The Supreme Court heard oral argument today to grapple with a First Circuit opinion striking down Puerto Rico’s own municipal bankruptcy law.
The high court’s decision, expected by the end of June, might give Puerto Rico the ability to adopt laws of its own to adjust the debts of its municipalities so long as they do not violate the Contracts Clause of the federal Constitution. Depending on how the high court writes the opinion, states not opting into the federal municipal bankruptcy system might also be able to adopt their own regimes to deal with their insolvent instrumentalities.
The high court’s decision could turn in two directions. The justices might tackle the case as a straightforward, although complex, question of statutory interpretation. Or, the Court could plunge into the depths of constitutional law by making a pronouncement on federalism.
If the Supreme Court opts for an opinion about federalism, the decision could have ramifications beyond bankruptcy law. Indeed, the effect on bankruptcy law could pale in comparison with the implications for state/federal relations.
Whichever way they go, the odds of a ruling in favor of Puerto Rico may have been diminished by the death of Justice Antonin Scalia, a stickler for adhering to the language of statutes and an advocate for states’ powers under the notion of federalism. Puerto Rico might have lost a second vote because Justice Samuel Alito recused himself, perhaps because he has investments in bond funds that hold Puerto Rico debt.
Debts ‘Not Payable’; Puerto Rico Enacts Its Own Law
The island’s governor admitted that Puerto Rico is saddled with debts that are “not payable.” Ineligible for municipal bankruptcy under chapter 9 of the federal Bankruptcy Code, Puerto Rico adopted its Public Corporation Debt Enforcement and Recovery Act in June 2014. The statute was designed so the commonwealth’s public corporations could restructure debt in a manner akin to chapter 11 reorganization.
That same month, bond funds affiliated with Franklin Resources Inc. and others sued the commonwealth in federal district court in Puerto Rico. In February 2015, District Judge Francisco A. Besosa in San Juan wrote a 75-page opinion saying that the Recovery Act was pre-empted by Section 903(1) of the Bankruptcy Code, thus violating the Supremacy Clause of the U.S. Constitution on its face. According to Judge Besosa, that section expressly pre-empts laws by states and Puerto Rico that would attempt to bind non-consenting creditors to “composition of indebtedness.”
Puerto Rico appealed and lost in what amounted to a 2-1 opinion issued in July 2015 by the First Circuit. The majority said that the invalidity of the island’s Recovery Act was evident from the “plain meaning” of the Bankruptcy Code.
How Puerto Rico Was Excluded from Bankruptcy
Until the 1984 amendments to the Bankruptcy Code, Puerto Rico could have authorized its municipalities and instrumentalities to use chapter 9. For reasons Congress did not explain, Section 101(52) of the Code was amended to define “States” as including Puerto Rico, except for the purpose of deciding who is eligible for chapter 9.
Thus no longer able to use the federal bankruptcy courts, Puerto Rico was hit from another direction because Section 903(1) of the Code says “State law” cannot bind non-consenting creditors to a debt adjustment.
The First Circuit held that Puerto Rico’s law is expressly pre-empted by the Bankruptcy Code. To deal with the impending insolvency of the island’s municipalities, the appeals court said that “Puerto Rico may turn to Congress for relief.” Bills to give Puerto Rico some bankruptcy relief were filed but have not progressed beyond initial hearings on the island’s financial predicament.
The Supreme Court granted certiorari in December, although there was no conflict of circuits.
Oral Argument Swung Back and Forth
Puerto Rico’s lawyer argued first, and it did not go well. Justices Elena Kagan, Sonia Sotomayor, and Stephen Breyer, all from the court’s liberal wing, sounded skeptical about the commonwealth’s contention that the Bankruptcy Code does not prohibit a municipal debt-composition law because the island is entirely outside of chapter 9. But after the justices heard argument from the bondholders, the pendulum seemed to swing in the other direction for those three justices.
Near the end of argument, Justice Sotomayor summed up an argument in Puerto Rico’s favor that will carry the day if only three other justices agree. For Puerto Rico and states that do not allow their instrumentalities to file under chapter 9, she asked why they could not adopt their own debt-composition laws so long as they do not violate the Contracts Clause of the federal Constitution.
Justice Ruth Bader Ginsburg made a comment near the end of oral argument suggesting that she might be the fourth vote. She asked why Congress would put Puerto Rico “in this Never-Never land” where its municipalities are ineligible for chapter 9 and at the same time cannot craft a local law that stops short of violating the Contracts Clause. Along the same lines, Justice Sotomayor suggested that territories should be able to pass laws forbidding municipal power companies from being forced to shut off the lights.
The case pivots on Section 903(1), which forbids “composition of indebtedness.” Several justices wondered why there could not be debt composition under non-federal law that is short of violating the Contracts Clause. With that distinction in mind, Justice Sotomayor asked how Congress could “rob a state of its power to regulate its municipalities if you offer them nothing in return.”
Puerto Rico’s Arguments
In briefs filed with the Supreme Court, the Puerto Rican government and the island’s development bank argue that there is no preclusion by strictly adhering to the language of the Bankruptcy Code. They say that Section 903(1) pre-empts state laws only where chapter 9 is available. Since Puerto Rico is not eligible for chapter 9, they believe that the “pre-emptive sweep” of Section 903(1) does not apply. Or, they contend, chapter 9 as a whole does not apply to Puerto Rico based on the language of the statute itself.
If statutory interpretation fails, Puerto Rico can fall back on a federalism argument based on the notion that states historically can enact laws to deal with the bankruptcy of entities like banks and insurance companies that are ineligible for federal bankruptcy. That contention was barely mentioned during oral argument.
Were they on the bench, Justices Scalia and Alito might have been on Puerto Rico’s side if they were persuaded by the commonwealth’s reading of the statute or if they saw an unwarranted intrusion into states’ prerogatives. The simple fact that the Supreme Court granted certiorari absent a conflict of circuits might mean that several justices concluded preliminarily that the appeals court was wrong.