Case of the Day: Puerto Rico v. Franklin California Tax-Free Trust

Reverse of Puerto Rico quarter

The case of the day is Puerto Rico v. Franklin California Tax-Free Trust (S. Ct. 2016). I’m sorry, readers who are looking for service of process or 1782 cases—you’ll have to stick it out for one more day of Puerto Rico coverage. By way of explanation, I take a particular interest in Puerto Rico status issues because the US Court of Appeals for the First Circuit, the federal appellate court here in Boston, hears appeals from the US District Court for the District of Puerto Rico, and because the underlying issues have—for me at least—inherent political and legal interest.

Today’s case relates directly to the ongoing fiscal crisis in Puerto Rico. Puerto Rico’s legislative assembly enacted a statute known as the Recovery Act in 2014. The statute provided a mechanism for compulsory restructuring of the debt of Puerto Rico’s public utilities as long as 75% of the debt holders agreed, and another mechanism for a court-supervised restructuring process as long as 50% of the debt holders agreed. Several investment funds sued to enjoin the government from implementing the Recovery Act on the grounds that the federal bankruptcy law preempted the statute. The District Court enjoined enforcement of the statute, and the First Circuit affirmed. Puerto Rico sought review in the Supreme Court.

a vulture soaring

Before proceeding, a word on the investors objecting to the Recovery Act. It’s easy to criticize them given the depth of Puerto Rico’s crisis, which everyone involved—Puerto Rico’s government and citizens, the US government, and US investors—had a role in creating. Someone who demands a hundred cents on the dollar when essential public services are being curtailed seems like a Scrooge. But it’s important to remember that some Puerto Rico bonds are held by individual Puerto Ricans themselves, and that when we talk about investment funds, we are talking about entities that invest other people’s money. If you’re saving for retirement in the United States, you, too, might own Puerto Rico government bonds! As for the “vulture” funds that have bought Puerto Rico debt on the cheap, again, there are two sides to the story. If demanding a hundred cents on the dollar is Scrooge-like, then how about demanding a hundred cents on the dollar when you bought the debt at a deep discount? Remember, though, that the vulture funds aren’t buying the debt from the Puerto Rico government. They’re buying it from the investors who fear getting wiped out and aren’t willing to bear either the risk of getting nothing or the cost of fighting to get more. So criticize vulture funds, but remember that they provide an important service for other investors.

On to the case! There are a bunch of provisions at issue:

  • Under § 109(c) of the Bankruptcy Code, in order to be a debtor under Chapter 9 (the part of the Code that applies to municipal bankruptcy), the insolvent municipality must be “specifically authorized” by a State “to be a debtor.”
  • The provision of the Code that defines the word “State”, § 101(52), provides that it “includes … Puerto Rico, except for the purpose of defining who may be a debtor under chapter 9.
  • The preemption provision, § 903(1), provides that “a State law prescribing a method of composition of indebtedness of such municipality may not bind any creditor that does not consent to such composition,” and “a judgment entered under such a law may not bind a creditor that does not consent to such composition.”

When you lay out the statutes like this, the case seems pretty easy even if the outcome is questionable as a matter of policy. On the one hand, because of the limitation in the definition of the word “State” in § 101″(52), it seems clear that Congress intended that Puerto Rico municipalities could not be debtors under Chapter 9 (because Puerto Rico is not a “State” that can authorize its municipalities to be debtors under § 109(c)). On the other hand, because the word “State” in § 903(1) is defined to include Puerto Rico, Puerto Rico itself cannot legislate a solution to its fiscal crisis. This seems to me to be the plain meaning of the statutory text. Since the text is clear, Justice Sotomayor’s dissent, which argued that § 903 should be read to apply only to states that have the power to approve municipal bankruptcies for their municipalities, garnered only one other vote (from Justice Ginsburg).

Puerto Ricans may well be upset at yet another illustration of what they might fairly call their second-class political status. We saw another example just recently in the Sánches Valle case. But it seems to me there is a straightforward answer: change Puerto Rico’s political status. At least according to the 2012 plebescite, a majority of Puerto Ricans favor a change to the status quo, and when asked what change they prefer, a clear majority say statehood. On the other hand, Governor García Padilla does not favor statehood and has not submitted a statehood petition to Congress. It seems to me that Puerto Rico should become a state if it wants to be treated as a state for all purposes in federal law. But if it stays in its current, sui generis status, it shouldn’t be a surprise that the rules that govern it are sui generis, too.

About Ted Folkman

Ted Folkman is a shareholder with Murphy & King, a Boston law firm, where he has a complex business litigation practice. He is the author of International Judicial Assistance (MCLE 2d ed. 2016), a nuts-and-bolts guide to international judicial assistance issues, and of the chapter on service of process in the ABA's forthcoming treatise on International Aspects of US Litigation, and he is the publisher of Letters Blogatory, the Web's first blog devoted to international judicial assistance, which the ABA recognized as one of the best 100 legal blogs in 2012, 2014, and 2015.

2 thoughts on “Case of the Day: Puerto Rico v. Franklin California Tax-Free Trust

  1. Let’s assume that they were to request statehood. Given the current state of Congress, would such a petition be accepted? Such a straightforward answer neglects not just the possibility that Puerto Rico doesn’t want statehood (a majority does, though perhaps not overwhelming) but that a Congress, particularly with a House of Representatives held by Republicans that sees a state likely to produce legislators that won’t be Republicans, is very likely to refuse to consider the petition. So sui generis is all they’re getting.

    1. Well, both parties’ platforms support the right of Puerto Rico’s people to statehood if they want it. If the GOP doesn’t follow through on its commitment if presented with a statehood petition, then we’d have a different discussion.

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