Puerto Rico v. Franklin California Tax-Free Trust

2016-06-13

Headline: Court holds Puerto Rico is a “State” for bankruptcy preemption and blocks Puerto Rico’s law letting its public utilities restructure debts outside federal Chapter 9, affecting island utilities and bondholders.

Holding: The Court rules that Puerto Rico remains a "State" for Chapter 9’s pre-emption provision, so federal bankruptcy law pre-empts and blocks Puerto Rico’s Recovery Act.

Real World Impact:

Blocks Puerto Rico’s law allowing utilities to restructure outside federal bankruptcy.
Leaves utilities and bondholders subject to federal bankruptcy preemption, limiting local restructuring options.
Puerto Rican municipalities cannot access Chapter 9 unless Congress changes the law.

Topics: municipal bankruptcy, Puerto Rico debt, public utilities, bondholder disputes

Summary

Background

Puerto Rico’s government and three government-owned utilities — the Puerto Rico Electric Power Authority, the Puerto Rico Aqueduct and Sewer Authority, and the Puerto Rico Highways and Transportation Authority — faced a severe fiscal crisis with more than $20 billion in shared debt and a combined 2013 deficit of $800 million. The Government Development Bank had lent heavily to these instrumentalities, and bond downgrades hurt access to capital. In 2014 Puerto Rico passed the Recovery Act to let its public corporations restructure debt through new local procedures; some provisions bind creditors when voting thresholds are met. Investment funds, including Franklin California Tax-Free Trust and BlueMountain, holding nearly $2 billion in bonds sued and won in lower courts, which enjoined the Recovery Act.

Reasoning

The central question was whether Puerto Rico counts as a "State" under the Bankruptcy Code’s rule that bars States from creating municipal bankruptcy schemes that bind nonconsenting creditors. The Court said a 1984 amendment excluded Puerto Rico only from the narrow "gateway" rule that lets a State authorize municipalities to file Chapter 9 (the provision defining who may be a debtor), but did not remove Puerto Rico from Chapter 9’s pre-emption clause. Relying on the statute’s text and history, the Court affirmed the First Circuit and held that the federal pre-emption provision bars the Recovery Act.

Real world impact

The ruling prevents Puerto Rico from using the Recovery Act to restructure utility debts and leaves utilities and their creditors subject to federal bankruptcy preemption. Puerto Rican municipalities remain unable to access Chapter 9 unless Congress changes the law. After briefing, Members of Congress proposed a separate bill to address Puerto Rico’s crisis, but that bill did not amend the Bankruptcy Code.

Dissents or concurrances

Justice Sotomayor, joined by Justice Ginsburg, dissented, arguing that because Puerto Rican municipalities cannot access Chapter 9, the pre-emption clause should not bar the Recovery Act and that blocking the Act risks serious harm to residents who rely on public services.