The Supreme Court heard oral arguments on whether Chapter 9 of the federal bankruptcy code, which does not apply to Puerto Rico, nevertheless preempts a law adopted by the commonwealth that would allow its utilities to restructure their debts. The case, Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust, sat at the center of Puerto Rico's escalating fiscal crisis and would determine whether the territory had any legal tool of its own to manage billions of dollars in public utility debt.
Why Puerto Rico cannot use normal bankruptcy law
Chapter 9 of the federal Bankruptcy Code lets financially distressed municipalities reorganize their debts under court supervision, the same chapter Detroit used during its 2013 bankruptcy. Puerto Rico's municipalities and public corporations, however, are excluded from Chapter 9. In 1984, Congress amended the definition of "state" in the bankruptcy code so that Puerto Rico, unlike other states, cannot authorize its municipal entities to file under Chapter 9.
What the Recovery Act tried to do
Facing a deepening fiscal emergency, Puerto Rico's legislature passed the Puerto Rico Public Corporation Debt Enforcement and Recovery Act in 2014, modeled in part on Chapters 9 and 11 of the federal bankruptcy code. It would have allowed the commonwealth's public utilities to restructure debt outside of federal bankruptcy court. Bondholders sued to block the law, and both a federal district court and the First Circuit ruled against Puerto Rico, finding the Recovery Act was preempted.
The ruling and its aftermath
On June 13, 2016, the Supreme Court ruled 5 to 2 against Puerto Rico. Writing for the majority, Justice Clarence Thomas held that Puerto Rico is treated as a "State" for purposes of the bankruptcy code's preemption provision, even though it is excluded from the definition of "State" for accessing Chapter 9 itself. Justice Sonia Sotomayor dissented, joined by Justice Ruth Bader Ginsburg.
The decision struck down the Recovery Act and eliminated the commonwealth's only local legal avenue for restructuring public utility debt. It intensified pressure on Congress, which acted within weeks by passing PROMESA, establishing a new, court-supervised debt restructuring process that was later used to restructure billions of dollars of Puerto Rico's central government and utility debt.