and therefore, only Congress can find a "final and equitable" solution to the crisis facing Puerto Rico - so say the U.S. Constitution. If a solution is not found, we might see a Constitutional crisis in the making.

The U.S. Congress and the SCOTUS have already established "lines in the sand" in anticipation of such an outcome.

The Board is required to have an office in DC, as well as the Commonwealth, so I assume the venue provision is designed to make DC an option. Of course, the DC bankruptcy court does not have much experience with very large cases..

Sorry, forgot to include in the previous post...

The U.S. Congress is delegating very specific powers to the Board in the PROMESA Act. It's very specific on two resident offices - Puerto Rico and the District of Colombia. I don't think they have the power to choice at their will.


The Puerto Rico situation originates from "war" and "politics." No necessarily a good combination for the People of Puerto Rico.


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