A lawsuit naming only public officials in their individual capacities is nonetheless automatically enjoined in municipal bankruptcies if the individuals are being indemnified by the government, according to a First Circuit opinion related to Puerto Rico’s debt-adjustment proceedings under the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.).
The May 12 opinion by Circuit Judge Sandra L. Lynch forestalls plaintiffs from pleading around the automatic stay in municipal bankruptcies by only suing individual government officers in their personal capacities.
The Civil Rights Suit
While the PROMESA proceedings were pending in 2019, plaintiffs filed a 42 U.S.C. § 1983 civil rights action in federal district court in Puerto Rico against several individuals from the island commonwealth’s insurance commissioner’s office. The complaint alleged that the government officials, in their individual capacities, had violated the plaintiffs’ First Amendment, due process and equal protection rights. In addition to injunctive relief, the complaint sought $30 million in compensatory damages.
The suit did not include the commonwealth among the defendants. Judge Sandra L. Lynch said that the plaintiffs left the commonwealth itself out of the complaint to avoid the automatic stay in Puerto Rico’s PROMESA proceedings.
The officials petitioned the island to cover their legal expenses under what Judge Lynch called Puerto Rico’s “idiosyncratic” indemnification law. She explained that indemnification is discretionary, not automatic or compulsory, in Puerto Rico.
Puerto Rico agreed to cover legal expenses but said that indemnification for a judgment would require another petition, because indemnification for a judgment invokes different conditions to coverage.
The Section 1983 suit was pending before a district judge in Puerto Rico who was not overseeing the PROMESA proceedings. In the 1983 suit, the government officials filed a notice about the automatic stay, but the district judge never directly ruled on the stay.
However, the district court issued several orders compelling the government officials to provide discovery. The government officials appealed the discovery orders to the First Circuit under the theory that the district court effectively denied a motion to impose the automatic stay. The officials argued that the 1983 suit was automatically halted by PROMESA. The First Circuit enjoined the suit during the pendency of the appeal.
Ruling on the merits, Judge Lynch vacated the discovery orders and ordered the entry of a stay.
The Stay in Municipal Bankruptcies
PROMESA incorporates Section 922, the provision in the Bankruptcy Code providing for automatic stays in municipal bankruptcies. First, Section 922(a) incorporates Section 362 in municipal bankruptcies. Then, it goes on in subsection (a)(1) to expand the Section 362 stay to cover an “action or proceeding against an officer or inhabitant of the debtor that seeks to enforce a claim against the debtor.” [Emphasis added.]
The civil rights plaintiffs argued that the stay in Section 922(a)(1) did not apply to their suit because they were not seeking to enforce a claim against Puerto Rico, the debtor.
If the plaintiffs’ argument were correct, Judge Lynch said that “Section 922 would have little if any role,” because actions against the debtor already would have been enjoined by Section 362. She therefore said, “Section 922 makes clear that for automatic stay purposes, an action can seek to enforce a claim against a governmental debtor even if it only does so indirectly.”
Judge Lynch noted that the lawsuit sought over $30 million, more than the plaintiffs could ever hope to recover from the government officials alone. For a “meaningful recovery,” she said that “the Commonwealth will in some manner step into the shoes of its officials.”
The plaintiffs countered by contending that indemnification for a judgment remained contingent. Judge Lynch said that a contingent claim for indemnification was nonetheless a claim enjoined by the stay.
Judge Lynch said that Section 922 “was enacted to prevent creditors from artfully pleading around the Section 362 automatic stay by bringing an action against an officer . . . rather than the municipality itself.”
If indemnification in Puerto Rico were mandatory, Judge Lynch said that the Section 922 stay would clearly apply. She agreed “with the view taken by courts in Chapter 9 and Chapter 11 bankruptcy actions that a commitment to indemnity costs is not required.”
Finding the stay applicable, Judge Lynch vacated the district court’s discovery orders and remanded with instructions to enter a stay.
The Concurrence
Characterizing the case as “a difficult matter of first impression,” Circuit Judge O. Rogeriee Thompson concurred in the judgment, but only because Puerto Rico’s government had already agreed to cover the officials’ defense costs.
Judge Thompson said she would leave out “the speculative possibility of an eventual judgment against Defendants.”
Indeed, Judge Thompson said she would “not rely at all” on indemnification because Puerto Rico was already picking up defense costs. She added that she would “not . . . chain today’s outcome to the possibility of future indemnification. It’s simply too speculative and unknowable whether indemnification would actually follow.”
A lawsuit naming only public officials in their individual capacities is nonetheless automatically enjoined in municipal bankruptcies if the individuals are being indemnified by the government, according to a First Circuit opinion related to Puerto Rico’s debt-adjustment proceedings under the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.).
The May 12 opinion by Circuit Judge Sandra L. Lynch forestalls plaintiffs from pleading around the automatic stay in municipal bankruptcies by only suing individual government officers in their personal capacities.