Puerto Rico is a “State” under U.S. Bankruptcy Law: Foreshadowing Bankruptcy-Type Relief for Other “States”?

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Foreshadowing (Photo by Marilyn Swanson)

By Donald L. Swanson

We must decide whether Puerto Rico is a “State” for purposes of this [bankruptcy] pre-emption provision. We hold that it is.”

Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust, U.S. Supreme Court Case No. 15-233 (Decided June 13, 2016).

The Bankruptcy Code definition of “State” is contained in Sec. 101(52) and reads:

“(52) The term ‘State’ includes the District of Columbia and Puerto Rico, except for the purpose of defining who may be a debtor under chapter 9 of this title.”

The Supreme Court Issue

The issue in the Supreme Court’s Franklin Trust case is the meaning of the “except for the purpose of defining” clause in the Bankruptcy Code’s definition of “State.”  [All quotes below are from this case.]

The Bankruptcy Code’s definition of “State” has “included Puerto Rico since it became a Territory of the United States in 1898.”

–“The first Federal Bankruptcy Act, also enacted in 1898, defined ‘States’ to include ‘the Territories [including Puerto Rico], the Indian Territory, Alaska, and the District of Columbia.'”

–“When Congress recodified the bankruptcy laws to form the Federal Bankruptcy Code in 1978, the definition of ‘State’ dropped out of the definitional section.”

–“Congress then amended the Code to reincorporate the definition of ‘State’ in 1984. . . . The amended definition includes Puerto Rico as a State,” with the one exception noted above.

The Supreme Court Ruling

In addressing the meaning of this “State” definition exception, the Supreme Court rules in Franklin Trust as follows:

–“By excluding Puerto Rico ‘for the purpose of defining who may be a debtor under chapter 9,’ the Code prevents Puerto Rico from authorizing its municipalities to seek Chapter 9 relief. Without that authorization, Puerto Rico’s municipalities cannot qualify as Chapter 9 debtors.”

–“But Puerto Rico remains a ‘State’ for other purposes.”

–“Resolving whether Puerto Rico is a ‘State’ for purposes of the pre-emption provision begins ‘with the language of the statute itself,’ and that ‘is also where the inquiry should end,’ for ‘the statute’s language is plain.'”

–“As a result, Puerto Rico’s municipalities cannot satisfy the requirements of Chapter 9’s gateway provision until Congress intervenes.”

The Supreme Court’s Dissent and Response

The two dissenting Justices in Franklin Trust suggest that the Court should look to the “context” of the statute in question, not to its plain meaning:

–“Finding pre-emption here means that a government is left powerless and with no legal process to help its 3.5 million citizens.”

–“Congress could step in to resolve Puerto Rico’s crisis. But, in the interim, the government and people of Puerto Rico should not have to wait for possible congressional action to avert the consequences of unreliable electricity, transportation, and safe water.”

In response, the majority opinion points out that a bill had already been introduced in the House of Representatives to establish a bankruptcy-type solution for both the Commonwealth of Puerto Rico and its municipalities. Such a bill did pass.

Bankruptcy Eligibility

One result of the “State” definition in the Bankruptcy Code is that neither the Commonwealth of Puerto Rico nor its municipalities are eligible for relief as debtors under the Bankruptcy Code. To resolve this problem, Congress created a new Bankruptcy-like law (i.e., the bill noted above). As a result, both the Commonwealth of Puerto Rico and one of its municipalities are now actual debtors, under this new law, in the U.S. Bankruptcy Court for the District of Puerto Rico.

Foreshadowing?

Perhaps the reality of Puerto Rico (a “State”) appearing as a debtor in a U.S. Bankruptcy Court foreshadows a development to come: where all States, of these United States, are eligible for bankruptcy-type relief. Current realities suggest that a number of our 50 States desperately need such relief.

And perhaps these Puerto Rico developments foreshadow another future development: i.e., sovereign states in financial stress gaining bankruptcy-type relief somehow and somewhere?! It’s not clear where a sovereign state in Europe, for example, would find jurisdiction to get and enforce bankruptcy-type relief — but here’s guessing someone is likely to try.

 

 

 

 

 

 

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