The First Circuit demonstrated little sympathy for secured bondholders who wanted to sue the government of Puerto Rico for orchestrating a fraudulent transfer in the midst of the island’s debt restructuring. Deciding an expedited appeal, the circuit court ruled that the district judge properly exercised her discretion by refusing to allow the bondholders to appoint a trustee and sue.
The latest appeal again involves holders of bonds issued by Puerto Rico’s retirement system. At the end of January, the First Circuit held that Section 552 of the Bankruptcy Code cut off the security interest held by bondholders in contributions made to Puerto Rico’s retirement system by employers after filing. To read ABI’s report on the January opinion, click here.
These two decisions and others suggest that the First Circuit won’t allow the bondholders to short circuit Puerto Rico’s court-supervised debt restructuring.
The Allegedly Fraudulent Transfer
After the Supreme Court ruled that Puerto Rico was ineligible for chapter 9 municipal bankruptcy, Congress quickly adopted the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.). The Chief Justice of the Supreme Court tapped District Judge Laura Taylor Swain of New York to sit by designation and preside over the proceedings under PROMESA. Large swaths of chapter 9, governing municipal bankruptcy, are incorporated into PROMESA.
Including the retirement system, Puerto Rico and many of its instrumentalities sought relief under PROMESA in 2017. In the debt-adjustment proceedings, Puerto Rico’s federally appointed Financial Oversight and Management Board effectively represented the retirement system.
At the Oversight Board’s behest, the Puerto Rico legislature passed legislation requiring the retirement system to transfer its assets to the commonwealth’s general fund. In turn, Puerto Rico’s government assumed responsibility for paying retirement benefits.
In October 2019, the bondholders demanded that the Oversight Board bring avoidance actions to overturn the transfer. The Board refused. In November, the bondholders filed a motion under Section 926 asking Judge Swain to appoint them as trustees to mount the avoidance action. Judge Swain denied the motion on January 7.
The bondholders appealed the next day. The First Circuit expedited the appeal and heard argument on March 3. The decision came down on March 19.
No Abuse of Discretion
For the appeals court panel, Circuit Judge Sandra L. Lynch reviewed Judge Swain’s decision for abuse of discretion in applying Section 926(a), one of many provisions in the Bankruptcy Code incorporated into PROMESA.
“If the debtor refuses to pursue a cause of action under section 544 . . . [or] 549(a),” the section provides that “the court may appoint a trustee to pursue such cause of action . . .” on “request of a creditor.” [Emphasis added.]
Judge Lynch said the word “may” bestows the court with “substantial discretion.”
The bondholders primarily argued, Judge Lynch said, that the court only should have considered the two pivotal factors in a commercial bankruptcy: (1) the costs and benefits for the debtor, and (2) whether the claims were “colorable.”
Judge Lynch said the bondholders were “flatly wrong.” The court was entitled “to consider all of the facts . . . in a governmental insolvency” because of “the clear differences between governmental and commercial bankruptcies.” She added that “[n]othing in the text of § 926 limits or even discusses the factors a court may take into consideration.”
For instance, the bondholders contended that Judge Swain should not have analyzed the strength of the claims, only whether the claims were “colorable.” Judge Lynch said that the strength of the claims “is surely relevant.”
Having decided that Judge Swain made no mistakes of law, Judge Lynch went on to rule there was no abuse of discretion in applying the facts to the law.
Judge Lynch ended her opinion by describing how the bondholders are in the midst of other proceedings in the PROMESA case designed to accomplish the same objective. She said it “was not an abuse of discretion . . . to avoid a proliferation of actions seeking essentially the same remedy.”
The First Circuit demonstrated little sympathy for secured bondholders who wanted to sue the government of Puerto Rico for orchestrating a fraudulent transfer in the midst of the island’s debt restructuring. Deciding an expedited appeal, the circuit court ruled that the district judge properly exercised her discretion by refusing to allow the bondholders to appoint a trustee and sue.
The latest appeal again involves holders of bonds issued by Puerto Rico’s retirement system. At the end of January, the First Circuit held that Section 552 of the Bankruptcy Code cut off the security interest held by bondholders in contributions made to Puerto Rico’s retirement system by employers after filing. To read ABI’s report on the January opinion, click here.
These two decisions and others suggest that the First Circuit won’t allow the bondholders to short circuit Puerto Rico’s court-supervised debt restructuring.
The Allegedly Fraudulent Transfer
After the Supreme Court ruled that Puerto Rico was ineligible for chapter 9 municipal bankruptcy, Congress quickly adopted the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.). The Chief Justice of the Supreme Court tapped District Judge Laura Taylor Swain of New York to sit by designation and preside over the proceedings under PROMESA. Large swaths of chapter 9, governing municipal bankruptcy, are incorporated into PROMESA.