As I was reviewing something a friend sent me, and it got me curious about an old SCOTUS case, Faitoute Iron & Steel Co. v. City of Asbury Park, 316 U.S. 502 (1942). In this case, the SCOTUS allowed a New Jersey law that changed obligations on some municipal bonds. Due to this case, in 1946, Congress amended the Bankruptcy Code to prohibit a state from providing the composition of debts by its municipalities.


As I reviewed the case, did some digging and found some interesting facts. In United Trust Company of New York v. New Jersey, 431 U.S. 1, 28 (1977), the issue was the repeal of a statutory covenant made by the two states (New York and New Jersey) that had limited the ability of the Port Authority to subsidize rail passenger transportation from revenues and reserves. A New Jersey superior court dismissed the complaint after trial, holding that the statutory repeal was a reasonable exercise of New Jersey’s police power and was not prohibited by the Contract Clause, and the New Jersey Supreme Court, affirmed the dismissal of the suit that challenged the provision. The SCOTUS reversed the New Jersey Court and found that the action violated the impairment of contractual obligations. The Court stated as follows:


Under the specific composition plan at issue in Faitoute, the holders of revenue bonds received new securities bearing lower interest rates and later maturity dates. This Court, however, rejected the dissenting bondholders’ Contract Clause objections. The reason was that the old bonds represented only theoretical rights; as a practical matter the city could not raise its taxes enough to pay off its creditors under the old contract terms. The composition plan enabled the city to meet its financial obligations more effectively. “The necessity compelled by unexpected financial conditions to modify an original arrangement for discharging a city’s debt is implied in every such obligation for the very reason that thereby the obligation is discharged, not impaired.” Id., at 511, 62 S.Ct. at 1134. Thus, the Court found that the composition plan was adopted with the purpose and effect of protecting the creditors, as evidenced by their more than 85% approval. Indeed, the market value of the bonds increased sharply as a result of the plan’s adoption.


It is clear that the instant case involves a much more serious impairment than occurred in Faitoute. No one has suggested here that the States acted for the purpose of benefiting the bondholders, and there is no serious contention that the value of the bonds was enhanced by repeal of the 1962 covenant. Appellees recognized that it would have been impracticable to obtain consent of the bondholders for such a change in the 1962 covenant, Brief for Appellees 97-98, even though only 60% approval would have been adequate. See n. 10, supra. We therefore conclude that repeal of the 1962 covenant cannot be sustained on the basis of this Court’s prior decisions in Faitoute and other municipal bond cases.


This narrowing of the Faitoute doctrine has been recognized by other courts. In In Re Detroit, 504 B.R. 97, 144-45 (B. E. D. Mich 2013) Judge Rhodes had the same view as did the Court in In Re Jefferson County, 465 B.R. 243, 293 n. 21 (B. N. D. Alabama). The Supreme Court of Illinois in Harding, Inc. v. Village of Mount Prospect, 99 Ill.2d 96, 103-104 (1983) held in a similar fashion and said:


In our judgment the opinion of the United States Supreme Court in United States Trust Co. v. New Jersey (1977), 431 U.S. 1, 97 S.Ct. 1505, 52 L.Ed.2d 92, is dispositive of this case, for the circumstances there considered insufficient to sustain legislative alteration of contractual obligations were substantially more compelling than here. In that case, the States of New York and New Jersey, by a 1962 statutory covenant, limited the ability of the Port Authority of New York and New Jersey to divert, for purposes of subsidizing rail-passenger transportation, certain revenues and reserves previously pledged as security for bonds issued by the Port Authority. Concurrent legislation in both States some 12 years later purported to retroactively repeal the earlier covenant. That legislation was attacked as impermissibly impairing the obligations of the Authority bonds issued prior to repeal. While the State court held the repealing legislation was a reasonable exercise of the State’s police power (United States Trust Co. v. State (1976), 69 N.J. 253, 353 A.2d 514), the Supreme Court reversed on the ground that the 1974 repealer statute was an unconstitutional impairment of the Port Authority’s contract with its bondholders. In reaching this conclusion, the court reviewed at length the history of the contracts clause and noted that it has upheld State legislation impairing contracts in very few cases. Only once in this century, in the case of Faitoute Iron & Steel Co. v. City of Asbury Park (1942), 316 U.S. 502, 62 S.Ct. 1129, 86 L.Ed. 1629, has the court upheld a statute that impaired contract rights of municipal bondholders. In that case, the challenged legislation permitted a bankrupt local government to go into receivership, but it also provided significant protections for all creditors: any bankruptcy repayment plan required approval of 85% of all creditors, and nonconsenting creditors were to be bound by the plan only after a State court determination that the municipality could not otherwise pay its creditors and that the repayment plan was in the best interest of all creditors.


