In a thundering endorsement of federal preemption, the First Circuit upheld confirmation of the plan of adjustment for the Commonwealth of Puerto Rico.
The Boston-based appeals court said that PROMESA enabled the district court to reject teachers’ contractual rights in a defined benefit pension plan. Furthermore, the island’s government was not required to enact enabling legislation, and federal preemption overrode the teachers’ rights under local law.
Puerto Rico’s Debt Adjustment
Facing intolerable liability for public workers’ unfunded pension benefits, the island government enacted legislation in 2013 that would have frozen accruals under the existing defined benefit plan while giving rights under a defined contribution plan to current and future workers.
The Puerto Rico Supreme Court invalidated the law as to existing workers, allowing them to continue accruing benefits under the defined benefit plan. The island’s financial problems did not abate.
The Supreme Court ruled in June 2016 that Puerto Rico was ineligible for chapter 9 municipal bankruptcy. To allow the island commonwealth to restructure its unsupportable debt, Congress almost immediately adopted the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.). Large swaths of chapter 9, governing municipal bankruptcy, are incorporated into PROMESA by Section 2161, including Section 365 on the rejection of executory contracts.
Unable to resolve financial problems outside of court, the Oversight Board commenced debt-adjustment proceedings for the commonwealth and its instrumentalities beginning in May 2017 in district court in Puerto Rico. District Judge Laura Taylor Swain of the Southern District of New York was designated to preside over the bankruptcy by the Chief Justice.
As Circuit Judge William J. Kayatta, Jr. said in his April 26 opinion, Puerto Rico’s principal liabilities were $55 billion in unfunded pension benefits and $30.5 billion in bonds. After strident litigation and arduous negotiations under the supervision of mediators, the district court confirmed the commonwealth’s debt-adjustment plan in January.
The plan rejected public school teachers’ rights to continue accruing retirement benefits under the island’s defined benefit pension plan. Instead, teachers became eligible for materially less favorable benefits under a defined contribution plan.
The teachers objected to confirmation and sought stays pending appeal after confirmation. The district court and the appeals court both denied stays pending appeal.
The First Circuit held oral argument on March 9 and upheld confirmation on the merits on April 26, without reference to equitable mootness.
Local Laws Ruled Ineffective
The First Circuit was being called on to resolve “several issues of first impression,” Judge Kayatta said.
The teachers’ best argument, Judge Kayatta said, was the idea that the Puerto Rico legislature had not revoked the legislation allowing teachers to continue accruing benefits under the defined benefit plan.
Although not the basis for the decision, Judge Kayatta said, “it would make little sense for the Board to have no ability to restrict accruals under the very pension payment regime that helped create the crisis in the first place.” Rather, he said, “The Plan of Adjustment deems those laws preempted to the extent they conflict with PROMESA.”
But did PROMESA give the Board the right to override local law? In that regard, the teachers conceded that the pension rights were contractual in nature and could be rejected under Section 365 in an ordinary bankruptcy.
The teachers argued, nonetheless, that the local laws remained enforceable because PROMESA was silent about the island’s pension obligations.
Judge Kayatta responded by saying the case was not about a private party seeking to override state law. Rather, the case was about the Commonwealth and rejection of its own commitment, which is contractual in nature, although contained in a statute.
While the Board had the right to reject, Judge Kayatta said, “Its quiver contains more pointedly the concept of [federal] preemption.” Specifically, Section 2103 of PROMESA says, “The provisions of this chapter shall prevail over any general or specific provisions of territory law, State law, or regulation that is inconsistent with this chapter.”
Section 2103, Judge Kayatta said, “makes clear that the portions of existing laws that enshrine defined-benefit plan accruals and cost-of-living adjustments are preempted.” He proceeded to hold:
PROMESA therefore preempts Commonwealth law insofar as that law purports to dictate (contrary to the Plan) the adjustment of the Commonwealth's financial obligations to participants in its pension plans.
Enabling Legislation Not Required
Having failed by virtue of preemption, the teachers contended that the island never enacted enabling legislation as required by Section 2174(b)(5) of PROMESA. It requires “any legislative, regulatory, or electoral approval necessary under applicable law in order to carry out any provision of the plan.”
Judge Kayatta responded by saying that it “does not by its plain terms require enabling legislation for every component of the Plan.” He therefore held:
[T]he lack of specific Commonwealth legislation permitting the Plan to modify the Commonwealth’s obligations to public school teachers does not bar the Plan’s confirmation.
Before upholding confirmation, Judge Kayatta said that the court was aware of how the “substantial reduction in hoped-for future pension benefits may create great distress and economic harm for affected pensioners.” Still, he said that the plan treated pensioners “more favorably” than others affected by the plan.
Judge Kayatta ended the opinion by saying,
Congress left it to the Board, subject to review by the [district] court, to adjust those unfunded promises so that the Commonwealth would have a chance to reset its financial footing and, in so doing, ultimately benefit all of the island's residents.
In a thundering endorsement of federal preemption, the First Circuit upheld confirmation of the plan of adjustment for the Commonwealth of Puerto Rico.
The Boston-based appeals court said that PROMESA enabled the district court to reject teachers’ contractual rights in a defined benefit pension plan. Furthermore, the island’s government was not required to enact enabling legislation, and federal preemption overrode the teachers’ rights under local law.