On May 6, 2015, the United States Court of Appeals for the First Circuit held the oral argument in the case of Franklin California Tax-Free Trust, et al. v. Commonwealth of Puerto Rico, et al. before judges Lynch, Torruella and Howard, in reference to the Recovery Act (quiebra criolla). Although there is no real time transmission, podcast was available late in the afternoon. Each party was allotted 15 minutes for argument and 5 minutes to the two amicis (friends of the Court).

As the losing party in the District Court, the Government of Puerto Rico, the Department of Justice and Alejandro García Padilla, represented by Christopher Landau, started the argument. The Government started arguing that in 1984, Congress amended Chapter 9, municipal and state corporations bankruptcy, to exclude PR from said chapter and hence, section 11 U.S.C. § 903(1), was inapplicable to the Recovery Act. Also, there was no evidence of Congressional intention to preclude PR from making its own bankruptcy law for municipalities and public corporations. Judge Torruella asked him to discuss opponent’s argument that bankruptcy law did not apply to banks and insurance companies and the need for uniformity. He also asked why was PR excluded, answer is that there is no record of why. Judge Torruella asked whether this was a case of no-man’s land of Guss v. Utah, 353 U.S. 1 (1957), Government said it was not but this was an exceptional case. What no man’s land means is an area of federal law in which the federal agency does not take jurisdiction but the state does not have jurisdiction because of preemption. Judge Howard asked whether the definition of state included territories before 1984 and the answer was yes. Judge Lynch asked further on the issue and the answer was that from 1898-1978, there was no definition of state in the law, 1978-1984 included territories and 1984 to the present, PR and DC are excluded.

Martin Bienenstock then took his turn representing Melba Acosta and the GDB and started by saying 903 did not apply to PR because it is excluded from Chapter 9. [Sounds like a good argument but what happens to those states that do not allow its municipalities and public corporations to apply for Chapter 9 protection? For those who don’t know it, 11 U.S.C. § 109(c) requires that state law specifically require that a particular entity file for Chapter 9 protection. Hence, it could be argued that 903 necessarily has to apply outside Chapter 9] Judge Howard asked about the severability of sections 307-309 of the Recovery Act and the authority to transfers assets. Bienestock tried to sidestep the issue but Judge Lynch forced to explain that the sections only applied when there was a case under Chapter 3. He continued to discuss that Judge Besosa went too far by invalidating the whole Recovery Act. [On this, he has a point. Judge Besosa enjoined PR from using the Recovery Act but he could have decided that 903 precluded the island from composing (impairing) the debts of creditors without their consent. Remains to be see if the Circuit Court will agree.] Bienenstock finalized by saying that the case was all about negotiating leverage.

Lewis Jeffrey Liman argued for PREPA as amicus curiae. PREPA was sued in the district court but was dismissed by Judge Besosa. Nevertheless as an amicus, put in its two cents. He started by saying that Congress did not intend to preclude PR from using its sovereign rights. Judge Torruellas asked about the measures PREPA could take. What he meant was the argument by plaintiffs’-appellees that PREPA could increase rates, etc. and not restructure or go into a Recovery Act. Liman said that in 2014, PREPA could not pay its debts but thanks to the Recovery Act it was able to get the forbearance agreement and negotiate with leverage. He said that plaintiffs offered a receiver but that everyone agreed that a receiver could only collect funds, but has no power to forbear, provide a super-priority lien, and can’t provide a stay. He continued explaining that PREPA could not raise rates since they were double of the rates in the states, that they were too high, that PR was poor and that business are leaving as are persons. He also mentions that it would need regulatory approval. If PREPA in the future asks for a rate increase in the near future, Mr. Liman’s argument is the perfect foil to any such effort. This important testimony as from minute 29:42 on, most specifically, minute 31.

It was then the bondholder’s’ turn. Matthew D. McGill argued for BlueMountain, and started saying that in 1984 Congress did not allow PR to enact state municipal bankruptcy to be enforced all over the nation. Good point. Judge Torruella again asked if Congress created a no-man’s land. Obviously this means he is very much considering that this case is one where federal law is preemptive but in a very exceptional situation it does not act and state law is preempted. The answer was that no state may enact a bankruptcy law. Judge Torruella then asked about statutory definition v. dictionary definition in a law. The answer was basically that in this case, the dictionary definition made more sense. Torruella then asked if Congress excluded PR from Chapter 9, why is 903 applicable. In a clever answer, McGill said that PR was excluded from being eligible for Chapter 9, not from Chapter 9 itself.

