BlueMountain Capital Management, LLC v. Garcia-Padilla, et al

Filing 46

OPINION AND ORDER re 29 Motion to Dismiss. The Court GRANTS in part and DENIES in part the Commonwealth defendants' motion to dismiss, Docket No. 29. The motion is GRANTED as to plaintiff's stay of federal court proceedings claim and DENIED as to plaintiff's preemption and contract clauses claims. The stay of federal court proceedings claim is DISMISSED WITHOUT PREJUDICE. Signed by Judge Francisco A. Besosa on 02/06/2015. (RRS)

UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF PUERTO RICO
FRANKLIN CALIFORNIA TAX-FREE
TRUST, et al.,
Plaintiffs,
Civil No. 14-1518 (FAB)
v.
COMMONWEALTH OF PUERTO RICO, et
al.,
Defendants.
BLUEMOUNTAIN CAPITAL
MANAGEMENT, LLC,
Plaintiff,
Civil No. 14-1569 (FAB)
v.
ALEJANDRO J. GARCIA-PADILLA, et
al.,
Defendants.

OPINION AND ORDER
BESOSA, District Judge.
Plaintiffs in these two cases seek a declaratory judgment that
the Puerto Rico Public Corporation Debt Enforcement and Recovery
Act (“Recovery Act”) is unconstitutional.

(Civil No. 14-1518,

Docket No. 85; Civil No. 14-1569, Docket No. 20.) Before the Court
are three motions to dismiss plaintiffs’ complaints and one crossmotion for summary judgment.
For the reasons explained below, the Court GRANTS in part and
DENIES in part the three motions to dismiss, (Civil No. 14-1518,

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

2

Docket Nos. 95 & 97; Civil No. 14-1569, Docket No. 29), and GRANTS
in part and DENIES in part the cross-motion for summary judgment,
(Civil No. 14-1518, Docket No. 78).

Because the Recovery Act is

preempted by the federal Bankruptcy Code, it is void pursuant to
the Supremacy Clause of the United States Constitution.
I. BACKGROUND
Plaintiffs collectively hold nearly two billion dollars of
bonds issued by the Puerto Rico Electric Power Authority (“PREPA”).
As background for the bases of plaintiffs’ claims challenging the
constitutionality of the Recovery Act, the Court first summarizes
relevant provisions of the PREPA Authority Act (which authorized
PREPA to issue bonds), the Trust Agreement (pursuant to which PREPA
issued bonds to plaintiffs), the Recovery Act itself, and Chapter
9 of the federal Bankruptcy Code.
A.

The Authority Act of May 1941
In

May

1941,

the

Commonwealth

of

Puerto

Rico

(“the

Commonwealth”) enacted the Puerto Rico Electric Power Authority Act
(“Authority Act”), P.R. Laws Ann. tit. 22 §§ 191-239, creating
PREPA and authorizing it to issue bonds, id. §§ 193, 206.

Through

the Authority Act, the Commonwealth expressly pledged to PREPA
bondholders “that it will not limit or alter the rights or powers
hereby vested in [PREPA] until all such bonds at any time issued,
together with the interest thereon, are fully met and discharged.”
Id.

§

215.

The

Authority

Act

also

expressly

gives

PREPA

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

3

bondholders the right to seek the appointment of a receiver if
PREPA defaults on any of its bonds.
B.

Id. § 207.

The Trust Agreement of January 1974
PREPA issued the bonds underlying these two lawsuits pursuant

to a trust agreement with U.S. Bank National Association as
Successor

Trustee,

dated

January

1,

1974,

as

amended

and

supplemented through August 1, 2011 (“Trust Agreement”). The Trust
Agreement

contractually

requires

PREPA

interest on plaintiffs’ bonds promptly.

to

pay

principal

and

Trust Agreement § 701.

Plaintiffs’ bonds are secured by a pledge of PREPA’s present and
future revenues, id., and PREPA is prohibited from creating a lien
equal to or senior to plaintiffs’ lien on these revenues, id. §
712.

Upon the occurrence of an “event of default,” as the term is

defined

in

accelerate

the

Trust

payments,

Agreement,

seek

the

plaintiff

appointment

bondholders

of

a

receiver

may
“as

authorized by the Authority Act,” and sue at law or equity to
enforce the terms of the Trust Agreement.

Id. §§ 802-804.

An

event of default occurs when, among other things, PREPA institutes
a proceeding “for the purpose of effecting a composition between
[PREPA] and its creditors or for the purpose of adjusting the
claims of such creditors pursuant to any federal or Commonwealth
statute now or hereafter enacted.”

Id. § 802(g).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
C.

4

The Recovery Act of June 2014
On June 25, 2014, the Commonwealth Senate and House of

Representatives approved the Recovery Act, and on June 28, 2014,
the Governor signed the Recovery Act into law.
Statement

of

Motives

indicates

that

The Recovery Act’s

Puerto

Rico’s

public

corporations, especially PREPA, “face significant operational,
fiscal, and financial challenges” and are “burdened with a heavy
debt load as compared to the resources available to cover the
corresponding debt service.”

Recovery Act, Stmt. of Motives, § A.

