The New York district judge overseeing Puerto Rico’s debt restructuring in substance said that no one will hit a home run through litigation and take home all the marbles. Instead, the Jan. 30 opinion by District Judge Laura Taylor Swain has the effect of forcing creditors of all stripes to participate in mediation and slog through the process of plan negotiation and confirmation.
Since May will be the first anniversary of Puerto Rico’s debt restructuring under the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.), some creditor groups have sought a quick exit, especially since Hurricane Maria destroyed the island’s infrastructure last September, along with any progress toward debt adjustment.
The creditor group with perhaps the best odds of staging a quick victory was the holders of general obligation bonds, sometimes known as constitutional debt because the bonds carry the island commonwealth’s full faith and credit. Holders of the bonds, known as GO bonds, contend they are entitled to full and timely payment, even “in times of economic scarcity.”
The GO bondholders therefore filed an adversary proceeding in which they contended that certain tax revenue cannot be used for any purpose other than the payment of constitutional debt and must be segregated for them alone. In response, Puerto Rico filed a motion to dismiss, which Judge Swain granted in her 19-page opinion on Jan. 30.
Judge Swain divided the claims for relief into two categories: She dismissed about a third for failure to state a claim on which relief could be granted. She dismissed the remainder for lack of subject matter jurisdiction.
The first category includes claims for declaratory judgments that certain tax revenues cannot be used for any purpose other than the payment of constitutional debt and must be segregated. Although they arose from a live, otherwise justiciable controversy, Judge Swain said they ran afoul of Section 305 of PROMESA and therefore failed to state a claim.
Section 305 prohibits the court from interfering with any of Puerto Rico’s governmental powers or income unless the “Oversight Board consent or the plan so provides.” Granting declaratory relief with respect to segregating tax revenue, Judge Swain said, would “result in declarations and injunctions that would directly restrict” Puerto Rico’s use of tax revenue.
Because there was no consent by the Board and no plan, Judge Swain dismissed that portion of the complaint for failure to state a claim because “Section 305’s prohibition is not limited to remedies that are directly coercive,” she said.
In the second category, the claims ask the judge to rule that certain tax revenue is not Puerto Rico’s property; the island commonwealth is a mere conduit; constitutional debt is secured by statutory liens; certain tax revenues are “special revenues” that can be applied only in compliance with provisions of chapter 9 that are applicable under PROMESA; and using certain tax revenue other than in payment of constitutional debt would be an unconstitutional taking of property.
Judge Swain said the second group of claims did not pass constitutional muster and therefore failed to state a claim because there was no “case or controversy.”
Although the bondholders were seeking declaratory judgments, not injunctions, Judge Swain explained that “even significant disagreement” by itself does not state a claim unless there is “a specific live controversy of sufficient immediacy and reality to warrant the issuance of a declaratory judgment.”
According to Judge Swain, there is no case or controversy because those claims sought “abstract declarations of the parties’ respective relationships to the subject revenues, without application of the relief to resolve any current concrete dispute.” Thus, the judge said, they “seek advisory opinions and do not frame justiciable controversies.”
On the claim about unconstitutional takings, Judge Swain said that Puerto Rico has not made any “final decision” about how to treat the taxes in question. The takings claim, she said, “is not ripe for adjudication.”
Judge Swain therefore dismissed the claims in the second category for lack of subject matter jurisdiction given the absence of a constitutional case or controversy.
Since Judge Swain dismissed the adversary proceeding, the bondholders can appeal to the First Circuit. Even if Judge Swain was wrong about the second category and there is a live controversy, those claims might also run afoul of Section 305 because they could have the effect of tying up the commonwealth’s tax revenue before a plan is approved.