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.
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.”