Thomas Moers Meyer argued for Franklin and dove right in by saying that PR was in a no-man’s land as in the Utah case. Judge Lynch then asked whether Congress had decided to keep the power to decide when and at what time PR would be eligible for Chapter 9 and if Congress does not act, Judge Torruella’s no man’s land scenario would come into effect. She continued by saying that PR had asked Congress for inclusion in Chapter 9 and that Congress had many options and Meyer agreed; Chapter 9 or others. It seems to me that at this point, minute 56, the Gov. lost its case. Judge Lynch’s option would mean that Congress decided to keep for itself the power to put PR in Chapter 9 or not. Since Congress has power to legislate over PR pursuant to the Territorial Clause of the Constitution, see Harris v. Rosario, 446 U.S. 651 (1980), this would mean that PR does not have the power to enact a bankruptcy law. Heavy stuff and much more sweeping than Judge Besosa’s decision.

Marc E. Kasowitz argued for the Association of Financial Guaranty Insurers, an amicus curiae for the bondholders. He immediately agreed that there was a no man’s land situation here and reminded that Court that when DC had economic problems in the 1990’s it went to Congress to be included in Chapter 9. Congress instead created a Financial Commission to run the districts finances. He also mentioned that Lisa Donahue, PREPA’s restructuring officer had stated that her plan, due on June 1, 2015, would include measures to take care of the utility’s problems. Judge Lynch answered that she was happy to hear that.

What is strange of Judge Torruella’s questions is that none of the briefs, including amici, make any mention of Guss v. Utah. Judge Torruella did not reveal whether he believes Puerto Rico’s situation with Chapter 9 is a no-man’s land as established by this case, but the inference is there to make. On the other hand, as the Judge asked Mr. Mayer, the no-man’s land situations pursuant to Guss are very narrow.

Something similar happens with Judge Lynch’s statement that Congress reserved the right to decide when PR could or could not enter Chapter 9. Although bondholders cleverly continued to argue that the Constitutional delegation to Congress to pass bankruptcy laws, once exercised, preempts any state or territory from making its own composition laws, they did not actually make this argument. One can guess that Judge Lynch will uphold the injunction issued by Judge Besosa but on other grounds, as may Judge Torruella. Judge Howard, as is his practice, made very few questions and I have no idea which side he is leaning.

Martin Bienenstock, representing Melba Acosta and the GBD, in his rebuttal turn, basically argued that PR was different than DC, that it was a Commonwealth, that Congress had approved a Constitution and had police power. Judge Lynch did not seem very convinced and asked “what is your point with all this”. Bienestock answered that Washington did not have police power but PR did. Whether that is true, Judge Lynch did not sound convinced.

This oral argument was different from most oral arguments in the First Circuit. The judges asked very few questions, rare for this Circuit and very few were in the Government’s. favor. Seems that Judge Lynch and Judge Torruella believe that PR cannot enact a bankruptcy law, but for different reasons. This may end up a 3-0 case with two opinions or even a 2-1 in the bondholders favor.

I must point out, however, that if the Government wins the appeal, the case will return to Judge Besosa, and plaintiffs will file summary judgment as to the claims he left alive, to wit, impairment of contractual obligations and taking of property (the right to appoint a receiver) without just compensation. It is very likely that Judge Besosa, who let these claims survive, then determine it is unconstitutional for violation these two provisions. It will be back to square one.

Mr. Kasowitz’ comment on the DC Financial Commission deserves further inquiry. In 1994, the District’s finances were a mess and Mayor Barry, who was arrested and convicted for crack use by the Federal Government was mayor. The District requested to be included in Chapter 9 but instead, Congress created a Financial Commission to take care of DC’s finances. At this point, all financial decisions in DC were taken by this Commission. It existed from 1995 to 2001 and was considered a successful experiment. I have privately floated this idea with economists and some politicians and all have said it is a good idea. You can read my blog post on this subject here. If the First Circuit upholds the unconstitutionality of PR’s Recovery Act and the island cannot continue to pay its bondholders, a type of Financial Commission could be an alternative to inclusion in Chapter 9 or a massive bailout. Food for thought.

Finally, I expect a decision by the panel soon since Judge Lynch said they knew it was an important and that they would work hard on it. Also, from the oral argument it is clear they have an idea of under what provisions to decide. It will probably be little more than a month for us to receive the decision.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s