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July 07, 2015

Kramer Levin Wins First Circuit Appeal Declaring Puerto Rico’s Restructuring Act Unconstitutional

On July 6, 2015, Kramer Levin clients Franklin Mutual and Oppenheimer funds scored a major win when the United States Court of Appeals ruled 3-0 that Puerto Rico’s Debt Enforcement and Recovery Act is pre-empted by the Federal Bankruptcy Code.

Puerto Rico had adopted the Act to compel a restructuring of over $18 billion in bonds issued by the Commonwealth’s electric, sewer and highway corporations. Kramer Levin’s victory protects bondholders across the United States from Puerto Rico’s now-void statute and from any other state attempting to enact a similar statute.

Franklin Mutual and Oppenheimer Funds hold over $1.5 billion in electric company bonds and retained Kramer Levin on June 27, 2014; Kramer Levin filed a complaint challenging the act within 24 hours, on the day the Act was signed into law. Later joined by Blue Mountain (represented by Gibson Dunn’s Ted Olson and Matt McGill), Franklin and Oppenheimer prevailed in United States District Court for the District of Puerto Rico on February 6, 2015. The First Circuit affirmed Judge Besosa after an expedited appeal, rejecting arguments made for Puerto Rico.

Puerto Rico’s act was the first municipal restructuring law enacted since the Great Depression. Puerto Rico argued that the Bankruptcy Code did not prevent the enactment of municipal restructuring laws generally and that Puerto Rico, in particular, is free to enact its own restructuring law because a 1984 amendment had excluded Puerto Rico’s municipal corporations from relief under the Bankruptcy Code. The First Circuit disagreed.

Chief Judge Lynch, joined by Judge Howard, observed that municipal bankruptcy statutes must navigate between Contract Clause protection of creditors and Tenth Amendment protection of states’ rights, and held that “Congress has retained for itself the authority to decide which solution best navigates the gauntlet in Puerto Rico’s case . . . . We must respect Congress’ decision to retain this authority.” The Court held that preemption "follows straightforwardly from the plain text and is confirmed by both statutory history and legislative history," and rejected the Commonwealth's "unsound and unsuccessful alternative readings."

The Court’s opinion also questions whether the Tenth Amendment applies to Puerto Rico – an issue not previously addressed by any reported decision.

In a concurring opinion, Judge Toruella agreed that the Debt Enforcement and Recovery Act was pre-empted but also opined that Congress’ exclusion of Puerto Rico’s municipal corporations from the Bankruptcy Act was unconstitutional.

The Kramer Levin litigation team who worked on the matter included Thomas Moers Mayer, Amy Caton, Philip Bentley, P. Bradley O’Neill, Jonathan Wagner, David Blabey Jr., Tobias Jacoby, Rachael Ringer, Alice Byowitz, Douglas Buckley, and David Mayo.

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