Only in one of the respondents merits briefs is Faitoute discussed in this fashion. At page 28 of Franklin California’s brief this issue is discussed. In addition, in Franklin California v. PR, 85 F.Supp.3d 577, 606 (D.P.R. 2015) Judge Besosa discussed the case and said:


The United States Supreme Court has long held that the Contract Clause prohibits states from passing laws, like the Recovery Act, that authorize the discharge of debtors from their obligations. See Ry. Labor Execs.’ Ass’n, 455 U.S. at 472 n. 14, 102 S.Ct. 1169 (“[T]he Contract Clause prohibits the States from enacting debtor relief laws which discharge the debtor from his obligations.”); Stellwagen v. Clum, 245 U.S. 605, 615, 38 S.Ct. 215, 62 L.Ed. 507 (1918) (“It is settled that a state may not pass an insolvency law which provides for a discharge of the debtor from his obligations.”); Sturges, 17 U.S. at 199 (Contract Clause prohibits states from introducing into bankruptcy laws “a clause which discharges the obligations the bankrupt has entered into.”).


The Commonwealth Legislative Assembly cites Faitoute Iron & Steel Co. v. City of Asbury Park, New Jersey, 316 U.S. 502, 62 S.Ct. 1129, 86 L.Ed. 1629 (1942), as support for the Recovery Act’s “constitutional basis.” Recovery Act, Stmt. of Motives, § C. In Faitoute, the Supreme Court sustained a state insolvency law for municipalities in the face of a Contract Clause challenge. 316 U.S. at 516, 62 S.Ct. 1129. The state law was narrowly tailored in three important ways: (1) it explicitly barred any reduction of the principal amount of any outstanding obligation; (2) it affected only unsecured municipal bonds that had no real remedy; and (3) it provided only for an extension to the maturity date and a decrease of the interest rates on the bonds. Id. at 504–07, 62 S.Ct. 1129. The Supreme Court was careful to state: “We do not go beyond the case before us. Different considerations may come into play in different situations. Thus we are not here concerned with legislative changes touching secured claims.” Id. at 516, 62 S.Ct. 1129. Unlike the state law in Faitoute, the Recovery Act (1) permits the reduction of principal owed on PREPA bonds, (2) affects secured bonds that have meaningful remedies, including the appointment of a receiver, and (3) permits modifications to debt obligations beyond the extension of maturity dates and adjustment of interest rates. Thus, Faitoute is factually distinguishable and provides no support for the Recovery Act’s constitutionality.


What does all this mean? Simple, even if the SCOTUS says that section 903 does not apply to PR since it is not eligible for Chapter 9, after the law clerks review the cases again, they may conclude and so inform the Justices, that the island cannot restructure its debts by affecting bondholders. Of course, the SCOTUS may modify or distinguish United Trust Company of New York to allow the restructuring or it can completely reverse it. On the other hand, since this issue is in one brief and the District Court opinion, the SCOTUS should not simply ignore it. If it does, Judge Besosa would have another issue to declare the Recovery Act unconstitutional.


El Posible Impago de Diciembre

El día 6 de noviembre de 2015, se reveló que el Gobierno no va cerrar operaciones ese mes. Eso puede querer decir que el Gobierno no pagará la deuda en diciembre o la pagará parcialmente. Recordemos que el Gobernador, a preguntas (obviamente plantadas) de Bernie Sanders, dijo que alguna de la deuda se había emitido en violación de la Constitución, probablemente el Artículo VI, sección 2. Esta posibilidad lleva meses sobre el tapete y puede ser develada en diciembre.

