By LEN WEISER-VARON and BILL KANNEL

A few thoughts on Tuesday’s oral arguments before the U.S. Supreme Court in the litigation over whether Puerto Rico’s Public Corporations Debt Enforcement and Recovery Act, an insolvency statute for certain of its government instrumentalities, is void, as the lower federal courts held, under Section 903 of the U.S. Bankruptcy Code:

  • Due to Justice Scalia’s death and Justice Alito’s recusal, only 7 Justices heard the case and only 4 votes are needed for a majority.  Almost all of the questioning at oral argument came from Justices Sotomayor, Kagan and Breyer, plus a couple noteworthy questions from Justice Ginsburg.  With the standard disclaimer that questions at oral argument are not necessarily predictive of a Justice’s votes, it seems clear from the questioning that Justice Sotomayor will vote to reinstate the Recovery Act and is the most passionate of the Justices about the issue, and, even if the relatively silent Chief Justice Roberts and the silent Justice Kennedy and Justice Thomas vote to affirm,  the questions and musings of Justices Kagan, Breyer and Ginsburg suggest that Justice Sotomayor could sway them to her position and thereby obtain the 4 votes necessary for reversal of the First Circuit’s holding and reinstatement of the legislation.
  • All that can be said about the actual statutory language that the Supreme Court will interpret is that the drafting does not represent Congress’s finest work.  (Justice Breyer provided the only moment of merriment on the Scalia-less panel when, after a suggestion that the opaque statutory language requires a contextual reading, he responded, “That may be, but I can’t say that an ‘airplane’ means a horse.”) There is no relevant legislative history, so it is not clear that Congress, when it amended the Bankruptcy Code to exclude Puerto Rico’s (and the District of Columbia’s) government instrumentalities from Chapter 9 eligibility, thought about the question of how that would or should impact Puerto Rico’s and D.C.’s right to enact their own insolvency statutes.  So while nominally a statutory interpretation case, this is, on a technical level, almost purely a “what makes the most sense” case.
  • The First Circuit was persuaded that it would make no sense for Congress to act affirmatively to withhold from Puerto Rico the right to authorize its insolvent instrumentalities to file for bankruptcy under Chapter 9, while intending that Puerto Rico have the right to authorize such filings under some insolvency statute of its own creation.  That seems almost unassailably correct; basic common sense suggests that whatever distrust of Puerto Rico must have motivated Congress to close the door to Puerto Rico’s ability to authorize its instrumentalities to file under Chapter 9 cannot be reconciled with Congressional intent that Puerto Rico be allowed to authorize such filings under its own version of an insolvency statute that might be identical to, or differ in unpredictable ways from, Chapter 9.
  • However, Puerto Rico seems to have gotten some traction before the Supreme Court with the proposition (which the First Circuit correctly rejected) that Congress cannot have intended to leave Puerto Rico’s instrumentalities in a “no man’s land” where they had no access to Chapter 9 and no access to an alternative insolvency regime. The short answer is that there is a high likelihood that Congress, if it had an intent on the matter when it eliminated Puerto Rico instrumentalities from Chapter 9 eligibility, precisely intended that Puerto Rico instrumentalities would not have access to an insolvency process unless and until Congress specifically authorized the applicable process (as it is currently being pressed to do by Puerto Rico and the U.S. Treasury.)  Such federal control would be and is consistent with Puerto Rico’s status as a U.S. territory, however it is labeled in the Bankruptcy Code.
  • Justice Sotomayor also raised the issue of whether the principles of federalism and state sovereignty that make the federal Chapter 9 available only to instrumentalities of states that have elected into the Chapter 9 regime would be violated if Chapter 9 were the only insolvency regime available to a state, i.e. whether interpreting Section 903 of the Bankruptcy Code as applicable to states that have not exercised such option (as well as to Puerto Rico and D.C., which have no such option to exercise) would be unduly coercive and raise Tenth Amendment issues.  The First Circuit left that question unaddressed on the grounds that Puerto Rico is not protected by the Tenth Amendment.  But as Section 903 applies to any “State”, if the Supreme Court interprets it, and its restriction on a “State’s” ability to enact insolvency legislation for its instrumentalities, as applying to Puerto Rico, it also will be interpreting it as applying to the 50 states, including those that have not opted to authorize their instrumentalities to use Chapter 9.  Whether or not any of the other Justices would view such an interpretation as presenting a substantial Tenth Amendment concern cannot be discerned from the oral argument, but the Court often interprets ambiguous statutes in a manner that avoids a potential constitutional concern, and Sotomayor’s apparent invocation of that principle may be targeted at her fellow Justices as a counterweight to the proposition that Congress, in eliminating Chapter 9 access for Puerto Rico’s instrumentalities,  must have intended to preclude any access to bankruptcy by such  instrumentalities absent direct authorization by Congress.  In divining what Congress intended by Section 903, Sotomayor appears to be suggesting, the Supreme Court cannot focus myopically on what Congress would have intended for Puerto Rico.
  •  As we have previously discussed, even if the Court revives the Recovery Act, the Recovery Act is, from Puerto Rico’s perspective, a problematic, and possibly ineffective, insolvency process.  A principal purpose of bankruptcy is to adjust, restructure and impair contracts.  The federal government is not subject to the constitutional restriction on impairment of contracts, and therefore the federally-enacted Chapter 9 process can impair debts and contracts.  Puerto Rico, and therefore its Recovery Act, have been held to be subject to the constitutional restriction on impairment of contracts.  A couple of the Justices noted this constraint, both in questioning what benefit Puerto Rico would derive from a reinstatement of the statute and as a potential protection that Congress might have taken into account if it did not intend to preclude non-federal insolvency law.  If the Recovery Act is reinstated and used by Puerto Rico, one can expect years of litigation on the question of whether any debt adjustment (or other contract adjustment) effected thereunder does or doesn’t meet the high bar of public necessity and unavailability of reasonable alternatives required for such adjustment not to constitute an unconstitutional “impairment.”
  • Puerto Rico’s persistence in seeking reinstatement of the Recovery Act reflects a calculus that an insolvency process that produces a legally questionable and potentially unenforceable result is better than no process, and provides creditors more incentive for consensual resolutions than no process.  Chapter 9 eligibility for Puerto Rico’s instrumentalities, and, if Congress were to grant it, “super Chapter 9“ eligibility for Puerto Rico itself,  would clearly, in Puerto Rico’s view, constitute a far more advantageous and conclusive process.  However, there is some risk to Puerto Rico that if the Supreme Court reinstates the Recovery Act before Congress acts on federal legislation to address Puerto Rico’s financial woes, the revival of the Recovery Act would undercut any Chapter 9 momentum, leaving Puerto Rico with its legally wobbly Recovery Act.  But Puerto Rico appears willing to gamble that the Supreme Court will issue its decision after Congress has done whatever it will do, and, in any event, to believe that a constitutionally vulnerable local bankruptcy statute in the hand is worth a constitutionally bulletproof federal bankruptcy statute in the bush.

