Creating a split of circuits, the First Circuit ruled that just compensation for a government’s taking of private property must be paid in full under the Fifth Amendment and not at the discount afforded to holders of unsecured claims in a municipal bankruptcy.
Beginning in 2017, Puerto Rico and some of its instrumentalities filed debt-adjustment proceedings under the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.). PROMESA adopts large swaths of chapter 9, governing municipal bankruptcy.
Five years later, Puerto Rico and two of its instrumentalities confirmed debt-adjustment proceedings in district court. However, the confirmed plan was not to the liking of the Financial Oversight and Management Board for Puerto Rico, the proponent of the plans. Here’s how it happened.
Several creditors had filed claims seeking “just compensation” for Puerto Rico’s alleged prepetition takings of their private property. In some instances, Puerto Rico had made cash deposits to cover what the commonwealth believed to be the value of the properties. In other cases, there were no deposits.
Originally, Puerto Rico’s plan treated the takings claims as secured to the extent there were cash deposits and unsecured claims to the extent that the value exceeded the deposits. Where there were there no deposits, the entire claim was treated as unsecured.
The district court sustained objections by the takings creditors. Once Puerto Rico amended the plan to pay takings claims in full, the district court confirmed the plans. Puerto Rico appealed to the First Circuit in February, seeking to reinstate the prior version of the plan where some or all of the takings claims would be treated as unsecured.
The appeals court heard oral argument on April 28. Circuit Judge William J. Kayatta, Jr. affirmed in a 31-page opinion on July 18. He said that the appeal presented “important questions about the interplay between the power to equitably restructure debts in bankruptcy and the Constitution’s requirement that just compensation be paid whenever the government takes private property for public use.”
The Board asserted the primacy of the Bankruptcy Clause over the Takings Clause. The Bankruptcy Clause gives Congress the power “to establish . . . uniform Laws on the subject of Bankruptcies throughout the United States.” The Takings Clause of the Fifth Amendment says, “Nor shall private property be taken for public use, without just compensation.”
Primacy of the Takings Clause
Judge Kayatta framed the question as whether “the Fifth Amendment precludes the impairment or discharge of prepetition claims for just compensation” under PROMESA. He characterized the Board as contending “that, by reorganizing in bankruptcy, the debtors can eliminate their obligation to pay just compensation and instead pay only reduced amounts based on a formula applicable to most unsecured creditors.”
For Judge Kayatta, the relationship between the Takings Clause and the bankruptcy laws was “very clear.” He cited cases from the Supreme Court in 1935 and 1982 for saying that “bankruptcy laws are subordinate to the Takings Clause.”
“Accordingly,” Judge Kayatta said, bankruptcy laws “are not categorically exempt from the requirements of the Fifth Amendment (any more than they are exempt from, for example, the First Amendment).”
Before pronouncing the Takings Clause victorious, he rejected several “fallback” arguments proffered by the Board.
First, the Board contended that the takings claimants no longer had any interests in property protected by the Takings Clause and held only unsecured claims subject to adjustment in bankruptcy. There being agreement that takings had occurred, Judge Kayatta was “not persuaded that the Fifth Amendment should be read to permit the impairment of prepetition claims for just compensation simply because the claimants no longer possess rights in the taken property postpetition.”
Next, the Board argued there was nothing about a takings claim making it different from a claim for money damages resulting from any other constitutional violation. Judge Kayatta saw a distinction because the Takings Clause “clearly spells out both a monetary remedy and even the necessary quantum of compensation due.”
The Circuit Split
The Board cast its lot with In re City of Stockton, 909 F.3d 1256 (9th Cir. 2018), which was “favorable” to the Board’s position, Judge Kayatta said. In Stockton, the majority on the Ninth Circuit panel held that an appeal from a chapter 9 municipal reorganization can be dismissed under the doctrine of equitable mootness.
Ruling also on the merits, the majority in the Ninth Circuit held that a takings claim “is only implicated in bankruptcy if the creditor has actual property rights.” Id. at 1266. Evidently conceding that the Takings Clause provides protection to a creditor claiming “actual property rights,” the majority said that a debt can be adjusted in bankruptcy if the creditor only has a right to monetary relief, citing the Collier treatise. Id. To read ABI’s report on Stockton, click here.
Judge Kayatta found the dissenting opinion in Stockton to be “more persuasive.” The dissenter would have held that “the Fifth Amendment’s requirement that the government provide just compensation for any taking of private property constrains the powers granted to Congress by the Bankruptcy Clause of Article I. Takings claims should therefore be excepted from discharge in bankruptcy.” Id. at 1269.
For Judge Kayatta, the answer to the question was “rather simple. The Fifth Amendment provides that if the government takes private property, it must pay just compensation.” He affirmed the district court, holding “that otherwise valid Fifth Amendment takings claims arising prepetition cannot be discharged in [PROMESA] bankruptcy proceedings without payment of just compensation.”
‘Cert’ Petition?
This writer will not be surprised if the Board files a petition for certiorari, raising the question with the Supreme Court. There is a split of circuits, although not yet entrenched. The Puerto Rico case is a good vehicle to raise the issue.
The Supreme Court has already agreed to hear two bankruptcy cases in the term to begin in October. Having a third bankruptcy case on the calendar would be unusual but not unprecedented.
If there is a certiorari petition, the Court may ask for the views of the Solicitor General, but the request might not come until early October. Because the Solicitor General would need several months to file a brief for or against a grant of certiorari, a decision by the Court to hear the case may not arrive in time for argument in the upcoming term.
As far as bankruptcy is concerned, the issue is attractive because a ruling by the Supreme Court should not have widespread repercussions for personal bankruptcy or corporate reorganization. That is to say, a decision should not rock the bankruptcy world like Stern v. Marshall.
Creating a split of circuits, the First Circuit ruled that just compensation for a government’s taking of private property must be paid in full under the Fifth Amendment and not at the discount afforded to holders of unsecured claims in a municipal bankruptcy.
Beginning in 2017, Puerto Rico and some of its instrumentalities filed debt-adjustment proceedings under the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA (48 U.S.C. §§ 2161 et. seq.). PROMESA adopts large swaths of chapter 9, governing municipal bankruptcy.
Five years later, Puerto Rico and two of its instrumentalities confirmed debt-adjustment proceedings in district court. However, the confirmed plan was not to the liking of the Financial Oversight and Management Board for Puerto Rico, the proponent of the plans. Here’s how it happened.
Several creditors had filed claims seeking “just compensation” for Puerto Rico’s alleged prepetition takings of their private property. In some instances, Puerto Rico had made cash deposits to cover what the commonwealth believed to be the value of the properties. In other cases, there were no deposits.