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The Commonwealth of Puerto Rico files appeal on Recovery Act ruling with the United States Court of Appeals of the First Circuit

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Procedural Background
The U.S. District Court for the District of Puerto Rico (“Court”) issued an Opinion and Order (“Opinion”) on February 6, 2015, declaring that the Puerto Rico Public Corporations Debt Enforcement and Recovery Act (the “Recovery Act”) is unconstitutional as it violates the Supremacy Clause of the U.S. Constitution. The Commonwealth of Puerto Rico (“Commonwealth”) and its governor (collectively, the “Appellants”) appealed this ruling to the United States Court of Appeals (“Court of Appeals”), filing an appellate brief on March 16, 2015 (“Appeal”).

The Recovery Act, adopted on June 28, 2014, enables a debt negotiation and restructuring process very similar to a petition under the provisions of Chapter 9 of the U.S. Bankruptcy Code (“Bankruptcy Code”). Puerto Rico is included in the Bankruptcy Code’s definition of a “state” for all purposes, except for filings under the provisions of Chapter 9 thereof. Franklin California Tax-Free Trust, Oppenheimer Rochester Fund Municipals, among others (“Franklin”) filed a complaint [on June 29, 2014], and BlueMountain Capital Management LLC (“BlueMountain”) (collectively, “Plaintiffs”) filed suit [on July 22, 2014], against the Appellants, challenging the constitutionality of the Recovery Act. Plaintiffs alleged that the Commonwealth was preempted from enacting the Recovery Act and the Court on February 6, 2015 ruled in favor of plaintiffs, declaring the Recovery Act as preempted by the Bankruptcy Code.

Appeal
The Commonwealth now avers the imperative need to file its Appeal in the face of the serious fiscal crisis affecting Puerto Rico, combined with delayed legislative affairs at both the state and federal level and an aggrieved liquidity problem throughout most of its public corporations.

The Appeal cements its argument on two main points: (i) that the Court erred by holding that The Recovery Act is preempted by Chapter 9 of the Bankruptcy Code even though that provision does not apply to Puerto Rico and (ii) that the Court erred by proceeding to address, on Plaintiffs Contract and Takings Clause, claims after holding that the Recovery Act is preempted. Appellants argue that the central question is whether the Chapter 9 of the Bankruptcy Code, which by its terms does not apply to Puerto Rico, nonetheless preempts the creation of laws for the restructuring of the debts of Puerto Rico’s public corporations, agencies, and instrumentalities. The Appellants assert that because Chapter 9 does not apply to Puerto Rico at all, that statute does not preclude the Commonwealth from enacting a restructuring law governing its own public corporations, agencies, and instrumentalities.

Appellants argue that Section 903 of the Bankruptcy Code (which prohibits states from enacting bankruptcy laws that bind creditors without their consent), in the Court’s Opinion, is not applicable to the Commonwealth. Appellants state that the Court erred by not following the cardinal rule that courts shall not read and interpret isolated sections or certain parts of laws, but must consider them in their entirety. Specifically, Appellants point to Section 101(52) of the Bankruptcy Code which, in defining a state, expresses that “[t]he term ‘State’ includes the District of Columbia and Puerto Rico, except for the purpose of defining who may be a debtor under chapter 9 of this title.” (Emphasis supplied). Thus, Appellants reason that if Section 903 is limited only to the effects of Chapter 9, under which it is undisputed that neither the Commonwealth nor its municipalities may be “debtors”, there would be no room for “creditors”, since the Bankruptcy Code itself defines a “creditor” by its relationship with a “debtor”.

Appellants further assert that the Court’s decision would leave Puerto Rico in a “no man’s land” with respect to insolvency legislation for restructuring debt of its municipal instruments, public corporations and agencies; a lack of a clear statement from Congress should not be ruled as preemption for any state, which includes Puerto Rico. In fact, Appellants affirm that courts have recognized Congress’ intention of not preventing certain entities, such as banks and insurance companies, from reorganizing entirely, and have instead preserved these entities’ right to reorganize under state law.

Finally, appellants contend that the Court erred by addressing Plaintiffs’ constitutional claims under the Contract and Takings Clauses after having concluded that the Recovery Act was preempted by the Bankruptcy Code. This line of argument was supported by stating that courts should avoid reaching constitutional questions unless it is absolutely necessary.

By way of relief, Appellants requested that the Court’s judgment be reversed and the holdings with respect to the Contract and Takings clause be vacated.

If you have any questions or comments about the above-mentioned decision, appeal, the local and federal statutes and policies involved, and/or wish to obtain more information related thereto, please contact any of the following attorneys from Ferraiuoli’s Bankruptcy Law Practice Group.

This document has been prepared for information purposes only and is not intended, and should not be relied upon, as legal advice.