 

By LEN WEISER-VARON, BILL KANNEL and ERIC BLYTHE

It is said that muddy water is best cleared by leaving it be.  The Supreme Court’s December 4 decision to review the legality of Puerto Rico’s local bankruptcy law, the Recovery Act, despite a well-reasoned First Circuit Court of Appeals opinion affirming the U.S. District Court in San Juan’s decision voiding the Recovery Act on the grounds that it conflicts with Section 903 of the U.S. Bankruptcy Code, suggests, at a minimum, that at least four of the Justices deemed the questions raised too interesting to let the First Circuit have the last word. This discretionary granting of Puerto Rico’s certiorari petition further muddies the already roiling Puerto Rican waters.

As a result of the Supreme Court’s granting of the Commonwealth’s petition for a writ of certiorari, eight Justices will hear the case (Justice Alito has recused himself), with oral arguments likely in March, 2016.  A decision would then be expected in June, 2016, coinciding with the Commonwealth’s fiscal year end.  At first glance, the decision to grant “cert” appears to be a victory for the Commonwealth (according to SCOTUSblog, over the past three terms the Supreme Court has reversed approximately 72% of cases it has accepted for review).  Of course, the Supreme Court could weigh-in in a manner or on a topic that does not fully resolve the status of the Recovery Act.  At the very least, the review may hinder creditor negotiations and the chances of a consensual resolution.  And a consensual resolution may be Puerto Rico’s best hope.

Even as Puerto Rico legislators laud the Supreme Court’s decision, their pleas for alternate solutions—namely, Chapter 9 eligibility and/or a voluntary debt exchange—continue.  They argue that, absent these solutions, the territory will reach its breaking point before the Supreme Court rules.  The reappearance of the Recovery Act as an arguable solution to Puerto Rico’s quest for a debt restructuring process will likely only contribute to the gridlock in Congress regarding Puerto Rico’s campaign for Chapter 9 eligibility or for “Super Chapter 9” legislation that would enable it to restructure its general obligation debt.  Consensual creditor resolutions may be the Commonwealth’s most realistic option; indeed, the Commonwealth was hopeful it could implement a voluntary debt exchange by May, 2016.  But that was before cert was granted.

