Updates to our Terms of Use

We are updating our Terms of Use. Please carefully review the updated Terms before proceeding to our website.

Tuesday, May 21, 2024 | Back issues
Courthouse News Service Courthouse News Service

Resolution of Puerto Rico bankruptcy in final stretch

The First Circuit appeared reluctant to upset the applecart after five years of negotiations finally succeeded in producing a plan.

BOSTON (CN) — Against complaints from police officers, a prominent dairy company and a group of Puerto Rican credit unions that say they are being shortchanged in debt-restructuring efforts, the First Circuit appeared primed Thursday to sign off on the conclusion of the island's lengthy bankruptcy proceedings.

Federal bankruptcy law says some types of fraud claims can’t be discharged, but that language doesn’t appear in Promesa, the law passed by Congress in 2016 to allow Puerto Rico to restructure its debt.

The credit unions claim that the Puerto Rico government used its regulatory power during the debt crisis to coerce them into buying its bonds that the government knew that it couldn’t pay off. They argue that their claims shouldn’t just be erased as part of the bankruptcy proceeding because the government committed fraud and because this amounted to a “taking” of their depositors’ property without just compensation in violation of the Fifth Amendment.

“As to the fraud claim, your problem is that the fraud language in the code is not in Promesa," U.S. Circuit Judge William Kayatta noted this morning in oral arguments. "You’re kind of stuck on that, aren’t you?”

The credit unions’ lawyer, Guillermo Ramos-Luina of San Juan, responded that “discharge is a privilege and is reserved for the honest but unfortunate debtor,” and allowing the government to get away with fraud would be “contrary to the essential principles of bankruptcy law.”

U.S. Circuit Judge O. Rogeriee Thompson was dubious. “Do you think Congress doesn’t have the authority” to allow fraud to be discharged, she asked.

“Congress never thought the government would engage in fraud and that’s why they didn’t make it clear,” Ramos-Luina suggested. “Nevertheless, that’s what happened.”

The road to the largest government bankruptcy in U.S. history began in 1996 when Congress ended favorable tax treatments that had subsidized the Puerto Rico economy, leading many businesses to flee. The island managed for a while by issuing a growing number of government bonds, which were attractive because they were tax-free in every state. By 2014, however, it became obvious that the government couldn’t repay the bonds and three major credit agencies downgraded them to “junk” status.

Although Congress enacted Promesa in 2016, a bankruptcy plan wasn’t confirmed until January of this year, owing to extensive litigation as well as the pandemic. Also, Hurricane Maria devastated the island in 2017 and largely destroyed its agriculture, power grid and communications systems.

Nestor Serrano walks on the upstairs floor of his home, where the walls were blown off, in the aftermath of Hurricane Maria, in Yabucoa, Puerto Rico, on Sept. 26, 2017. (AP Photo/Gerald Herbert, File)

The plan would pay the territory’s debtors roughly 69 cents on the dollar. It wipes out the island’s public pension debt and reduces its general obligation debt by some $30 billion, slashes annual debt service obligations from $2.1 billion to $666 million, and freezes payments to most public retirees at their current level.

The credit unions, or “cooperativas,” represent some 70,000 mostly lower-class depositors and small businesses. A lower court ruled that their fraud claims could be discharged. The court ruled that takings claims in general can’t be discharged but that the credit unions didn’t have a valid takings claim — an issue being contested in a separate appeal.

Representing the Puerto Rico Financial Oversight and Management Board, Martin Bienenstock of Proskauer Rose in New York City argued Thursday that “there’s no rhyme or reason” to saying that a takings claim can’t be discharged when claims for other types of constitutional violations can be.

Kayatta, an Obama appointee, wasn’t so sure. “From 50,000 feet,” he said, “municipalities generally know in advance that they will need to file bankruptcy. Any municipality could simply find the lands they like most, take them, and then file bankruptcy and pay only bankruptcy dollars for them.”


But “if there were any evidence that that happened, a court could dismiss the case for lack of good faith,” Bienenstock replied. “There’s no evidence that happened here.”

Bienenstock put out a hypothetical where the government negligently destroyed a house and the owners brought a tort claim, saying they would get 24 cents on the dollar under the current plan. “It makes no sense that if the same house was taken they get full value,” he said.

Representing the U.S. government, Daniel Winik told the judges that they didn’t have to decide the thorny constitutional question of whether takings claims were dischargeable because they could hold that the lower court simply exercised statutory discretion not to discharge them.

“Time out,” interrupted Kayatta. “I can’t see any indication that the judge purported to exercise discretion. So how can we affirm on discretion when the judge relied on constitutional grounds?”

Kayatta then suggested remanding the case just so the judge could clarify her position and possibly allow the appeals court to avoid the issue. But he also suggested that the whole question might be moot if the court finds in the separate appeal that the credit unions haven’t made out a valid claim.

“Why do we need to be here on the takings claim?” he asked Ramos-Luina.

The judges had even less patience with Suiza Dairy, which alleged a taking based on the island government’s milk price regulations. Suiza had previously entered into a stipulation under which it was to receive some payments from the government and an ability to raise its prices, but it claims the government didn’t live up to the deal.

“When settlements like this occur, we treat it as a contract claim” that is dischargeable, the Obama-appointed Thompson told Suiza’s lawyer, Rafael Gonzalez-Valiente.

Kayatta added: “Suppose I have a car accident claim. We settle. I give up my claim and you agree to pay me $100, but you don’t pay me. Do I still have a tort claim or do I have a contract claim?”

Gonzalez-Valiente ignored the question and insisted that the settlement “did not change the essential nature of the takings claim.”

The argument by police officers and other public employees was that the plan deprived them of pension benefits, but the judges faulted their lawyer, Victor Rivera-Rios, for not intervening in the underlying proceeding when the deal came together quickly.

“I hear you saying this was adjudicated in another proceeding, but it all happened really fast, in seven to eight days, and so we should disregard it and let you attack it,” Kayatta remarked skeptically.

U.S. Circuit Judge Jeffrey Howard, George W. Bush appointee, asked: “Do you have an argument that you weren’t on notice that things might happen quickly? Why wasn’t 7 days enough?”

Bienenstock reminded the judges that the bankruptcy was a zero-sum game and that allowing the objectors to win would mean less money for other deserving creditors. “Every dollar we pay a takings claimant is going to reduce the cash available for others,” he said.

But Ramos-Luina argued in his brief that there was enough money in the plan to pay the takings claims in full, and even if there wasn’t, the creditors that would be hurt are sophisticated hedge funds that recently bought up Puerto Rico’s debt at pennies on the dollar and can afford a speculative loss.

Puerto Rico has been part of the First Circuit since 1915 as a result of a law designed to relieve the Supreme Court from having to hear frequent direct appeals from the territory. At the time the First Circuit was one of the least busy federal appeals courts and a number of wealthy New Englanders had strong financial ties to the island.

Categories / Appeals, Financial, National

Subscribe to Closing Arguments

Sign up for new weekly newsletter Closing Arguments to get the latest about ongoing trials, major litigation and hot cases and rulings in courthouses around the U.S. and the world.