To address this “state of fiscal emergency,” the Recovery Act
establishes two procedures for Commonwealth public corporations to
restructure their debt.
creates

the

Courtroom

Public

Id., Stmt. of Motives, §§ A, E.

Sector

(hereinafter,

Debt

Enforcement

“special

court”)

and
to

It also

Recovery
preside

Act
over

proceedings and cases brought pursuant to these two procedures.
Id. § 109(a).
The first restructuring procedure is set forth in Chapter 2 of
the Recovery Act and permits an eligible public corporation to seek
debt

relief

from

its

creditors

with

authorization

Government Development Bank for Puerto Rico (“GDB”).
§ 201(b).

from

the

Recovery Act

The public corporation invoking this approach proposes

amendments, modifications, waivers, or exchanges to or of a class
of specified debt instruments.

Id. § 202(a).

If creditors

representing at least fifty percent of the debt in a given class

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

5

vote on whether to accept the changes, and at least seventy-five
percent of participating voters approve, then the special court may
issue an order approving the transaction and binding the entire
class.

Id. §§ 115(b), 202(d), 204.

Chapter

3

of

the

restructuring approach.

Recovery

Act

sets

forth

the

second

Under this approach, an eligible public

corporation, again with GDB approval, submits to the special court
a petition that lists the amounts and types of claims that will be
affected by a restructuring plan.

Recovery Act § 301(d). The

public corporation then files a proposed restructuring plan or a
proposed transfer of the corporation’s assets.

Id. § 310.

The

special court may confirm the plan if the plan meets certain
requirements, id. § 315, including a requirement that “at least one
class of affected debt has voted to accept the plan by a majority
of all votes cast in such class and two-thirds of the aggregate
amount of affected debt in such class that is voted,” id. § 315(e).
The special court’s confirmation order binds all of the public
corporation’s creditors to the restructuring plan.

Id. § 115(c).

Chapter 2 of the Recovery Act provides for a suspension period
and Chapter 3, an automatic stay, during which time creditors may
not assert claims or exercise contractual remedies against the
public corporation debtor that invokes the Recovery Act.
Recovery Act §§ 205, 304.

See

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
D.

6

Chapter 9 of the Federal Bankruptcy Code
The Recovery Act is modeled on Title 11 of the United States

Code (“the federal Bankruptcy Code”), and particularly on Chapter
9 of that title.

Recovery Act, Stmt. of Motives, § E.

Chapter 9

governs the adjustment of debts of a municipality, 11 U.S.C. §§ 901
et

seq.,

and

“municipality”

includes

instrumentality of a state, id. § 101(40).

a

public

agency

or

A municipality seeking

to adjust its debts pursuant to Chapter 9 must receive specific
authorization from its state.

Id. § 109(c)(2).

municipalities

prohibited

are

expressly

adjustment pursuant to Chapter 9.

from

Puerto Rico
seeking

debt

Id. § 101(52).

II. THE PRESENT LITIGATION
A.

Franklin and Oppenheimer Rochester Plaintiffs’ Second Amended
Complaint (Civil No. 14-1518)
Franklin plaintiffs1 are Delaware corporations or trusts that

collectively

hold

approximately

$692,855,000

(Civil No. 14-1518, Docket No. 85 at ¶ 3.)

1

of

PREPA

bonds.

Oppenheimer Rochester

The Court refers to the following parties collectively as “Franklin
plaintiffs”: Franklin California Tax-Free Trust (for the Franklin California
Intermediate-Term Tax Free Income Fund), Franklin Tax-Free Trust (for the series
Franklin Federal Intermediate-Term Tax-Free Income Fund, Franklin Double Tax-Free
Income Fund, Franklin Colorado Tax-Free Income Fund, Franklin Georgia Tax-Free
Income Fund, Franklin Pennsylvania Tax-Free Income Fund, Franklin High Yield
Tax-Free Income Fund, Franklin Missouri Tax-Free Income Fund, Franklin Oregon
Tax-Free Income Fund, Franklin Virginia Tax-Free Income Fund, Franklin Florida
Tax-Free Income Fund, Franklin Louisiana Tax-Free Income Fund, Franklin Maryland
Tax-Free Income Fund, Franklin North Carolina Tax-Free Income Fund, and Franklin
New Jersey Tax-Free Income Fund), Franklin Municipal Securities Trust (for the
series Franklin California High Yield Municipal Bond Fund and Franklin Tennessee
Municipal Bond Fund), Franklin California Tax-Free Income Fund, Franklin New York
Tax-Free Income Fund, and Franklin Federal Tax-Free Income Fund.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

7

plaintiffs2 are Delaware statutory trusts that hold approximately
$866,165,000 of PREPA bonds.
Franklin
amended

and

Oppenheimer

complaint

against

Id. at ¶ 4.

Rochester
the

On August 11, 2014, the

plaintiffs

Commonwealth

filed
of

a

second

Puerto

Rico,

Alejandro Garcia-Padilla (in his official capacity as Governor of
Puerto Rico), Melba Acosta (in her official capacity as a GDB
agent), and PREPA.

(Civil No. 14-1518, Docket No. 85.)