Creditors may now be even more wary of negotiating given the greater uncertainty the Supreme Court’s review engenders.  Parties striking deals with the Commonwealth and its entities are going to want to make sure the arrangements reached are “Recovery Act remote”, “Chapter 9 remote”, “Super Chapter 9 remote” and “Whatever the heck Congress, the courts or the Puerto Rico legislators do remote”.  Given the uncertainties regarding Recovery Act implementation (if/when/how), creditors may be unwilling to bear these risks and may choose to leave the muddy water be, for now.  That could be disastrous for Puerto Rico.

Finally, even if the Supreme Court reinstates the Recovery Act, the Recovery Act may still be an ineffectual vehicle for debt restructuring.  Because it is not enacted by the federal government, any plan confirmed under its provisions will be subject to a variety of constitutional challenges under the contracts clause and the takings clause of the U.S. Constitution.

The future’s not ours to see.

 

By LEN WEISER-VARON and BILL KANNEL

The Commonwealth of Puerto Rico and the Puerto Rico Electric Power Authority (PREPA) yesterday filed separate motions to dismiss the federal court complaint filed last month by some PREPA bondholders seeking to invalidate the recently-enacted Puerto Rico Public Corporation Debt Enforcement and Recovery Act.  As anticipated, the motions to dismiss assert that the plaintiffs lack standing and the claims lack ripeness because PREPA has not, to date, sought relief under the challenged legislation.

PREPA’s motion is limited to standing and ripeness arguments; the Commonwealth’s motion to dismiss also engages the bondholders’ substantive claims, arguing that the bondholders have failed to state claims on which relief can be granted.  In our prior analysis of the bondholders’ complaint, our assessment was that the bondholders’ strongest argument is the statutory argument that Section 903 of the federal Bankruptcy Code preempts Puerto Rico’s bankruptcy legislation.   The Commonwealth’s motion to dismiss confirms that assessment, as its attempts to rebut the preemption argument consist principally of an argument that Congress cannot have intended to leave Puerto Rico’s public corporations without recourse to a bankruptcy process, even though that is exactly what Section 903 appears to do as a literal matter.

Section 903 provides that “a State law prescribing a method of composition of indebtedness of [a] municipality may not bind any creditor that does not consent to such composition.”   The Commonwealth’s motion argues that “because Puerto Rico’s public corporations may not avail themselves of Chapter 9, Section 903—which, by its own terms, applies only when Chapter 9 is invoked—is wholly inapplicable to the Commonwealth.” (emphasis added)  The Commonwealth’s motion to dismiss does not corroborate its assertion that Section 903 “by its own terms … applies only when Chapter 9 is invoked” with any identification of the “terms” of Section 903 that allegedly limit its application to jurisdictions that are eligible to adopt Chapter 9.

Apparently recognizing that its textual analysis of what Section 903 literally says may be unpersuasive, the Commonwealth’s motion next asserts that Section 903 cannot possibly mean what it apparently says.  According to the motion: “That Congress would have denied Puerto Rico and its public corporations [the] ability to escape financial ruin in a brief statutory provision unrelated to Puerto Rico strains credulity.”   Finally, the Commonwealth argues that if Section 903 says what it appears to say, Section 903 of the Bankruptcy Code may be unconstitutional because it discriminates against Puerto Rico: “In any event, even if Section 903 could plausibly be read to pre-empt the Act—and it cannot—Plaintiffs’ construction of Section 903—under which Puerto Rico would not only be excluded from Chapter 9, but also barred from enacting a nearly identical restructuring mechanism of its own—would force this Court to confront constitutional concerns about whether Congress properly exercised its power to establish ‘uniform laws on the subject of bankruptcies through the United States.’”

With regard to the Commonwealth’s suggestion that it might be unconstitutional for Congress to exclude Puerto Rico from access to a bankruptcy process that binds non-consenting creditors, it should be noted that the federal courts have held that “Congress, which is empowered under the Territory Clause of the Constitution, U.S.Const., Art. IV, § 3, cl. 2, to ‘make all needful Rules and Regulations respecting the Territory . . . belonging to the United States,’ may treat Puerto Rico differently from States so long as there is a rational basis for its actions.” New Progressive Party v. Hernandez Colon, 779 F. Supp. 646, 661 (D.P.R. 1991)(citing Harris v. Rosario, 446 U.S. 651 (1980)).

In sum, the motions to dismiss seek to defer adjudication of the validity of Puerto Rico’s bankruptcy legislation until one or more of Puerto Rico’s public corporations seek protection under the legislation.  As to the merits of the challenge, the Commonwealth’s motion to dismiss raises predictable counter-arguments to the constitutional challenges, but contains little firepower on what is likely to be the central issue, the federal Bankruptcy Code’s statutory prohibition on non-federal debt composition statutes that purport to bind nonconsenting creditors.  The motion’s arguments that Section 903 doesn’t say what it appears to say, can’t say what it appears to say, and is unconstitutional if it says what it appears to say, do little to dispel our perception that this legislation faces a battle under Section 903.