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Exposing the Lack of Uniformity in U.S. Bankruptcy Law: Puerto Rico’s Own Municipal Bankruptcy Law Preempted by Chapter 9

By: Matthew Repetto

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

            In Franklin v. Puerto Rico, the First Circuit held that Puerto Rico’s effort to restructure the debt of its public utilities through the enactment of its own municipal bankruptcy law, the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (“Recovery Act”), was preempted by Section 903(1) of the United States Bankruptcy Code.[1]  Amid the most serious fiscal crisis in its history, Puerto Rico’s public utilities are currently at risk of becoming insolvent.[2]  Unlike states, Puerto Rico is a territory and “may not authorize its municipalities . . . to seek federal bankruptcy relief under chapter 9 of the U.S. Bankruptcy Code.”[3]  Thus, the Recovery Act was Puerto Rico’s attempt to “fill the gap” by providing relief on its own.[4]  The Recovery Act was enacted to mirror chapter 9 and chapter 11 of the United States Bankruptcy Code.[5]  Those in favor of the Recovery Act argued that preemption would leave Puerto Rico with no means of relief.[6]  However, the First Circuit disagreed, and noted that Puerto Rico could, as it had already, seek relief directly from Congress.[7]

            In Franklin, the answer to whether the Recovery Act was preempted by Section 903(1) was “largely driven by examining whether the amendment to the Bankruptcy Code in 1984 [which added] Section 101(52), altered Section 903(1)’s effect.”[8]  In Section 101(52), the definition of a “state” was changed to “include Puerto Rico, ‘except’ for the purpose of defining who may be a debtor under chapter 9.”[9]  Significantly, Section 903 falls within chapter 9, and it refers only to “states” which Puerto Rico has been excluded from under 101(52).[10]  Section 903(1) states in full: “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.”[11]  Its purpose is to “ensure the uniformity of federal bankruptcy laws by prohibiting state municipal debt restructuring laws that bind creditors without their consent,” which is exactly what the Recovery Act sought to do.[12]  Consequently, the court held that Section 903(1) does not currently suggest that Puerto Rico is outside of its reach even though Section 101(52) excluded Puerto Rico from the definition of a “state” under Chapter 9.[13]  The First Circuit reasoned that the prohibition of municipal debt restructuring in Section 903(1) applied to Puerto Rico prior to Section 903(1)’s enactment in 1946.[14]  Therefore, the court refused to “erode past bankruptcy practice absent a clear indication that Congress intended such a departure”[15] and stated, “[i]f Congress had wanted to alter the applicability of Section 903(1) to Puerto Rico, it ‘easily could have written’ Section 101(52) to exclude Puerto Rico’s laws from the prohibition of Section 903(1).”[16]  Congress was authorized to enact Section 903(1) because the Constitution provides Congress the power to enact “uniform” bankruptcy laws.[17]  Yet, forcing a United States territory to seek bankruptcy recovery through different means than the rest of the country appears to be anything but uniform.[18]

            The decision in Franklin exposed the lack of uniformity within the bankruptcy laws, which begs the question: “is the 1984 amendment unconstitutional?”[19]  In his concurring opinion, Judge Torruella raised the possibility that “the non-uniform treatment of Puerto Rico under the bankruptcy laws violated the Bankruptcy Clause” of the United States Constitution.[20]  Judge Torruella argued, “Puerto Rico should be free to authorize its municipalities to file for bankruptcy protection under the existing chapter 9 of the Bankruptcy Code.”[21]  This would put Puerto Rico on the same footing as the States and other territories and promote uniformity by ensuring that Puerto Rico obtained the same authority to seek chapter 9 relief as it had before the 1984 amendment was enacted.[22]  In his argument, Judge Torruella pointed to the fact that the 1984 Amendment “lacks any record or justification.”[23]  There is no legislative record on which to rely for determining Congress’s reasoning behind the addition of 101(52) exempting Puerto Rico from chapter 9 relief.[24]  Moreover, chapter 9 is supposed to be a ‘cooperative’ state-federal scheme,[25] but the addition of Section 101(52) and the interpretation of Section 903(1) as applied to Puerto Rico appear to be anything but cooperative.

 

 



[1] Franklin California Tax-Free Trust v. Commonwealth of Puerto Rico, 805 F.3d 322, 325 (1st Cir. 2015).

[2] See id. at 324.

[3] Id.; see also 11 U.S.C. § 101(52).

[4] See Franklin, 805 F.3d at 331.

[5] Id. at 332.

[6] See id. at 325.

[7] See id.

[8] Id. at 333.

[9] Id. at 330–31.

[10] See id. at 334.

[11] Id.

[12] Id. at 324–25; see also 11 U.S.C. § 903(1) (2012) (prohibiting all states from enacting municipal debt restructuring laws that bind creditors without their consent).

[13] Franklin, 805 F.3d at 325.

[14] Id.

[15] Id. (citing Cohen v. De la Cruz, 523 U.S. 213, 221(1998)).

[16] Id. at 337.

[17] See id. at 347; see also U.S. Const. art. I, § 8, cl. 4 (establishing uniform bankruptcy laws throughout United States).

[18] See Franklin, 805 F.3d at 348.

[19] See id. at 355.

[20] Id. (Torruella, J., concurring).

[21] Id.

[22] Id.

[23] See id. at 349.

[24] See id. at 337.

[25] See id. at 329.