In a 5-2 decision in Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust (Justice Alito recused), the U.S. Supreme Court has held that the Commonwealth of Puerto Rico may neither avail itself of the protections of Chapter 9 of the U.S. Bankruptcy Code nor, by way of a “Recovery Act,” authorize its municipalities and utilities to restructure debts owed to bondholders and various other entities (some $70 billion, at last count). Justice Thomas’s opinion for the Court rests on a strict reading of the statute, which says (in one provision) that Puerto Rico isn’t a “state” “for purposes of defining who may be a debtor under chapter 9” but defines the Commonwealth as a “state” for purposes of its preemption provision, which bars any state from enacting debt relief measures for municipalities outside Chapter 9. Justice Sotomayor’s dissent, joined by Justice Ginsburg, advocates a more “contextual” reading, which would have salvaged Puerto Rico’s Recovery Act. The majority responds that “[e]xcept in cases arising under the Affordable Care Act [stat cites omitted], our constitutional structure does not permit this Court to ‘rewrite the statute that Congress has enacted’ [citations omitted].”
Okay: I made up the subordinate “except” clause, for no reason except to highlight the institutional backdrop. The majority’s plain-text analysis—Chapter 9 is unavailable, and any other mechanism is preempted—entails that Puerto Rico has no way of restructuring debt unless Congress changes the law. The judicial expectation that Congress can’t be expected to do a darn thing has played a big role in the Court’s ACA decisions, and it wasn’t far from the justices’ mind in this case. Justice Sotomayor says that the “government and people of Puerto Rico should not have to wait for possible congressional action to avert” disaster. The majority opinion references, in an asterisk footnote, a pending House bill to assist Puerto Rico. The Court’s jurisprudence can be described as conditional textualism: provided Congress looks vaguely alert and competent, we’ll read rather than re-write its statutes.
In the case at hand, that small favor actually looms rather large. The Puerto Rico bill (“PROMESA”), helpfully summarized here, has since been approved by a broad, bipartisan House majority and is widely expected to be enacted into law. (The Court’s decision adds urgency to that course.) And while bills supported by the Stupid Party and the Evil Party always provide reasons to suspect that the act is in fact both stupid and evil, this one actually isn’t half-bad.
Miraculously, the bill recites the constitutional authority on which it rests: not the Bankruptcy Clause of Article I, but the Territories Clause of Article IV (which authorizes Congress to make “all needful rules and regulations” for the Territories). That turns out to matter because Congress could quite probably not do to states, under the Bankruptcy Clause or any other clause, what it’s here doing to Puerto Rico: establish an Oversight Board, patterned after a board established back when for the District of Columbia and urged in congressional testimony and on this site by the indispensable Alex Pollock, with comprehensive authority to revamp the place, control its budget, and propose a debt reorganization plan to a federal district court. All that, and more, without the local government’s consent and over its objections.
These draconian measures—coupled with the fact that nothing else has any chance of success—shed further light on the Chapter 9 process and its limitations. Justice Sotomayor’s dissent holds out that option as preferable for all concerned. In a word: no.
Corporate (Chapter 11) bankruptcies serve one of two purposes. Either the firm is a basket case, in which case it’s liquidated and the creditors are made whole in order or priority and so far as possible. Or else, the firm has greater value as a going concern (it just has a temporary liquidity problem), in which case the bankruptcy process serves to overcome collective action problems and to reorganize the firm—to make a “fresh start.”
For good reasons, Chapter 9 differs in countless respects. Obviously we can’t liquidate state or local governments; in any event, Chapter 9 prohibits it. Thus, Justice Sotomayor champions the “fresh start” theory. That, respectfully, is a misunderstanding.
Chapter 9 works tolerably well for genuine, temporary liquidity problems especially in small jurisdictions (as when somebody slips on a banana peel and the local mosquito abatement district, annual budget $145,000, gets hit with a million-dollar verdict). Puerto Rico and other headline-grabbing muni bankruptcies are nothing like that. Those outfits have deep structural problems, ultimately rooted in the fact that they’re allowed to govern themselves. That is why PROMESA promises to take Puerto Rico into federal receivership until the Oversight Board decides to end it. Chapter 9 doesn’t permit and indeed specifically prohibits structural reforms. Make it more like Chapter 11, let alone PROMESA: you’d have constitutional problems out the wazoo.
“Wait,” you might say. “Wasn’t Detroit effectively reorganized under Chapter 9?” Why, yes: by violating half the rules in the Bankruptcy Code and ignoring the rest. Which supports the proposition that the de facto receivership option of PROMESA is the way to go, so far as the Constitution permits. Which in turn suggests that the Court—regardless of one’s views about (con)textualist gymnastics—was well advised to let the political process work in this case.
To make it work going forward, the Oversight Board, once established, will have to do its part. The pending bill imposes receivership on Puerto Rico; it permits other territorial jurisdictions to avail themselves of that option. The Board will have to make the process sufficiently painful to serve as a deterrent, not an invitation.