The

Franklin and Oppenheimer Rochester plaintiffs seek declaratory
relief on the following claims: (1) Preemption: that the Recovery
Act in its entirety is preempted by section 903 of the federal
Bankruptcy Code and violates the Bankruptcy Clause of the United
States Constitution; (2) Contract Clause: that sections 108, 115,
202, 312, 315, and 325 of the Recovery Act violate the Contract
Clause

of

the

United

States

Constitution

by

impairing

the

contractual obligations imposed by the Authority Act and the Trust
Agreement; (3) Takings Clause: that the Recovery Act violates the
Takings Clause of the United States Constitution by taking without
2

The Court refers to the following parties collectively as “Oppenheimer
Rochester plaintiffs”: Oppenheimer Rochester Fund Municipals, Oppenheimer
Municipal Fund (on behalf of its series Oppenheimer Rochester Limited Term
Municipal Fund), Oppenheimer Multi-State Municipal Trust (on behalf of its series
Oppenheimer Rochester New Jersey Municipal Fund, Oppenheimer Rochester
Pennsylvania Municipal Fund and Oppenheimer Rochester High Yield Municipal Fund),
Oppenheimer Rochester Ohio Municipal Fund, Oppenheimer Rochester Arizona
Municipal Fund, Oppenheimer Rochester Virginia Municipal Fund, Oppenheimer
Rochester Maryland Municipal Fund, Oppenheimer Rochester Limited Term California
Municipal Fund, Oppenheimer Rochester California Municipal Fund, Rochester
Portfolio Series (on behalf of its series Oppenheimer Rochester Limited Term New
York Municipal Fund), Oppenheimer Rochester AMT-Free Municipal Fund, Oppenheimer
Rochester AMT-Free New York Municipal Fund, Oppenheimer Rochester Michigan
Municipal Fund, Oppenheimer Rochester Massachusetts Municipal Fund, Oppenheimer
Rochester North Carolina Municipal Fund, and Oppenheimer Rochester Minnesota
Municipal Fund.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
just

compensation

appointment

of

plaintiffs’

a

receiver,

8

contractual

see

Recovery

right
Act

§

to

seek

the

108(b),

and

plaintiffs’ lien on PREPA revenues, see id. §§ 129(d), 322(c); and
(4) Stay of Federal Court Proceedings: that section 304 of the
Recovery Act unconstitutionally authorizes a stay of federal court
proceedings

when

a

public

corporation

files

for

debt

relief

pursuant to the Recovery Act. (Civil No. 14-1518, Docket No. 85 at
¶¶ 58-71.)
B.

Franklin and Oppenheimer Rochester Plaintiffs’ Cross-Motion
for Summary Judgment
On August 11, 2014, the Franklin and Oppenheimer Rochester

plaintiffs filed a cross-motion for summary judgment on their
preemption and stay of federal court proceedings claims (while
opposing original motions to dismiss).

(Civil No. 14-1518, Docket

No. 78.)
C.

Plaintiff BlueMountain’s Amended Complaint (Civil No. 14-1569)
BlueMountain Capital Management, LLC (for itself and for and

on behalf of investment funds for which it acts as investment
manager) (“BlueMountain”) is a Delaware company that holds PREPA
bonds and that manages funds that hold more than $400,000,000 of
PREPA bonds.

(Civil No. 14-1569, Docket No. 20 at ¶ 6.)

On August

12, 2014, BlueMountain filed an amended complaint against Alejandro
Garcia-Padilla (in his official capacity as Governor of Puerto
Rico), Cesar R. Miranda Rodriguez (in his official capacity as the
Attorney General of Puerto Rico), and John Doe (in his official

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
capacity as a GDB agent).

9

(Civil No. 14-1569, Docket No. 20.)

Plaintiff BlueMountain seeks declaratory relief on the following
claims: (1) Preemption: that the Recovery Act in its entirety is
preempted

by

the

federal

Bankruptcy

Code

and

violates

the

Bankruptcy Clause of the United States Constitution; (2) Contract
Clauses: that the Recovery Act impairs the contractual obligations
imposed by the Authority Act and the Trust Agreement and therefore
violates the contract clauses of the United States and Puerto Rico
constitutions; and (3) Stay of Federal Court Proceedings: that
sections

205

and

304

of

the

Recovery

Act

unconstitutionally

authorize a stay of federal court proceedings when a public
corporation files for debt relief pursuant to the Recovery Act.
(Civil No. 14-1569, Docket No. 20 at ¶ 83.)
D.

Consolidation Order
On August 20, 2014, the Court consolidated Civil Case Nos. 14-

1518 and 14-1569.

In so doing, the Court aligned the briefing

schedules for both cases but did not merge the suits into a single
cause of action or change the rights of the parties.

(Civil No.

14-1518, Docket No. 92; Civil No. 14-1569, Docket No. 26.)
The two cases contain overlapping claims but are distinct in
three salient ways.

First, the Franklin and Oppenheimer Rochester

plaintiffs bring suit against Commonwealth defendants and PREPA (in
Civil No. 14-1518), whereas BlueMountain names only Commonwealth
defendants (in Civil No. 14-1569).

