Puerto Rico is caught in a potentially crippling debt crisis. When the island’s economy started to contract in 2006, Puerto Rican officials warded off deep cuts in public services by issuing bonds. Now, the U.S. territory is over $70 billion in debt and could be forced to gut much of its educational and health care system, among other things, in order to pay its creditors.
Normally, when a debtor falls into such a deep hole, the Bankruptcy Code permits them to restructure their debts. As Justice Sonia Sotomayor explains in an opinion handed down Monday, “bankruptcy gives the debtor a ‘fresh start,’ discourages creditors from racing each other to sue the debtor, prohibits a small number of holdout creditors from blocking a compromise, protects important creditor rights such as the prioritization of debts, and allows all parties to find equitable and efficient solutions to fiscal problems.”
Sotomayor, however, wrote these words in a dissenting opinion. According to Justice Clarence Thomas’ majority opinion in Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust, a quirk in the Bankruptcy Code locks Puerto Rico out of legal protections afforded to nearly any other debtor. Your profligate uncle can obtain relief through bankruptcy, but the people of Puerto Rico must suffer.
The Puerto Rico case concerns about $20 billion of Puerto Rico’s debt, which is owed by the islands publicly-owned utilities companies. As Sotomayor explains, “these utilities provide power, water, sewer, and transportation to residents of the island.” Yet, “with rising interest rates and limited access to capital markets, their debts are proving unserviceable.” The utilities claim that, unless the law steps in to allow them to restructure their debts, “they will be unable to pay for things like fuel to generate electricity, which will lead to rolling blackouts.” Meanwhile, “other vital public services will be imperiled, including the utilities’ ability to provide safe drinking water, maintain roads, and operate public transportation.”
These lost services, moreover, are likely to exacerbate Puerto Rico’s debt problems, as Puerto Ricans with means flee the island to places that are able to provide them with basic services. That would depress Puerto Rico’s tax base even further, potentially forcing deeper cuts, which will lead even more residents to flee.
Your profligate uncle can obtain relief through bankruptcy, but the people of Puerto Rico must suffer.
If public utility companies in one of the 50 states found themselves in a similar situation, they could seek relief through bankruptcy. The provision of the Bankruptcy Code laying out “who may be a debtor” permits “a municipality” (a term that encompasses cities but also includes government-owned utilities) to declare bankruptcy, provided that it is specifically authorized to do so by the state.
The Puerto Rican utilities, however, do not have access to municipal bankruptcy under federal law because of a provision which provides that “the term ‘State’ includes the District of Columbia and Puerto Rico, except for the purpose of defining who may be a debtor under chapter 9 of this title.” Thus, the Bankruptcy Code requires municipalities to seek their state’s permission before they can declare bankruptcy, but Puerto Rico does not count as a “State” for purposes of this provision. The island’s utilities are effectively locked out of the protections afforded to similar debtors in the 50 states.
To compensate for this problem, Puerto Rico enacted the Puerto Rico Corporation Debt Enforcement and Recovery Act, which effectively creates a special bankruptcy code under the island’s own law that fills the gap in federal law. The problem with this law, according to Justice Thomas, is that it runs afoul of another provision of the federal Bankruptcy Code that prevents states from enforcing their own bankruptcy provisions against unwilling creditors. That provision restricts “a State law prescribing a method of composition of indebtedness.”
The primary disagreement between Thomas and Sotomayor is whether Puerto Rico can count as a “State” for purposes of this later provision but not for purposes of its ability to greenlight municipal bankruptcies.
Thomas’ argument, that Puerto Rico effectively lives in the worst of both worlds, is not a frivolous one. Indeed, it is worth noting that left-of-center Justices Stephen Breyer and Elena Kagan both join Thomas’ opinion. Thomas argues that the Bankruptcy Code’s provision defining the word “State” only excludes Puerto Rico “for the purpose of defining who may be a debtor.” The definition, he argues, does not exclude Puerto Rico for other purposes, such as the provision preventing the island from enforcing its own bankruptcy law.
Whatever the legal merits of Thomas’ opinion, however, it is likely to be a disaster for the people of Puerto Rico, unless a higher power intervenes. Sotomayor closes her dissent with what is effectively a prayer to such a higher power — “Congress could step in to resolve Puerto Rico’s crisis” — and, indeed, Congress is considering legislation that would afford some relief to the island. It would do so, however, at a very high price. Legislation that passed the U.S. House last Thursday would place much of Puerto Rico’s fiscal future in the hands of a seven-member federal control board, something some of Puerto Rico’s leaders view as akin to colonialism.
After the Supreme Court’s decision on Monday, however, Puerto Rico will not be able to rely upon the most natural solution afforded to a debtor in over their heads: ordinary bankruptcy. The House-passed legislation, in other words, may be their only hope.