The Puerto Rico v. Franklin Trust case and its impact, explained

by | Aug 29, 2016 | Courts, Headlines | Comments

On June 13, the US Supreme Court voted 5-2 to reject Puerto Rico’s bid to restructure portions of its massive bond debt through their own public utilities. This ruling effectively denies Puerto Rico self-control over debt management, forcing Congress to pass legislation to allow for the enactment of any debt restructuring reforms.

The case at hand, Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust, marks the third consecutive ruling against Puerto Rican interests. Previously, the ruling on double jeopardy case Puerto Rico v Sanchez Valle barred Puerto Rico from prosecuting individuals previously tried in the US for the same crime, weakening Puerto Rican judicial autonomy. Further, denial of review on Tuaua v. United States affirmed Puerto Ricans do not receive automatic US birthright citizenship.

The ruling on Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust officially affirms Puerto Rico’s ultimate financial subservience to its mainland protectors. Clarence Thomas delivered the crushing majority opinion, holding that while not officially a state, Puerto Rico should be treated as a state within the preemption provision of Chapter 9 bankruptcy regulations. In other words, the island cannot pass autonomous bankruptcy laws that conflict with Chapter 9. Puerto Rico thus lacks both protection under American bankruptcy code and the autonomy to capably restructure its debts.

 

Background

Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust likely should have never existed. Prior to 1984, US bankruptcy law allowed Puerto Rico to authorize municipalities and public corporations to enter bankruptcy.

A 1978 Jimmy Carter endorsed amendment to Chapter 9 bankruptcy law defined a public entity able to declare bankruptcy as “a political subdivision or public agency or instrumentality of a State.” The amendment succeeded in finally defining the exact institutions able to file for bankruptcy, yet incredibly failed to define the precise definition of a state.

Arizona’s Democratic senator, Dennis DeConcini, proceeded to introduce the 1979 Bankruptcy Technical Amendments Act, which if passed would “amend the definition of ‘State’ to include the Commonwealth of Puerto Rico, the Panama Canal Zone, the District of Columbia, and any territory or possession of the United States.” The amendment passed through the Senate without alteration. However, the Democrat-controlled House Judiciary Committee modified the bill’s definition of a state, redefining the term “state” to include “the District of Columbia and Puerto Rico, except for the purpose of who may be a debtor under Chapter 9 of this title.” This small shift in wording effectively stripped Puerto Rico of access to federal bankruptcy law. Without protection, Puerto Rico must employ other means to protect against debt insolvency.

Former House Judiciary Committee bankruptcy consultant Kenneth Klee once testified that “there is no legislative history explaining the purpose or rationale” for the language. The wording change remains a baffling mystery. No official reason for the shift has ever been given on record. Puerto Rico municipalities showed no signs of needing to seek protection under bankruptcy law at the time. The island’s classically liberal economic policy had created a very stable economy, providing no reason for the exclusion from protection.

The amended Bankruptcy Technical Amendments Act never officially passed into law. Eventually, its core provisions, including the unintentionally devastating definition of a state, were incorporated into the Bankruptcy Amendments and Federal Judgeship Act of 1984. This bill passed swiftly though Congress, was signed by Ronald Reagan, and set into motion the events leading to Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust.

 

The Case

In 2014, Puerto Rico passed the Public Corporation Debt Enforcement and Recovery Act, allowing public corporations to restructure their debts without adhering to US federal bankruptcy codes. In other words, Puerto Rico would’ve autonomously restructured up to one third of its debt, allowing the island to avoid default on its bond debts.

The bill explicitly provides protections for creditors not offered under Chapter 9 bankruptcy regulations. Under current federal law, Congress must pass specific provisions to allow states to pass debt-restructuring acts outside Chapter 9 bylaws. The Recovery Act posed a direct challenge to this provision, arguing that Puerto Rico’s lack of protection under Chapter 9 allows the island to pass its own autonomous debt restructuring legislation.

A group of the island’s major investors challenged the Recovery Act, filing suit against Puerto Rico and arguing that the 1984 amendment prevents the island from either seeking protection under Chapter 9 or enacting its own bankruptcy policy. Since Puerto Rico is not treated as a state under Chapter 9, it can’t file for bankruptcy. And since Puerto Rico is treated as a state by all other forms of financial law, it can’t create its own bankruptcy laws.

Prior to Supreme Court action on the investors’ case, Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust, a district court ruled in favor of the plaintiffs, which the US Court of Appeals for the First Circuit then affirmed. Both courts ruled in favor of the plaintiffs on the grounds that Congress must first amend Chapter 9 prior to passage of autonomous Puerto Rican bankruptcy law. Each court refused to overturn the 1984 amendment, blocking the immediate implementation of the Recovery Act.

The Supreme Court granted a hearing on Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust on December 4, 2015, argued the case on March 22, 2016, and delivered their ruling on June 13. Congress made unprecedented progress on debt-restructuring legislation during this time period, pushing the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) to the brink of passage. (President Obama signed the bill into law on June 30.)

A ruling in favor of Puerto Rico would have prevented the necessity for passage of PROMESA and allowed Puerto Rico to implement autonomous legislation to fix its debt crisis. Instead, as previously stated, the Clarence Thomas written decision struck two major blows into the island’s heart. First, the Supreme Court ruled that Chapter 9 bankruptcy law preempts any law in conflict with its bylaws. This officially ended any chance of passage of the Recovery Act and any future autonomous Puerto Rican bankruptcy legislation. Second, and even more frustratingly, the Court ruled against granting Puerto Rico access to Chapter 9 bankruptcy protection, upholding the meaning of “state” to include Puerto Rico under all provisions except for Chapter 9.

Sonia Sotomayor and Ruth Bader Ginsburg dissented from the ruling. Sotomayor argued that since Puerto Rico is not a state under Chapter 9, it should not be preempted from passing autonomous legislation.

 

Three Effects

Post-ruling, and with the enactment of PROMESA, Puerto Rico will functionally operate as a US fiscal colony. The US can and will control Puerto Rican economic policy, playing the role of benevolent savior to its unruly child. The government of Puerto Rico has been stripped of nearly all fiscal power, and will be forced to turn to Congress to enact major economic change. Need for Congressional approval will likely slow down the island’s ability to reform and will force further incorporation within the greater US framework. Puerto Rican economic autonomy is all but gone.

On June 30, President Obama signed PROMESA into law. PROMESA establishes an independent, Congressionally controlled economic oversight board to manage the restructuring of the island’s debt. This may lead to temporary recovery, and produce positive short-term economic growth. Yet, the colonial aspects of an economic oversight board strip Puerto Rico of its chance to rebuild a more stable economy with a truly sustainable job market. Without full incorporation into the US statehood framework, Puerto Rico will likely fall back into the same cycle of economic boom and recession.

The ruling also leaves Puerto Rico in statehood purgatory, as PROMESA paradoxically pushes the island both further and closer toward a need for full statehood incorporation. More than ever, the island is a true US colony, stripped of rights granted to states and forced to enact legislation as dictated by a foreign Congress. However, the US must now handle the massive Puerto Rican debt without Puerto Rican help. Full statehood would be a practical solution to this increasingly confusing situation. While highly inconclusive, tentative polling data indicates Puerto Rican support for statehood is on the rise. In a recent El Nuevo Dia poll, 65 percent of polled Puerto Rican citizens supported statehood, while only 28 percent supported independence.

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