Circuit Upholds Dismissal of Suits to Restrict Puerto Rico’s Use of Tax Revenue

In February, bondholders were able to persuade the First Circuit 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. To read ABI’s coverage, click here.

On a separate appeal that could have given them an immediate upper hand in Puerto Rico’s debt restructuring under the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.), the bondholders were not equally persuasive.

In an opinion for the First Circuit on March 26, Circuit Judge Juan R. Torruella upheld a ruling from January 2018, where District Judge Laura Taylor Swain dismissed a lawsuit by holders of Puerto Rico general obligation bonds who sought declarations that would have restricted Puerto Rico’s use of tax revenue. Judge Torruella also wrote the decision in February where he had reversed Judge Swain and held the appointment of the Oversight Board to be unconstitutional.

The Lawsuit

Holders of general obligation bonds, or GO bonds, filed an adversary proceeding in June 2017 in the island commonwealth’s PROMESA proceedings. The GO bonds are sometimes known as constitutional debt because they carry the island commonwealth’s full faith and credit. The GO bondholders contended that they are entitled to full and timely payment, even “in times of economic scarcity.”

In their suit, the GO bondholders argued that certain tax revenue, referred to as restricted revenue, cannot be used for any purpose other than the payment of their bonds and other constitutional debt and must be segregated for them alone. In response, Puerto Rico filed a motion to dismiss. Presiding by designation over the PROMESA proceedings, Judge Swain dismissed the suit in her 19-page opinion on Jan. 30, 2018. To read ABI’s report, click here.

In his 21-page opinion, Judge Torruella upheld dismissal, employing Judge Swain’s logic and analysis.

The Circuit’s Analysis

Judge Torruella divided the claims in the bondholders’ complaint into three buckets. The first included requests for declaratory judgments that restricted revenue can only be used to pay constitutional debt and that the bondholders have a statutory lien on those revenues.

The bondholders argued that the requested declarations would facilitate plan formulation and provide critical guidance at confirmation.

Citing Supreme Court authority, Judge Torruella said there must be a case or controversy, even in a declaratory judgment action. Absent “an actual controversy, federal courts cannot issue advisory opinions,” he said.

Although there is an actual controversy, Judge Torruella said it still must be “sufficiently immediate or real to warrant declaratory relief.” In that regard, he saw dangers in issuing declarations that, he said, could “unleash ramifications . . . and implicate the potential claims of other creditors without them having a say in the current suit.”

Judge Torruella upheld dismissal of the first group of claims because they sought “abstract declarations that are unrelated to any concrete dispute, such as a claim objection proceeding, request for adequate protection or relief from stay, or confirmation-related proceeding.”

The next claim dealt with the request for a declaratory judgment that the diversion of restricted venue would be an unconstitutional taking under the Fifth Amendment.

The complaint itself was the bondholders’ undoing. The bondholders alleged that the diversion of restricted revenue “would constitute” an unconstitutional taking. Judge Torruella said that the use of the word “‘would’ . . . laid bare the hypothetical nature” of the claim.

Since the complaint did not allege that a taking had already occurred, Judge Torruella upheld dismissal because the claim was unripe.

Last, Judge Torruella dealt with a batch of claims seeking declarations that Puerto Rico cannot use restricted revenue except to pay GO bondholders or other constitutional debt.

Like Judge Swain, Judge Torruella said that the claims ran afoul of Section 305 of PROMESA, which prohibits the court from interfering with any of Puerto Rico’s governmental powers or income unless the “Oversight Board consents or the plan so provides.”

The bondholders contended that the declarations would not interfere because a declaratory judgment does not mandate compliance.

Absent the Oversight Board’s consent, Judge Torruella upheld dismissal under Section 305 because he found “no way around the fact that . . . the requested declarations would constitute decrees that unlawfully interfere with the autonomy of the Commonwealth and its entities in the use of the ‘Restricted Revenues.’”

N.B.: The First Circuit’s holding under Section 305 of PROMESA is applicable in chapter 9 municipal debt arrangements because Section 305 is derived from Section 904.