On May 3, 2017, the Commonwealth of Puerto Rico declared bankruptcy under the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”). ((See Mary Williams Walsh, Puerto Rico Declares Bankruptcy, N.Y. Times (May 3, 2017), https://www.nytimes.com/2017/05/03/business/dealbook/puerto-rico-debt.html.)) Puerto Rico is now in the unique position of being the first U.S. territory to ever declare bankruptcy. Local governments have been bankrupt before with Detroit being a notable recent example. ((See Michael A. Fletcher, Detroit Files Larges Municipal Bankruptcy in U.S. History, Wash. Post (July 18, 2013), https://www.washingtonpost.com/business/economy/2013/07/18/a8db3f0e-efe6-11e2-bed3-b9b6fe264871_story.html?utm_term=.b8a6178b1053.)) In fact, Chapter 9 of the U.S. Bankruptcy Code allows municipalities to declare bankruptcy. ((See 11 U.S.C. §§ 901-946 (2010).)) However, no state or polity similar to a state has ever declared bankruptcy before a federal court. In fact, the situation is so novel that Congress passed PROMESA in order for the Commonwealth government to enter into a process similar to restructuring. ((See Richard V. Reeves & Katherine Guyot, Keeping Our PROMESA: What The U.S. Can Do About Puerto Rico’s Fiscal Crisis, Brookings Inst. (Sept. 11, 2017), https://www.brookings.edu/research/keeping-our-promesa-what-the-u-s-can-do-about-puerto-ricos-fiscal-crisis/.))
Judge Laura Swain, a former bankruptcy judge, of the Southern District of New York is presiding over the filing. ((See Swain, Laura Taylor, Fed. Jud. Ctr. (Jan. 8, 2018, 9:00 PM), https://www.fjc.gov/history/judges/swain-laura-taylor.)) Given the novelty of a territory declaring bankruptcy, Judge Swain is in a position to determine the caselaw governing such an issue. PROMESA, rather than the U.S. Bankruptcy Code, governs the filing. However, commentators have noted that PROMESA contains Chapter 9 provisions. ((See Walsh, supra note 1.)) This implies that the Code and caselaw referencing it influence PROMESA. Bankruptcy caselaw identifies a duty for debtors, following their filing for bankruptcy, to owe obligations to shareholders and to creditors. Given that the Code influences PROMESA and the case is clearly a bankruptcy filing, creditors might argue that the Commonwealth owes fiduciary duties to them not to deepen insolvency or risk substantial reductions in payments in the course of the reorganization. It is unlikely that Judge Laura Swain will apply such a duty, if it exists at all. The Code affords significant exemptions to governments. Also, the fact that the Oversight Board is managing Puerto Rico’s fiscal powers appears to indicate that fiduciary duties are unnecessary for the immediate case. Therefore, it would be inappropriate and unnecessary for creditors to rely on such fiduciary rights to protect their claims.
To begin, there appears to be a federal common law fiduciary duty to protect creditors’ interests following a bankruptcy filing. A number of federal cases suggest such a duty. When a debtor files for bankruptcy and enters the jurisdiction of a Bankruptcy Court, its fiduciary duties extend to all interested parties of an estate, including creditors. ((See Commodity Futures Trading Comm’n v. Weintraub, 471 U.S. 343, 355-56 (1985).)) Weintraub also held that a debtor-in-possession must maximize value for all interested parties, treat constituencies with conflicting interests fairly, and consider how each is affected when another is favored. ((Id. at 353, 355.)) Several circuits reinforce Weintraub’s position. ((See Hall v. Perry (In re Cochise College Park, Inc.), 703 F.2d 1339, 1357; (9th Cir. 1983); see also Federal Deposit Ins. Corp. v. Sea Pines Co., 692 F.2d 973, 977 (4th Cir. 1982) (quoting Davis v. Woolf, 147 F.2d 629, 633 (4th Cir. 1945).)) The Ninth Circuit acknowledged numerous longstanding cases that held that a trustee is a fiduciary for every creditor in an estate. ((See In re Cochise College Park, Inc. at 1357 (citing Wolf v. Weinstein, 372 U.S. 633, 650 (1963); Ford Motor Credit Co. v. Weaver, 680 F.2d 451, 461 (6th Cir.1982); Sherr v. Winkler, 552 F.2d 1367, 1374 (10th Cir.1977); Moulded Products, Inc. v. Barry, 474 F.2d 220, 224 (8th Cir. 1973).)) In addition, in In re Rigden, the Ninth Circuit formally acknowledged that a debtor-in-possession owes a fiduciary duty to all interested parties and must exercise a standard of care that an ordinary person would perform. ((In re Rigden, 795 F.2d 727, 727 (9th Cir. 1986).)) Collectively, the federal bankruptcy caselaw infers a fiduciary duty to creditors in bankruptcy cases.