Second, only the Franklin and

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

10

Oppenheimer Rochester plaintiffs raise a Takings Clause claim.
Third, only BlueMountain brings a Puerto Rico Constitution Contract
Clause claim.
E.

Commonwealth and PREPA Motions to Dismiss
On September 12, 2014, the Commonwealth defendants3 moved to

dismiss the Franklin and Oppenheimer Rochester plaintiffs’ second
amended complaint and BlueMountain’s amended complaint, and opposed
the Franklin and Oppenheimer Rochester plaintiffs’ cross-motion for
summary judgment.

(Civil No. 14-1518, Docket No. 95, mem. at

Docket No. 95-1; Civil No. 14-1569, Docket No. 29, mem. at Docket
No. 29-1.)4

The Commonwealth defendants argue that plaintiffs’

claims are unripe and fail on the merits as a matter of law.
PREPA joined the Commonwealth defendants’ motion to dismiss
the Franklin and Oppenheimer Rochester plaintiffs’ second amended
complaint and opposition to the cross-motion for summary judgment.
(Civil No. 14-1518, Docket No. 97 at p. 1.)

PREPA also filed its

own motion to dismiss, arguing that the Franklin and Oppenheimer

3

The following parties are collectively referred to as the “Commonwealth
defendants”: the Commonwealth of Puerto Rico, Alejandro Garcia-Padilla (in his
official capacity as Governor of Puerto Rico), Cesar R. Miranda Rodriguez (in his
official capacity as Attorney General of Puerto Rico), Melba Acosta (in her
official capacity as a GDB agent), and John Doe (in his official capacity as a
GDB agent).

4

These two memoranda are identical. Compare Civil No. 14-1518, Docket No. 95-1,
with Civil No. 14-1569, Docket No. 29-1. That is, the Commonwealth defendants
raised identical arguments in moving to dismiss the Franklin and Oppenheimer
Rochester plaintiffs’ second amended complaint and BlueMountain’s amended
complaint.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

11

Rochester plaintiffs lack standing and that their claims are
unripe.

(Civil No. 14-1518, Docket No. 97.)

The Franklin and Oppenheimer Rochester plaintiffs opposed the
Commonwealth defendants’ motion and PREPA’s motion, (Civil No. 141518, Docket No. 102), and BlueMountain opposed the Commonwealth
defendants’ motion, (Civil No. 14-1569, Docket No. 41).

The

Commonwealth defendants replied, (Civil No. 14-1518, Docket No.
108; Civil No. 14-1569, Docket No. 44),5 as did PREPA (Civil No.
14-1518, Docket No. 109).
III. SUBJECT MATTER JURISDICTION
Defendants challenge the Court’s subject matter jurisdiction
and seek dismissal pursuant to Federal Rule of Civil Procedure
12(b)(1) (“Rule 12(b)(1)”).

Defendants argue that plaintiffs’

claims are unripe because PREPA has not sought to restructure its
debt pursuant to the Recovery Act.

Therefore, defendants argue,

plaintiffs have no basis to claim that the Recovery Act injured
plaintiffs in their capacity as PREPA bondholders.

(Civil No. 14-

1518, Docket No. 95-1 at pp. 8-13; Civil No. 14-1569, Docket No.
29-1

at

pp.

8-13.)

In

addition

to

this

ripeness

argument,

defendant PREPA argues separately that the Franklin and Oppenheimer
Rochester plaintiffs lack standing. (Civil No. 14-1569, Docket No.
97 at pp. 5-14.)

5

These two memoranda are identical. Compare Civil No. 14-1518, Docket No. 108,
with Civil No. 14-1569, Docket No. 44.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
A.

12

Rule 12(b)(1) Motion to Dismiss Standard
Pursuant to Rule 12(b)(1), a defendant may seek dismissal of

claims

by

asserting

jurisdiction.

that

the

Court

Fed. R. Civ. P. 12(b)(1).

lacks

subject

matter

The plaintiffs bear “the

burden of clearly alleging definite facts to demonstrate that
jurisdiction is proper.”

Nulankeyutmonen Nkihtaqmikon v. Impson,

503 F.3d 18, 25 (1st Cir. 2007).

The Court accepts as true the

well-pled factual allegations in the plaintiffs’ complaints and
makes

all

reasonable

inferences

in

the

plaintiffs’

favor.

Downing/Salt Pond Partners, L.P. v. Rhode Island & Providence
Plantations, 643 F.3d 16, 17 (1st Cir. 2011).

On a Rule 12(b)(1)

motion, the Court may consider materials outside the pleadings to
determine jurisdiction.

Gonzalez v. United States, 284 F.3d 281,

288 (1st Cir. 2002).
B.

Ripeness
The ripeness doctrine “has roots in both the Article III case

or controversy requirement and in prudential considerations.”
Mangual v. Rotger-Sabat, 317 F.3d 45, 59 (1st Cir. 2003).

“The

‘basic rationale’ of the ripeness inquiry is ‘to prevent the
courts,

through

avoidance

of

premature

adjudication,

entangling themselves in abstract disagreements.’”

from

Roman Catholic

Bishop of Springfield v. City of Springfield, 724 F.3d 78, 89 (1st
Cir. 2013) (quoting Abbott Labs. v. Gardner, 387 U.S. 136, 148
(1967)).

