Puerto Rico and the Bankruptcy Clause

Abstract

Puerto Rico has about $72.6 billion in outstanding debt, and its public corporations have about $24.8 billion of that debt. But Puerto Rico's public corporation are not permitted to file for municipal bankruptcy under chapter 9 of the Bankruptcy Code.

To solve this problem, Puerto Rico recently enacted an insolvency statute, commonly called the “Recovery Act,” which is a practical blend of chapters 9 and 11 of the U.S. Bankruptcy Code. The new law provides a framework to restructure the public corporations’ debts.

Immediately after the Recovery Act was signed into law, bondholders filed two lawsuits against it. The suits contend that the Recovery Act violates the Bankruptcy Clause, which the plaintiffs argue gives the federal government the exclusive right to legislate on bankruptcy. Indeed, the plaintiffs even call for the court to recognize the existence of a “Dormant Bankruptcy Clause,” like its better-known relative in the Commerce Clause.

The plaintiffs also make a companion argument that the federal Bankruptcy Code supersedes the new Puerto Rican law, despite the exclusion of the Commonwealth’s municipal entities from the Code’s chapter 9. In short, the bondholders argue that Congress intended to preclude Puerto Rico and its divisions from any bankruptcy process whatsoever, and the Act interferes with that purpose.

None of these arguments stands up to much scrutiny. This paper explains why.

Keywords: chapter 11, chapter 9, Puerto Rico, Bankruptcy Clause, constitutional law and bankruptcy