Given this substantial caselaw, many claimants anxious for full or substantial repayments might seek to assert this fiduciary duty or some form of obligation against Puerto Rico before Judge Swain. PROMESA states that any federal, state, or territorial law, as applicable, governs the bankruptcy proceeding. ((40 U.S.C. § 2232 (2016).)) Aside from issues of whether or not the caselaw establishes a clear fiduciary duty to assure claimants of some form of repayment or merely to balance creditors’ interests with those of the debtor’s, Judge Swain will likely deny applying such obligations on the Commonwealth. A contrary outcome is unlikely because while the Bankruptcy Code might control PROMESA, it remains that other Code provisions might provide persuasive authority to the court to not allow claimants to assert fiduciary duties that they would against a private corporation. The Bankruptcy Code limits the term “person” and excludes “governmental units” except for circumstances when it acquires an asset from a person due to a loan or liquidation agreement, when a government is a guarantor of a pension benefit payable on its behalf, or is the legal or beneficial owner an eligible deferred compensation plan. ((See 11 U.S.C. § 101(41).)) This statute effectively prevents Chapter 9 petitions from incorporating features of Chapter 11 reorganizations, which many private actors use when not seeking a Chapter 7 liquidation of businesses. As such, Judge Swain would be influenced not to introduce fiduciary duties common in a petition for reorganization to a scenario akin to Chapter 9 actions. It would be inappropriate for claimants to rely on such fiduciary rights to protect their interests.
Supposing that Judge Swain was still free to impose an abridged form of the fiduciary duties or obligations given the sheer scope of the debt, the court’s imposition of fiduciary duties remains unlikely because of the existence of a trustee in the form of the Oversight Board. The Board has two primary obligations: (1) approve and certify the Governor’s Fiscal Plan, and (2) certify the Governor and Legislature’s Budget. ((See 48 U.S.C. §§ 2141-42 (2016).)) The Board can effectively approve or reject the Commonwealth’s fiscal decisions, which affect the government’s ability to repay the bankruptcy claimants. With this in mind, Judge Swain might rule that it is unnecessary for claimants to assert federal fiduciary duties owed to creditors when there is an alternative institution to protect their interests.
The Puerto Rico bankruptcy case is unique in that a whole separate federal statute governs the litigation and a federal-appointed Oversight Board exercises control over the sovereign debtor’s fiscal powers. Given that this is a novel bankruptcy proceeding, it is possible for Judge Swain to inject bankruptcy jurisprudence that would support requiring Puerto Rico to assure some repayments to claimants and not deepen insolvency in the course of the case. However, influential Bankruptcy Code sections and the existence of the Oversight Board as a manager for debtor Puerto Rico’s fiscal and budgetary decisions makes it inappropriate and unnecessary for the claimants to rely on such rights. This suggests that if Board approves fiscal plans that might risk lower repayments to creditors while helping Puerto Rico self-govern, then claimants cannot assert fiduciary rights to block such measures. This limitation can serve to guide future bankruptcy filings involving territorial governments, such as the U.S. Virgin Islands, which owes $6.5 billion to pensions and other debts as of July 2017. ((See Mary Williams Walsh, After Puerto Rico’s Debt Crisis, Worries Shift to Virgin Islands, N.Y. Times (June 25, 2017), https://www.nytimes.com/2017/06/25/business/dealbook/virgin-islands-debt-payment-pensions.html.)) This might also animate a debate on whether the Bankruptcy Code should be expanded to clarify to courts on how to adjudicate and apply caselaw to territorial bankruptcies and to clarify creditors’ expectations.
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