The ripeness test has two prongs: “‘the fitness of the

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

13

issues for judicial decision’ and ‘the hardship to the parties of
withholding court consideration.’”

Pac. Gas & Elec. Co. v. State

Energy Res. Conservation & Dev. Comm’n, 461 U.S. 190, 201 (1983)
(quoting Abbott Labs., 387 U.S. at 149).

Both the fitness and

hardship prongs of this test “must be satisfied, although a strong
showing on one may compensate for a weak one on the other.”
McInnis-Misenor v. Maine Med. Ctr., 319 F.3d 63, 70 (1st Cir.
2003).
The

First

Circuit

Court

of

Appeals

has

repeatedly

cautioned that ripeness inquiries are “highly fact-dependent, such
that the ‘various integers that enter into the ripeness equation
play out quite differently from case to case.’”

Verizon New

England, Inc. v. Int’l Bhd. of Elec. Workers, Local No. 2322, 651
F.3d 176, 188 (1st Cir. 2011) (quoting Doe v. Bush, 323 F.3d 133,
138 (1st Cir. 2003) (quoting Ernst & Young v. Depositors Econ.
Prot. Corp., 45 F.3d 530, 535 (1st Cir. 1995))).
1.

Plaintiffs’ Preemption and Contract Clauses Claims Are
Ripe
As discussed below, the Court concludes that plaintiffs’

preemption and contract clauses claims are fit for review, and that
withholding judgment on these claims will impose hardship.
a)

Fitness
“The fitness prong of the ripeness test has both

constitutional and prudential components.”
of Springfield, 724 F.3d at 89.

Roman Catholic Bishop

The constitutional component is

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
“grounded

in

the

prohibition

against

14
advisory

opinions”

and

“concerns whether there is a sufficiently live case or controversy,
at the time of the proceedings, to create jurisdiction in the
federal courts.”
omitted).

Id. (internal quotation marks and citations

A sound way to determine constitutional fitness is to

“evaluate the nature of the relief requested; [t]he controversy
must be such that it admits of ‘specific relief through a decree of
conclusive character, as distinguished from an opinion advising
what the law would be upon a hypothetical state of facts.’”

Rhode

Island v. Narragansett Indian Tribe, 19 F.3d 685, 693 (1st Cir.
1994) (quoting Aetna Life Ins. Co. of Hartford, Conn. v. Haworth,
300 U.S. 227, 241 (1937)).
Texas

v.

United

States,

523

U.S.

296

(1998),

provides a prime example of an unfit case where the plaintiff seeks
an opinion advising what the law would be in a hypothetical
scenario.

In that case, the Texas Education Code permitted the

imposition of ten possible sanctions if a school district failed
the state’s accreditation criteria.

Texas, 523 U.S. at 298.

The

State of Texas sought a declaratory judgment that the Voting Rights
Act “under no circumstances” would apply to the imposition of two
of these sanctions.
never imposed.

Id. at 301.

Id. at 298.

The sanctions, however, were

Thus, the circumstances under which

the sanctions could be imposed were entirely hypothetical and
speculative.

As to the fitness inquiry, the United States Supreme

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
Court

concluded

that

it

would

not

15
employ

its

“powers

of

imagination” and that the operation of the sanction provisions
would be “better grasped when viewed in light of a particular
application.”

Id.

at

301;

see

Int’l

Longshoremen’s

&

Warehousemen’s Union, Local 37 v. Boyd, 347 U.S. 222, 224 (1954)
(“Determination of the scope . . . of legislation in advance of its
immediate adverse effect in the context of a concrete case involves
too remote and abstract an inquiry for the proper exercise of the
judicial function.”).
Here, plaintiffs’ preemption and contract clauses
claims rely on the enactment of the Recovery Act, not on its
application.

Plaintiffs do not seek a declaration that the

Recovery Act would be preempted if enforced in a hypothetical way.
Nor do plaintiffs seek a declaration that the Recovery Act would
impair

contractual

scenario.

obligations

if

applied

in

a

hypothetical

Rather, the relief plaintiffs seek - a declaration that

the Recovery Act is unconstitutional because federal law preempts
it and because the Contracts Clause prohibits it - is conclusive in
character, not dependant on hypothetical facts, and completely
unlike the advisory opinion sought in Texas.
The

prudential

component

of

the

fitness

prong

considers “the extent to which resolution of the challenge depends
upon facts that may not yet be sufficiently developed.”
Young, 45 F.3d at 535.

Ernst &

Accordingly, cases “intrinsically legal

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
nature” are likely to be found fit.

16

Riva v. Massachusetts, 61 F.3d

1003, 1010 (1st Cir. 1995); see Thomas v. Union Carbide Agr.
Products Co., 473 U.S. 568, 581 (1985) (claim that a law violated
Article III of the Constitution was fit for review because it was
“purely legal, and [would] not be clarified by further factual
development”).

Courts are also likely to find cases fit when “all

of the acts that are alleged to create liability have already
occurred.”

