Puerto Rico is facing the most critical fiscal situation in its history. Its public corporations are especially compromised, overwhelmed by growing deficits and unsustainable debt loads but barred from reorganizing under federal law. Last June, Puerto Rico enacted the Puerto Rico Public Corporation Debt Enforcement and Recovery Act, which allows eligible public corporations to restructure their debt burdens.
The Recovery Act is likely preempted by federal bankruptcy law. Although the Recovery Act was justified as a valid exercise of the Commonwealth’s police power, the statute is likely unconstitutional under the Supremacy Clause. Where state law conflicts with federal law — as does the Recovery Act with section 903 of the Bankruptcy Code — the state law is preempted. On February 6, 2015 Judge Francisco Besosa of the U.S. District Court for the District of Puerto Rico held this was the case in Franklin California Tax-Free Trust v. Commonwealth of Puerto Rico and Blue Mountain Capital Management v. Governor Alejandro Garcia-Padilla.
Yet despite the Recovery Act’s probable constitutional infirmity, the threat of potential public corporation default nonetheless exerted sufficient pressure to motivate temporary consensual relief. In choosing this approach, Puerto Rico risks weakening outside investor interest in future securities offerings. But perhaps such high-stakes federalism will prompt Congress to reconsider the basis for and desirability of Puerto Rico’s idiosyncratic treatment under Chapter 9 of the Bankruptcy Code, and elsewhere in federal law.
This article was published in the Harvard Law Review, February 2015. To read the full article, click here.
This post comes from Robert Niles (J.D./M.B.A. ’16), a member of the Bankruptcy Roundtable team