First Circuit Cans the Puerto Rico Oversight Board as Unconstitutionally Appointed

Reversing the district court, the First Circuit threw the Puerto Rico debt restructuring into a cocked hat by declaring that the appointment of the members of the Financial Oversight and Management Board of Puerto Rico violated the Appointments Clause of the Constitution because they were not nominated by the President and confirmed by the Senate.

The appeals court attempted to limit damage by declaring that the ruling will not go into effect for 90 days, allowing the President and the Senate in the meantime to validate the appointments to the Board or to reconstitute the Board in accordance with the Appointments Clause.

Relying on the de facto officer doctrine, the First Circuit ruled that its opinion would “not eliminate any otherwise valid actions of the Board prior to the issuance of our mandate in this case.” In other words, the appeals court is allowing the Board to continue functioning for 90 days and will not unravel any actions already taken by the Board.

But that’s not the end of the story. The bondholders who brought the appeal wanted the First Circuit to dismiss Puerto Rico’s debt restructuring and invalidate all of the Board’s prior actions.

By having been denied some of the relief they sought, the bondholders are entitled to file a petition for rehearing en banc in the First Circuit or, more likely, a petition for certiorari in the Supreme Court.

Until a petition for certiorari is denied or the First Circuit’s opinion becomes final, there will be a pall of uncertainty over the ongoing debt restructuring under the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.).

The Challenge to the Board

Aurelius Investment LLC and affiliates filed a motion in August 2017 seeking dismissal of Puerto Rico’s debt arrangement proceedings, arguing that the filing of the petition on behalf of the Commonwealth of Puerto Rico by the Board under Title III of PROMESA violated the Appointments Clause. Holders of Puerto Rico general obligation bonds joined Aurelius but were opposed by the Oversight Board, the official unsecured creditors’ committee, and COFINA bondholders, among others.

District Judge Laura Taylor Swain, sitting in the District of Puerto Rico by designation, held a hearing in January 2018 and issued a 35-page opinion in July, holding that PROMESA and the Board were properly constituted under the Territories Clause of the Constitution, Article IV, Section 3, Clause 2. In re The Financial Oversight and Management Board for Puerto Rico, 17-3283 (D.P.R. July 13, 2018). To read ABI’s discussion of the district court opinion, click here.

The bondholders appealed, asking the First Circuit to invalidate the appointment of the Board and suggesting that the appeals court should declare that the Board’s actions have been invalid. In a 55-page opinion on February 15 by Circuit Judge Juan R. Toruella, the bondholders won the argument on the Appointments Clause.

The Circuit Court’s Rulings

The appeal was a contest between two former Solicitors General, Theodore B. Olson for the bondholders and Donald B. Verrilli, Jr. for the Board. Olson won the day in large part, just as he did in the Supreme Court in Bush v. Gore.

The opinion is of greatest significance for constitutional law scholars. Reminiscent of the turmoil created in the bankruptcy courts by Northern Pipeline, the remedies portion of the opinion attempts to limit the damage caused by overturning the Board’s appointment. Cf. Northern Pipeline Construction Co. v. Marathon Pipeline Co., 102 S. Ct. 2858 (1982).

Differing from the district court, the First Circuit ruled that the Territorial Clause did not displace the Appointments Clause in naming members of the Board. Judge Toruella reasoned that the Appointments Clause is the more specific provision in the Constitution and controls over the more general Territorial Clause.

Next, the appeals court had no difficulty deciding that the Board members were “officers of the U.S.,” because they occupy a continuing position and exercise significant authority pursuant to laws of the U.S. In that regard, Judge Toruella noted that major federal appointments to Puerto Rico’s civil government in the first half of the 20th century were made under the Appointments Clause, apart from a short period of military administration following the Spanish-American War.

From there, Judge Toruella explained why the Board members were not “inferior officers”: because they “are answerable to and removable only by the President and are not directed or supervised by others who were appointed by the President and confirmed by the Senate.”

Since they therefore were “principal officers,” Judge Toruella found a constitutional violation because they were not appointed by the President and confirmed by the Senate.

The Remedy

Judge Toruella said the bondholders wanted the appeals court to dismiss the PROMESA proceedings. He said they “suggest that we ought to deem invalid all of the Board’s actions until today.”

The bondholders wanted a constitutionally reconstituted Board to ratify, or not, the unconstitutional Board’s actions. (Imagine the complexities and uncertainty in deciding whether to set aside actions taken in reliance on final court orders.)

Judge Toruella said there was “unlikely” to be a “perfect solution.” He sought a remedy “to reduce the disruptions that our decision may cause.” He found salvation in the severability clause in PROMESA, allowing him to set aside Board appointments without invalidating the entire legislation.

Judge Toruella overruled the bondholders’ desire to dismiss the PROMESA proceedings, saying that dismissal would “cast a specter of invalidity over all of the Board’s actions until the present day.” Instead, he adopted the de facto officer doctrine.

Described as an “ancient tool of equity,” he said the doctrine confers validity on actions taken by someone acting under an official title even though the appointment is later discovered to be improper.

Declining to dismiss the PROMESA proceedings, Judge Toruella said that the appeals court would “not eliminate any otherwise valid actions of the Board prior to the issuance of our mandate in this case.” In that respect, he alluded to the Federal Elections Commission, where the Supreme Court did not invalidate the Commission’s past acts, although the members had been appointed in contravention of the Appointments Clause.

Judge Toruella said the appeals court would not issue the mandate for 90 days, giving the President and the Senate time to “validate the currently defective appointments or reconstitute the Board in accordance with the Appointments Clause.” In the meantime, he said, “the Board may continue to operate as until now.”

What’s Next?

Will the President quickly nominate and the Senate confirm the current members of the Board? By their actions so far, the Board members have made as many enemies as they have friends.

And if the President and the Senate do not act, what then? Will the First Circuit extend the deadline? Unlike the situation in Northern Pipeline, there can’t be a local court rule to serve as a temporary fix.

There is a different President who may not be partial to sitting Board members selected by the former President. And even if the President goes along, will the Senate confirm?

Under PROMESA as written, six members of the Board were selected by the majority and minority leaders of the House and Senate. The initial selection mechanism is now invalid, because the President exercises the power of appointment, not the House and Senate.

And even if the Board is reappointed, uncertainty will remain unless the bondholders allow the First Circuit opinion to become final or the Supreme Court denies certiorari. And if the composition of the Board changes, will the members rethink the decisions and policies of their predecessor?

We decline to guess how this mess works out.