Verizon New England, 651 F.3d at 189 (quotation marks

and citation omitted); see Roman Catholic Bishop of Springfield,
724 F.3d at 91-93 (dismissing claims that rely on a potential
future application of an ordinance as unfit for review, but holding
that

the

Ordinance”

claims
are

that
fit

“rest

for

solely

review

on

because

the
“no

existence
further

of

the

factual

development is necessary”); Pustell v. Lynn Pub. Sch., 18 F.3d 50,
52 (1st Cir. 1994) (finding constitutional challenge fit where
“[n]o further factual development [was] necessary for [the court]
to resolve the question at issue”).
The

issues

presented

in

plaintiffs’

preemption

claims are purely legal: the Court need not consider any fact to
determine whether the Recovery Act, on its face, is preempted by
federal law.
limited

Plaintiffs’ contract clauses claims involve two

factual

inquiries:

(1)

whether

the

enactment

of

the

Recovery Act substantially impaired the contractual relationships
created in the Authority Act and the Trust Agreement, and (2)

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

17

whether the enactment of the Recovery Act was “reasonable and
necessary to serve an important public purpose.” See infra Part V.
Both of these inquiries involve solely acts that occurred and facts
that existed at or before the Recovery Act’s enactment in June
2014.

Thus, plaintiffs’ contract clauses claims do not require

further factual development.
The

Court

therefore

finds

that

plaintiffs’

preemption and contract clauses claims are fit for review.
b)

Hardship
The hardship prong of the ripeness test evaluates

whether “the impact” of the challenged law upon the plaintiffs is
“sufficiently

direct

and

immediate

appropriate for judicial review.”

as

to

render

the

issue

Abbott Labs., 387 U.S. at 152.

This inquiry should also “focus on the judgment’s usefulness” and
consider “whether granting relief would serve a useful purpose, or,
put another way, whether the sought-after declaration would be of
practical assistance in setting the underlying controversy to
rest.”

Rhode Island, 19 F.3d at 693; accord Verizon New England,

651 F.3d at 188.
Plaintiffs allege that the enactment of the Recovery
Act

totally

eliminated

several

remedial

and

security

rights

promised to them in the Authority Act and in the Trust Agreement.
First, in the Authority Act, the Commonwealth expressly pledged
that it would not alter PREPA’s rights until all bonds are fully

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
satisfied

and

discharged.

P.R.

18

Laws

Ann.

tit.

22

§

215.6

Plaintiffs allege that the Recovery Act eliminates this guarantee
by giving PREPA the right to participate in a new legal regime to
restructure its debts.

Second, section 17 of the Authority Act

grants bondholders the right to seek appointment of a receiver if
PREPA defaults.
incorporated

P.R. Laws Ann. tit. 22 § 207.

into

section

804

of

the

Trust

This right is

Agreement,

which

guarantees that bondholders have the right to seek “the appointment
of

a

receiver

defaults.

as

authorized

by

Trust Agreement § 804.

the

Authority

Act”

if

PREPA

Plaintiffs allege that the

Recovery Act expressly eliminates the right to seek the appointment
of a receiver.

See Recovery Act § 108(b).7

Third, the Trust

Agreement includes a guarantee that PREPA will not create a lien
equal to or senior to the lien on PREPA’s revenues that secures
plaintiffs’ bonds.

Trust Agreement § 712.

Plaintiffs allege that

the Recovery Act eliminates this guarantee by permitting PREPA to
obtain credit secured by a lien that is senior to plaintiffs’ lien.

6

The Authority Act provides as follows:
The Commonwealth Government does hereby pledge to, and agree with,
any person, firm or corporation, or any federal, Commonwealth or
state agency, subscribing to or acquiring bonds of [PREPA] to
finance in whole or in part any undertaking or any part thereof,
that it will not limit or alter the rights or powers hereby vested
in [PREPA] until all such bonds at any time issued, together with
the interest thereon, are fully met and discharged.
P.R. Laws Ann. tit. 22 § 215.
7

“This Act supersedes and annuls any insolvency or custodial provision included
in the enabling or other act of any public corporation, including Section 17 of
[the Authority Act].” Recovery Act § 108(b).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
See Recovery Act §§ 129(d), 206(a), 322(c).8

19
Fourth, in the event

of default, the Trust Agreement gives PREPA bondholders the right
to accelerate payments.

Trust Agreement § 803.

Plaintiffs allege

that the Recovery Act destroys their right to this remedy both
during the suspension and stay provisions, Recovery Act §§ 205,
304, and after the special court approves a plan pursuant to

8

Section 322(c) of the Recovery Act permits the special court to authorize
public corporations that seek debt relief pursuant to Chapter 3 to obtain credit
“secured by a senior or equal lien on the petitioner’s property that is subject
to a lien only if - (1) the petitioner is unable to obtain such credit otherwise;
and (2) either (A) the proceeds are needed to perform public functions and
satisfy the requirements of section 128 of this Act; or (B) there is adequate
protection of the interest of the holder of the lien on the property of the
petitioner on which such senior or equal lien is proposed to be granted.”
Recovery Act § 322(c). This right extends to corporations seeking debt relief
pursuant to Chapter 2 of the Recovery Act.
See id. § 206(a) (“After the
commencement of the suspension period, an eligible obligor may obtain credit in
the same manner and on the same terms as a petitioner pursuant to section 322 of
this Act.”)
Section 129(d) of the Recovery Act disposes of the “adequate
protection” requirement in section 322(c)(2)(B) when “police power” justifies it.
Id. § 129(d).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
Chapter 2 or 3, id. §§ 115(b)(2), 115(c)(3).9

20
Fifth, the Trust

Agreement contains an ipso facto clause that provides that PREPA is
deemed in default if PREPA institutes a proceeding “for the purpose
of effecting a composition between [PREPA] and its creditors or for
the purpose of adjusting the claims of such creditors.”
Agreement § 802(g).

