Bankruptcy Laws for Puerto Rico: A Series of Unfortunate Technicalities and Screw-ups

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A series of unfortunate events — Exhibit by Nathan Sawaya (photo by Marilyn Swanson)

By: Donald L. Swanson

The U.S. Supreme Court has agreed to decide the constitutionality of the bankruptcy-type system under which Puerto Rico is operating.  The case is Financial Oversight and Management Board for Puerto Rico v. Aurelius Investment, LLC (Case No. 18-475).

Sounds ominous . . . and monumental . . . , right?

The reality is, indeed, ominous [e.g., what happens if it is unconstitutional?]. But the reality is, also, about a technicality.  Here’s the question before the Supreme Court in this case:

  • Was Senate advice and consent needed for officials who were appointed to run the system for Puerto Rico—because such advice and consent was neither sought nor obtained? [Fn. 1]

That’s it. Seriously. There’s nothing more.  But it’s one more thing in a long series of unfortunate technicalities and screw-ups

In the Beginning

In the beginning (i.e., 1978), Congress adopts the Bankruptcy Code. And it was good.

The Bankruptcy Code, at its inception, authorizes any “State” to allow its own municipalities to file for protection under Chapter 9 of the Bankruptcy Code. The word “State” at that time, for Bankruptcy Code purposes, included Puerto Rico and other territories of the United States.

The First Screw-up

In 1982, the U.S. Supreme Court comes within one vote of declaring the entire Bankruptcy Code unconstitutional in Northern Pipeline v. Marathon Pipe Line. The Supreme Court doesn’t go that far, back then, but it manages to create a crisis for the entire Bankruptcy Code system anyway.

The Second Screw-up

To address the Northern Pipeline v. Marathon Pipe Line crisis, Congress adopts the Bankruptcy Amendments and Federal Judgeship Act of 1984. This Act goes a long way toward solving many issues for the Bankruptcy Code system.

But the new Act also contains the beginnings of future calamity for Puerto Rico. Here’s how:

  • Sec. 421(j)(6) of the new Act (now codified at 11 U.S.C. § 101(52)) says this:  “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 Congressional record is totally devoid of any explanation on why this District of Columbia and Puerto Rico distinction is included in § 101(52) [Fn. 2].

Constitutionality of 11 U.S.C. § 101(52)?

The constitutionality of Puerto Rico being singled out in 11 U.S.C. § 101(52) is questioned in a forceful, but unavailing, opinion by Circuit Judge Torruella in Franklin v. Puerto Rico, 805 F.3d 322, 345-56 (1st Cir. 2015) (concurring). Here is why, according to Judge Torruella, singling out Puerto Rico in § 101(52) is invalid:

  • It contravenes the “Bankruptcies” clause of the U.S. Constitution, which requires “uniform laws on the subject of bankruptcies”;
  • It fails the requirement that a “rational basis” is needed for a statute that treats Puerto Rico differently—there is no record or justification for the disparate treatment that deprives Puerto Rico of a fundamental and inherently managerial function over its municipalities;
  • It requires Puerto Rico to go back to Congress for a political solution, where it is excluded from the political process; and
  • It continues a “colonial relationship” that “violates our Constitution and the Law of the Land as established in ratified treaties.”

A Technical Ruling

On June 13, 2016, the U.S. Supreme Court declares in Puerto Rico v. Franklin that, unlike other “States,” Puerto Rico cannot authorize its municipalities to file bankruptcy under Chapter 9—because of 11 U.S.C. § 101(52).

Here’s what the Supreme Court says (italics in original):

The Bankruptcy Code has long included Puerto Rico as a “State,” but in 1984 Congress amended the definition of “State” to exclude Puerto Rico “for the purpose of defining who may be a debtor under chapter 9.”
. . .
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.

The Supreme Court does not address Judge Torruella’s constitutionality concerns.

The Next Screw-ups

Congress felt compelled to act on Puerto Rico’s financial problems, in 2016, particularly after those problems were magnified by natural disasters.

Congress could have taken a minimalist approach by removing the words “except for the purpose of defining who may be a debtor under chapter 9 of this title” from 11 U.S.C. § 101(52). That would have allowed municipalities in Puerto Rico to file bankruptcy under Chapter 9, just like other municipalities have done elsewhere (e.g., the City of Detroit).

But, no. Congress did not want a minimalist approach. It wanted, instead, to adopt the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). As that title suggests, Congress wanted to get into “oversight” and “management” of Puerto Rico’s financial affairs.

To do so, Congress also created the “Financial Oversight and Management Board of Puerto Rico” to micromanage Puerto Rico’s financial affairs. And it is the appointment of members of this Board where the constitutional issue arises:

  • The seven members of this Board were appointed by the President of the United States from a list of candidates prepared by Congress and without Senate involvement; but
  • The Appointments Clause of the U.S. Constitution requires “Advice and Consent of the Senate” for appointments of “Officers of the United States.”

So, the question now before the Supreme Court is whether Board members qualify as “Officers of the United States” under the Appointments Clause.

First Circuit Opinion

The U.S. First Circuit Court of Appeals ruled on the question that’s now before the Supreme Court. The First Circuit held:

  1. “the process PROMESA provides for the appointment of Board Member is unconstitutional”; but
  2. To “reduce the disruption that our decision may cause,” the “defacto officer doctrine” is utilized to deny the appellants’ motions to dismiss Puerto Rico’s bankruptcy-type proceedings

A Potential Crisis?

Since their appointment, the Board members in question have taken momentous actions that cannot be undone. Such actions include, (i) the filing of bankruptcy-type proceedings for the Commonwealth of Puerto Rico and for several of its municipalities, and (ii) the restructure of much of their debts.

A negative ruling from the Supreme Court on constitutionality of the Board appointments could have serious consequences—of crisis proportions. But that seems unlikely. Here’s guessing that, if they affirm the First Circuit’s ruling on constitutionality, they will also affirm the First Circuit’s use of the defacto officer doctrine to minimize adverse consequences that might flow from its ruling—or do something else with a similar effect.

Conclusion

Puerto Rico faces many difficulties. Those difficulties have been magnified by the technicalities and screw-ups that the U.S. legal system has thrown in their path.

Here’s hoping the U.S. Supreme Court, in the case it recently agreed to hear, can do something to minimize the series of unfortunate screw-up and technical impediments for the benefit of Puerto Rico and the people living there.

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