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Puerto Rico v. Franklin California Tax-Free Trust: Puerto Rico is a State for Purposes of the Federal Bankruptcy Code’s Preemption Provision

Case AnalysisAlexis Gebhardt

Puerto Rico v. Franklin Cal. Tax-Free Trust, 136 S. Ct. 1938 (2016).
Opinion issued June 13, 2016.  Westlaw Link
Written by: Alexis Gebhardt, Editor in Chief

 The petitioner was facing a financial crisis where a $20 billion debt, shared by three government-owned public utilities companies, was assumed by a government-owned bank facing a financial crisis of its own. In response to the crisis, the petitioner passed a Recovery Act allowing the public utilities to restructure their debt. This debt modification allowed the public utilities to propose changes to the terms of their outstanding debt instruments, such as interest rates or maturity dates, by which all creditors would be bound. The respondent claimed that the Federal Bankruptcy Code prohibited the petitioner from implementing its own municipal bankruptcy system.

 The issue before the Court was whether the petitioner was a “state” for purposes of the preemption provision of 11 U.S.C § 903, which prohibits a state from implementing its own municipal bankruptcy system. The Court analyzed three different provisions of the Federal Bankruptcy Code: (1) the definition of “state”; (2) who constitutes a debtor requiring a state to specifically authorize relief under Chapter 9 prior to filing a petition; and (3) the preemption provision—barring states from enacting their own municipal bankruptcy systems. Section 101 of the Federal Bankruptcy Code defines “state” to include the petitioner, but does not define who may be a debtor under Chapter 9 bankruptcy proceedings. Section 109(c) of the Federal Bankruptcy Code explains that an entity can be a debtor under Chapter 9 if it is a municipality, but a state must specifically authorize it to seek Chapter 9 relief. By analyzing the language of the statutes, the Court held that the petitioner is not a “state” for purposes of the gateway provision of § 109(c), and cannot, therefore, specifically authorize municipalities to seek Chapter 9 relief.  On the other hand, the Court held that the petitioner is a state for purposes of the § 903 preemption provision, which prohibits a state from enacting a municipal bankruptcy system of its own.  The Court stated that Congress specifically excluded the petitioner from being defined as a debtor under Chapter 9, but did not remove it from the scope of Chapter 9’s preemption provision.  Therefore, the petitioner is prevented from enacting its own bankruptcy system and is preempted by federal law. 

This ruling has made it clear that Puerto Rico has not been afforded the same bankruptcy protections as the states within the contiguous United States.