Trust

Plaintiffs allege that the Recovery Act

explicitly renders this ipso facto clause unenforceable in a

9

Section 205 prohibits bondholders from exercising remedies during Chapter 2’s
suspension period.
Recovery Act § 205 (“Notwithstanding any contractual
provision or applicable law to the contrary, during the suspension period, no
entity asserting claims or other rights, . . . in respect of affected debt
instruments . . . may exercise or continue to exercise any remedy under a
contract or applicable law . . . that is conditioned upon the financial condition
of, or the commencement of a restructuring, insolvency, bankruptcy, or other
proceedings (or a similar or analogous process) by, the eligible obligor
concerned, including a default or an event of default thereunder.”). Section 304
stays “any act to collect, assess, or recover on a claim against the petitioner”
during Chapter 3’s automatic stay period. Id. § 304.
Section 115 prohibits bondholders from exercising remedies after the special
court approves a plan pursuant to Chapter 2 or 3. Id. § 115(b)(2) (“Upon entry
of an approval order . . . under chapter 2 of this Act . . . no entity asserting
claims or other rights, including a beneficial interest, in respect of affected
debt instruments of such eligible obligor . . . shall bring any action or
proceeding of any kind or character for the enforcement of such claim or remedies
in respect of such affected debt instruments, except with the permission of the
[special court] and then only to recover and enforce the rights permitted under
the amendments, modifications, waivers, or exchanges, and the approval order.”);
id. § 115(c)(3) (“[U]pon entry of a confirmation order, . . . all creditors
affected by the plan . . . shall be enjoined from, directly or indirectly, taking
any action inconsistent with the purpose of this Act, including bringing any
action or proceeding of any kind or character for the enforcement of such claim
or remedies in respect of affected debt, except as each has been affected
pursuant to the plan under chapter 3.”).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

21

section titled “Unenforceable Ipso Facto Clauses.”

See Recovery

Act § 325(a); see also id. § 205(c).10
The Commonwealth’s nullification of this series of
statutory and contractual security rights and remedial provisions,
through its enactment of the Recovery Act, is a “direct and
immediate” injury to the plaintiff bondholders.
387 U.S. at 152.
substantially

See Abbott Labs.,

Plaintiffs should not be forced to live with such

impaired

contractual

rights

-

rights

that

they

bargained for when they purchased the nearly two billion dollars
worth of PREPA bonds that they hold collectively.
This
concrete

than

the

hardship
“threat

is
to

certainly
federalism”

more

immediate

hardship

that

and
the

plaintiff alleged in Texas, which the Supreme Court viewed as an
“abstraction” that was “inadequate to support suit unless the
[plaintiff’s] primary conduct is affected.”

523 U.S. at 302.

Here, not having the guarantee of remedial provisions that they

10

Section 325 of the Recovery Act provides as follows in its first subsection:
Notwithstanding any contractual provision or applicable law to the
contrary, a contract of a petitioner may not be terminated or
modified, and any right or obligation under such contract may not be
terminated or modified, at any time after the filing of a petition
under chapter 3 of this Act solely because of a provision in such
contract conditioned on (1) the insolvency or financial condition of the petitioner at any
time before the closing of the case;
(2) the filing of a petition pursuant to section 301 of this Act and
all other relief requested under this Act; or
(3) a default under a separate contract that is due to, triggered
by, or as a result of the occurrence of the events or matters in
subsections (a)(1) [the petitioner’s insolvency] or (a)(2) [the
filing of a Chapter 3 petition] of this section.
Recovery Act § 325(a). Section 205(c) of the Recovery Act has nearly identical
language and renders ipso facto clauses unenforceable during the suspension
period of a Chapter 2 proceeding. Id. § 205(c).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

22

were promised affects plaintiffs’ day-to-day business as PREPA
bondholders, particularly when negotiating with PREPA over remedies
and

potential

restructuring.

Indeed,

the

threat

of

PREPA’s

invocation of the Recovery Act hangs over plaintiffs and diminishes
their bargaining power as bondholders.

See Metro. Wash. Airports

Auth. v. Citizens for Abatement of Aircraft Noise, Inc., 501 U.S.
252, 265 n.13 (1991) (concluding that constitutional challenge to
“veto power” of administrative board was ripe “even if the veto
power has not been exercised to respondents’ detriment” because the
“threat of the veto hangs over the [decisionmakers subject to the
veto] like the sword over Damocles, creating a ‘here-and-now
subservience’” to the administrative board).
In addition, plaintiffs’ sought-after declaration
that the Recovery Act is unconstitutional would “be of practical
assistance in setting the underlying controversy to rest” because
it would completely restore plaintiffs’ contractual rights.
Rhode Island, 19 F.3d at 693.

