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High Court Grapples With Puerto Rico’s Debt Crisis

(CN) - With Puerto Rico cutting public services to chip away at $72 billion of debt, the Supreme Court wrangled today over whether Congress designed its local government to be the legal equivalent of Peter Pan's island.

Puerto Rico's enormous debt represents nearly 70 percent of its $103 billion gross domestic product.

Taking drastic austerity measures, Puerto Rico already has shuttered roughly 150 public schools, but a small number of wealthy mutual fund and hedge fund creditors have agitated for massive teacher lay-offs to enrich their bondholders.

Invoking the commonwealth's police powers in a time of crisis, Puerto Rico lawmakers passed the Recovery Act two years ago to restructure the debt of public utilities like electricity and water.

Mutual fund Franklin California Tax-Free Trust and hedge fund BlueMountain Capital Management argued that a 1984 amendment to the U.S. bankruptcy code specifically stripped Puerto Rico of this right.

Two lower courts have endorsed this position, including a San Juan judge and the First Circuit.

Although he found in favor of the funds, Circuit Judge Juan Torruella slammed the bankruptcy amendment that hobbled Puerto Rico as "irrational and arbitrary."

"While favoring particular economic interests - i.e., Puerto Rico creditors - to the detriment of 3 1/2 million U.S. citizens, is perhaps 'business as usual' in some political circles, one would think it hardly qualifies as a rational constitutional basis for such discriminatory legislation," he said.

On Tuesday, the Supreme Court's progressive wing questioned whether Congress actually meant to do that.

"Why would Congress put Puerto Rico in this Never­-Never Land?" Justice Ruth Bader Ginsburg asked, according to the transcript.

Puerto Rico's lawyer Christopher Landau contended that in fact Congress didn't, because the statute defined the island as a "state."

"'State' includes the District of Columbia and Puerto Rico, except for the purpose of defining who may be a debtor under Chapter 9 of this title," the law states.

Though the statute removed Puerto Rico's bankruptcy protection here, Landau argued that the law expressly granted it state-like authority to deal with the crisis.

"I think there's really no way to understand that [statute] other than to say that 'state' doesn't include Guam and the Virgin Islands," he said.

The hedge funds' lawyer Michael McGill, on the other hand, said that the historical context showed that Congress has long "micromanaged" Puerto Rico's debt, starting with the Jones Act in 1920.

When Congress passed the 1984 amendment, Puerto Rico already was swimming in $9 billion of debt, he added.

Landau derided this argument as "selective textualism," referring to the legal theory championed by the late Justice Antonin Scalia that the ordinary meaning of a statute's text should govern its interpretation.

Eric LeCompte, the executive director of the debt fairness group Jubilee USA, explained in a phone interview that the distinction was about the funds trying to pick and choose what powers Puerto Rico has as a state.

"Basically, it's a complicated way of saying you can't look at information and say that some of it is true according to its ordinary meaning and some of it is not," LeCompte said.

Based in Washington, Jubilee USA monitors what many have described as "vulture funds," which buy distressed debt in poor nations like Peru, Argentina and the Congo and then sue for the full amount.

Justice Sonia Sotomayor indirectly invoked this comparison in her questioning of the funds.

"If 98 percent of the creditors want to reorganize their debt with you and those 2 percent vultures are saying no, and a court would say it's not an impairment of a contract to redo this debt because of the need, everything else that we've said in the past, you're saying states can't do it if they can only do it under Chapter 9?" she asked.

McGill countered that U.S. territories with no access to Chapter 9 could push for congressional action.

"Now, what's going on today with respect to Puerto Rico and D.C. is Congress is addressing right now, across the street, how to deal with Puerto Rico's fiscal crisis," he said.

Indeed, Democrats last year introduced variations of the Puerto Rico Chapter 9 Uniformity Act of 2015, bills that would put its bankruptcy code in line with the rest of the nation's.

Congresswoman Nydia Velazquez, D-New York, cited the Puerto Rican debt crisis as a reason to pass the Hedge Fund Sunshine Act, which would alert regulators when these companies own more than 1 percent of a class of equity securities.

There also has been bipartisan movement for a bill that would create an oversight board regulating Puerto Rico's debt crisis, which has drawn criticism for its colonial overtones.

Setting aside the legal wrangling, Landau told the justices not to lose sight of the "flesh-and-blood" question hovering over the crisis: "Whether people in a village in Puerto Rico will be able to get clean water."

LatinoJustice PRLDEF, a Manhattan-based advocacy group, illustrated the devastation the debt crisis has had to Puerto Rico's economy in a friend-of-the court brief.

Skyrocketing unemployment and poverty have driven more than 144,000 people a year to emigrate from Puerto Rico to the U.S. mainland between 2010 and 2013, the group says.

Meanwhile, Puerto Rico's debt crisis has also taken surprising turns on the presidential campaign trail.

Former Republican candidate Marco Rubio won the Puerto Rico primary, despite counting many of its bondholders as his donors and opposing bankruptcy protection for the island.

On the Democratic side, both Hillary Clinton and Bernie Sanders have favored extending bankruptcy protection to Puerto Rico, but Sanders took a stronger line against Wall Street insurance companies that sued its government in another case.

"Vulture funds on Wall Street must understand that they cannot profit from this crisis while Puerto Rico suffers high unemployment rates, struggles to rebuild its economy and children go hungry," he said .

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