El escenario sería así. En diciembre, el BGF, que es quien debe la cantidad mayor, $354.7 millones, hace un pago parcial, diciendo que a base de su análisis, esto es lo que constitucionalmente debe ya que la mayor parte fue emitida en violación de la Carta Magna. Los bonistas entonces tendrían que decidir entre demandar o sentarse con Melba Acosta para que les explique la teoría. Exactamente lo mismo ocurriría en enero de 2016, cuando se vencen muchos pagos, incluyendo $331.6 millones de bonos de obligación general (GO’s).

La maniobra tiene varias ventajas para el Gobernador. Al hacer esto, acalla a aquellos sectores de izquierda que están clamando por que no corra para la reelección, se queda con millones de dólares para utilizar en proyectos para comprar votos y tal vez, solo tal vez, lograr la reelección. El que la maniobra falle e impida a PR volver al Mercado por varios años no le importará por que cuando todo acabe, o es gobernador de PR o esta fuera del gobierno. Así es la política Boricua.


La Administración Obama ha filtrado su propuesta que ofrecerá en la vista de mañana ante el Senado para manejar el problema fiscal de PR. La misiva es corta pero contundente. La Administración Obama entiende que hay que reestructurar la deuda y que los bonistas, entre otros, tienen que coger un recorte. Eso incluye bonistas boricuas, estadounidenses y hasta los de China. Obama propone un Supercapítulo 9, donde todas las deudas del ELA se puedan modificar. También habla de una Junta de Supervisión Fiscal. “To strengthen reform, Congress should provide independent fiscal oversight while respecting Puerto Rico’s autonomy.” (pág. 3) “The oversight body’s powers should include the authority to ensure that annual budgets and expenditures are in conformance with Puerto Rico’s multi-year fiscal plan. There are also some authorities, like the ability to impose new taxes and raise fees, which should remain solely within the control of democratically-elected officials.” (page 7). Pero la Junta sabemos no podrá lograr nada de importancia a menos que tenga control verdadero.

Me parece que todo esto es un subterfugio para negociar la inclusión de PR en un Capítulo 9 regular y aceptar una Junta de Control Financiera a la Washington. Congreso sede un poco y Obama sede un poco. Obama debe saber que su propuesta está abierta a ataque constitucional, ver Art. I, sección 8, línea 4 de la Constitución Federal. Pero incluir a PR en Cap. 9 regular no lo tendría.

Que nadie cante victoria aquí. Un Supercapítulo 9 querría decir que las obligaciones generales podrían ser menoscabadas, al igual que los contratos con las uniones (ojo Utier), contratos de arrendamiento, las pensiones de los retirados (así paso en Detroit), así como cualquier otra obligación del ELA, así sea de bonos, de sentencias, de contratos de servicios, contratos de suplidores, etc. Y habrán despidos de empleados sin duda. Todo esto pasaría en un Capítulo 9 regular pero solo sobre las obligaciones de las Corporaciones públicas que puedan cumplir con los requisitos del 11 U.S.C. sec. 109(c), que requiere prueba de que es una instrumentalidad pública (no el gobierno en si), que esta insolvente, etc. En cualquier caso, la litigación va a ser intensa y no necesariamente en PR. El Chief Judge del Primer Circuito es el que determina en un Capítulo 9 que juez manejará el caso. Si más de una corporación pública radica la petición, necesitarán más de un Juez. Con los jueces de quiebra manejando más de 7,000 casos cada uno, el traer jueces de otro distrito o trasladar el caso de PR es siempre posible, máxime si es un Supercapítulo 9. Veremos

Irrespectivamente, hay cosas positivas como la paridad de Medicaid, páginas 8-9, y el Earned Income Tax Credit, páginas 9-10. Ahora a ver que acepta, si algo, hacer el Congreso, quien tiene la última palabra sobre los territorios. Si por los menos esas dos nos dan, van a ser positivo.