On the last page of an 18-page opinion, the First Circuit told Puerto Rico bondholders how they can challenge the constitutionality of the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.). Under PROMESA, the island commonwealth is restructuring its unsupportable debt.
Curiously, bondholders cannot raise a challenge to the constitutionality of PROMESA in the proceedings in the Puerto Rico District under PROMESA.
The Bondholders’ Plight
After the Supreme Court ruled in June 2016 that Puerto Rico’s instrumentalities are ineligible for municipal debt adjustment under chapter 9 of the Bankruptcy Code and that the island commonwealth cannot adopt local laws dealing with the insolvencies of its units, Congress adopted PROMESA, which is patterned in large part on the municipal debt arrangement provisions in chapter 9 of the Bankruptcy Code.
The dispute came to the First Circuit on appeal by holders of highway bonds. To secure the debt, Puerto Rico pledged oil and gas tax revenues and highway tolls, among other things. The pledge, however, was not absolute. Puerto Rico had the right to divert the pledged revenues to the payment of general obligation bonds if other revenue sources were insufficient.
Even before commencement of the formal debt arrangement proceedings under PROMESA, Puerto Rico adopted a moratorium that halted the flow of the pledged revenues to the bondholders. The moratorium also barred the bondholders from enforcing remedies.
Next, the Financial Oversight and Management Board of Puerto Rico, established under PROMESA, adopted a fiscal plan calling for the continued diversion of the pledged revenues. The initiation of the debt arrangement proceedings under Title III of PROMESA invoked an automatic stay akin to Section 362 of the Bankruptcy Code.
The Puerto Rico fiscal agency then directed the bondholders’ trustee to withhold payments to bondholders from funds already held in trust. A default on the bonds ensued.
The guarantor for the highway bonds filed an adversary proceeding in the PROMESA proceedings district court in Puerto Rico. The suit alleged that the diversion of pledged revenues was in violation of the Contracts, Takings and Due Process Clauses of the U.S. Constitution, among other things. The suit sought a declaration and injunction to restore the flow of revenue to the bondholders.
On a variety of grounds, the district court dismissed the suit last year. See Ambac Assurance Corp. v. Puerto Rico (In re Financial Oversight & Management Board for Puerto Rico), 297 F. Supp. 3d 269 (D.P.R. 2018).
The Circuit’s Opinion
In an opinion for the First Circuit on June 24, Circuit Judge William J. Kayatta, Jr. upheld dismissal. Simply stated, two provisions in PROMESA stripped the PROMESA court of jurisdiction or power to grant the relief sought by the bondholders’ guarantor.
The first bar appears in Section 106 of PROMESA, 48 U.S.C. § 2126(e), declaring there “shall be no jurisdiction in any United States district court to review challenges to the Oversight Board’s certification determinations under this chapter.” According to Judge Kayatta, the injunctive relief sought by the bondholders, invalidating the Oversight Board’s fiscal plan, “is plainly precluded as a result of section 106.”
The second bar to relief for the bondholders flows from Section 305 of PROMESA, 48 U.S.C. § 2165, which provides that “the court may not, by any stay, order or decree . . . interfere with (1) any of the political or governmental powers of the debtor . . . .” Judge Kayatta explained that Section 305 “mimics” Section 904 of the Bankruptcy Code.
“On its face,” Judge Kayatta said that “the text of section 305 bars the [PROMESA] court from granting [the bondholders] such relief absent consent from the Oversight Board or unless the Fiscal Plan so provides.”
Judge Kayatta reported how the bondholders contended at oral argument that the appeals court’s interpretation of Section 305 “would raise due process concerns because [the bondholders] would be left without a venue in which to bring its constitutional claims.” Not so, the judge said.
“[N]othing in our holding today,” he said, “suggests that [the bondholders] cannot seek traditional stay relief pursuant to 11 U.S.C. § 362 and raise its constitutional and statutory arguments in a separate action.” Quoting from Financial Oversight and Management Board for Puerto Rico v. Ad Hoc Group of Puerto Rico Electric Power Authority Bondholders, 899 F.3d 13, 21 (1st Cir. 2018), he said that Section 305 does not “impose any such restraint on another court.” [Emphasis added.]
Observations
Do the bondholders have a ghost of a chance under either route offered by Judge Kayatta? In terms of winning a modification of the automatic stay, it ain’t gonna happen, at least not in district court. When is the last time you saw a reorganization court modify the stay in a huge case and wreck the restructuring?
And what about a separate suit in district court, but not in the PROMESA court, attacking PROMESA as unconstitutional on its face or as applied?
At the conclusion of the PROMESA proceedings, the bondholders are assured of the recognition of whatever rights they have under PROMESA and the U.S. Constitution. The bondholders are not being deprived of their right to payment permanently, only temporarily during the course of the PROMESA proceedings. So, it seems unlikely a court will find a deprivation of constitutional rights.
In a number of decisions already, the district court and the First Circuit have rebuffed attempts by other bondholders to short circuit the PROMESA proceedings and take home their marbles immediately. See, e.g., Assured Guaranty Corp. v. Financial Oversight and Management Board for Puerto Rico (In re Financial Oversight and Management Board for Puerto Rico, as Representative for the Puerto Rico Highways and Transportation Authority), 919 F.3d 121 (1st Cir. March 26, 2019). For ABI’s discussion of Assured Guaranty, click here.
On the last page of an 18-page opinion, the First Circuit told Puerto Rico bondholders how they can challenge the constitutionality of the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.). Under PROMESA, the island commonwealth is restructuring its unsupportable debt.
Curiously, bondholders cannot raise a challenge to the constitutionality of PROMESA in the proceedings in the Puerto Rico District under PROMESA.
After the Supreme Court ruled in June 2016 that Puerto Rico’s instrumentalities are ineligible for municipal debt adjustment under chapter 9 of the Bankruptcy Code and that the island commonwealth cannot adopt local laws dealing with the insolvencies of its units, Congress adopted PROMESA, which is patterned in large part on the municipal debt arrangement provisions in chapter 9 of the Bankruptcy Code.
The dispute came to the First Circuit on appeal by holders of highway bonds. To secure the debt, Puerto Rico pledged oil and gas tax revenues and highway tolls, among other things. The pledge, however, was not absolute. Puerto Rico had the right to divert the pledged revenues to the payment of general obligation bonds if other revenue sources were insufficient.