The First Circuit mended a gaping hole torn in the side of the automatic stay by reversing a decision in February by a district judge in Puerto Rico interpreting PROMESA, the federal law to alleviate Puerto Rico’s financial crisis.
In an 11-page per curiam opinion concluding an expedited appeal, the First Circuit adopted an expansive reading of the word “control” to hold that a lawsuit by bondholders was enjoined by PROMESA’s automatic stay. The appeals court handed down its decision on April 4, the same day it held oral argument.
The First Circuit’s decision is the latest in a series of back-and-forth opinions exploring the similarities between the automatic stays in PROMESA and the Bankruptcy Code.
The Dispute Between Bondholder Groups
Within days after the Supreme Court held in June that Puerto Rico is precluded from adopting local laws to ameliorate the insolvencies of its units, the President signed the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA. The high court also held that the commonwealth’s instrumentalities are ineligible for municipal debt adjustment under chapter 9 of the Bankruptcy Code.
PROMESA contains a broad automatic stay modeled after Section 362 of the Bankruptcy Code. Both statutes bar actions to “control” property of the debtor, not just those that attempt to gain possession of estate property.
Immediately after the adoption of PROMESA, the commonwealth defaulted on $817 million in general obligation bonds but continued to pay so-called COFINA bonds, which are secured by revenue from sales and use taxes.
Holders of general obligation bonds filed suit in July in federal district court in San Juan under PROMESA, referring to their bonds as “constitutional debt” backed by the island’s full faith, credit and taxing powers. Relying on Puerto Rico’s Constitution, they argued that their debt must be paid from all revenue sources before COFINA bonds.
The general obligation bondholders sought a declaration and injunction that would bar Puerto Rico from using sales and use taxes to pay COFINA bonds.
Puerto Rico and the COFINA bondholders filed motions contending that the lawsuit was automatically enjoined by Section 405, the automatic stay under PROMESA that expires on May 1.
Because he believed that the general obligation bondholders were not attempting to collect on a claim and were only seeking a declaration and injunction, District Judge Francisco A. Besosa ruled on Feb. 17 that the automatic stay did not preclude the suit from proceeding.
Established under PROMESA, the Financial Oversight & Management Board appealed, along with COFINA bondholders. Indicating that a reversal was possible, if not likely, the First Circuit expedited the appeal on March 17 and invited the appellants to file a motion for a stay pending appeal. The circuit court entered a stay three days later.
The First Circuit’s Opinion
Contrary to the conclusion by the district court, the circuit court said that the general obligation bondholders were seeking an injunction that would compel Puerto Rico to default on the COFINA bonds by barring the commonwealth from using sales and use taxes to pay those bonds. The per curiam opinion said that Congress “could hardly have envisioned” that one group of bondholders, “during the stay period” to end on May 1, would “dispossess the other by driving its bonds into default.”
Next, the panel construed the word “control,” as used in PROMESA’s automatic stay, and said it mimics the same word in Section 362. Like the term in the Bankruptcy Code, “control” is interpreted “quite broadly.”
“From this expansive understanding of ‘control,’” the circuit court reversed the district court, imposed the stay on the general obligation bondholders’ suit, and held that “the stay applies to litigation seeking declaratory and injunctive relief at least where, as here, the express purpose of the lawsuit is to preclude the Commonwealth from using its own funds as it sees fit.”
What Does It Mean?
The April 4 opinion is the second time the First Circuit has addressed the breadth of PROMESA’s automatic stay. The first decision was in January in Peaje Investments LLC v. Garcia-Padilla, 845 F.3d 505 (1st Cir. Jan. 11, 2017). There, the appeals court equated the two statutes when it concluded that lack of adequate protection is reason for vacating the automatic stay, although the lack of adequate protection is not among the enumerated grounds in PROMESA like it is in Section 362(d)(1).
On the other hand, the First Circuit ruled that PROMESA is different from the Bankruptcy Code because PROMESA has no provision like Section 362(g) that puts the burden of proof on the debtor for everything except the debtor’s equity in the property. Consequently, the appeals court put the entire burden on the creditor to show “cause,” including lack of adequate protection.
Therefore, Peaje seems to mean that the two automatic stays are similar, although not identical. Subtle differences in language may or may not lead to different results.
A month later, District Judge Besosa appeared to construe PROMESA’s automatic stay more narrowly. If nothing more, the circuit’s reversal precludes litigants from arguing that Judge Besosa’s decision is authority for a narrow construction of the automatic stay under Section 362.
The First Circuit’s newest decision may have been driven by PROMESA’s avowed objective of fostering consensual restructurings. Notably, the appeals court appeared repulsed at the notion that one group could force a default on other bondholders.
Prior to May 1, the contending creditor groups are intended by PROMESA to negotiate among themselves and with Puerto Rico on consensual restructurings. If voluntary negotiations fail, Puerto Rico can then initiate a court-supervised debt adjustment similar to chapter 9 municipal bankruptcy.
The April 4 decision might be an effort to keep the parties focused on negotiations by precluding any creditor group from attempting to gain the upper hand through litigation. Perhaps the main takeaway from the April 4 opinion is the notion that PROMESA, like cases in chapters 9 and 11, should focus primarily on negotiations rather than litigation to achieve a global debt adjustment.
In the final analysis, the April 4 decision was a relatively terse, hurriedly issued, per curiam opinion. Perhaps it’s best not to read too much into the opinion aside from the direct holding about “control.”
To read ABI’s discussion of the First Circuit’s PROMESA decision in January, click here. For District Judge Besosa’s February opinion, click here.