See

In this sense, the hardship here is

unlike the hardship in Ernst & Young, 45 F.3d 530.

In that case,

the plaintiff alleged that a Rhode Island law limiting nonsettling
tortfeasors’ right of contribution against joint tortfeasors caused
two hardships: increased pressure to settle a negligence suit and
an inability to evaluate its exposure therein.
539.

45 F.3d at 532-33,

The First Circuit Court of Appeals, in holding the claim

unripe, reasoned that resolving the challenge to the Rhode Island

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

23

law would be of “limited utility” to the plaintiff because (1) the
plaintiff would still be faced with the negligence suit, and (2)
the right to contribution was only one of many factors involved in
the plaintiff’s settlement calculations.

Id. at 540 (explaining

that “the usefulness that may satisfy the hardship prong . . . is
not met by a party showing that it has the opportunity to move from
a position of utter confusion to one of mere befuddlement”). Here,
the declaration that plaintiffs seek on their preemption and
contract clauses claims - that the Recovery Act in its entirety is
unconstitutional - would be of great utility to plaintiffs because
it

would

completely

restore

their

rights

guaranteed

in

the

Authority Act and the Trust Agreement.
In sum, delaying adjudication on the merits of
plaintiffs’ constitutional claims until PREPA invokes the Recovery
Act - the event that the Commonwealth defendants concede would
render plaintiffs’ challenges ripe, (Civil No. 14-1518, Docket No.
95-1 at pp. 1, 12-13) - would continue to inflict hardship on
plaintiffs with no identifiable corresponding gain.

Thus, having

satisfied the fitness and hardship prongs of the ripeness test, the
Court concludes that plaintiffs’ preemption and contract clauses
claims are ripe for review.
2.

Plaintiffs’ Stay of Federal Court Proceedings Claims Are
Not Ripe
Plaintiffs seek a declaratory judgment that the Recovery

Act violates the United States Constitution to the extent that

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
section

304

of

the

Act

authorizes

a

24
stay

of

federal

court

proceedings when a public corporation files for debt relief.
(Civil No. 14-1518, Docket No. 85 at ¶¶ 55, 69; Civil No. 14-1569,
Docket

No.

additionally

20

at

claims

unconstitutionally
proceedings.

¶¶

76,

that

83(d).)

section

authorizes

a

205

Plaintiff
of

suspension

the
of

BlueMountain
Recovery
federal

Act
court

(Civil No. 14-1569, Docket No. 20 at ¶¶ 76, 83(d).)

Plaintiffs do not identify a specific provision of the Constitution
that these provisions violate, but rather rely on the United States
Supreme Court holding in Donovan v. City of Dallas, 377 U.S. 408,
413 (1964), that “state courts are completely without power to
restrain federal-court proceedings in in personam actions.”
First, as to the claims’ fitness, the Court evaluates
whether plaintiffs are requesting “specific relief through a decree
of conclusive character” as opposed to “an opinion advising what
the law would be upon a hypothetical state of facts.”

Rhode

Island, 19 F.3d at 693 (quoting Aetna Life Ins. Co., 300 U.S. at
241). The following language in plaintiffs’ complaint reveals that
they seek the latter:
To the extent any provision of the [Recovery
Act] enjoins, stays, suspends or precludes
[plaintiffs] from exercising their rights in
federal court, including their right to
challenge
the
constitutionality
of
the
Recovery Act itself in federal court, those
provisions also violate the Constitution.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

25

(Civil No. 14-1518, Docket No. 85 at ¶ 57; Civil No. 14-1569,
Docket No. 20 at ¶ 77.)

Plaintiffs essentially seek an opinion

that certain applications of the suspension and stay provisions of
the Recovery Act would be unconstitutional.

The Court finds that

this request is akin to the relief sought in Texas, and that the
operation of sections 304 and 205 of the Recovery Act would be
“better grasped when viewed in light of a particular application.”
Texas, 523 U.S. at 301.
Second, as to the prudential component of the fitness
prong,

the

“remoteness

and

abstraction”

of

plaintiffs’

pre-

enforcement injury is “increased by that fact that [the suspension
and stay provisions have] yet to be interpreted by the [Puerto
Rico] courts.”

See Texas, 523 U.S. at 301.

Thus, “‘[p]ostponing

consideration of the questions presented, until a more concrete
controversy arises, also has the advantage of permitting the state
courts further opportunity to construe’ the provisions,” and indeed
to construe them in a constitutional way.

See id. (quoting Renne

v. Geary, 501 U.S. 312, 323 (1991)).
Finally,

concerning

the

hardship

prong,

the

Court

examines whether withholding judgment on the stay of federal court
proceedings claims would create a “direct and immediate dilemma for
the parties.”

See Stern v. U.S. Dist. Court for Dist. of Mass.,

214 F.3d 4, 10 (1st Cir. 2000).

Because PREPA has not filed for

debt relief pursuant to the Recovery Act, the suspension period and

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

26

automatic stay in sections 205 and 304 of the Recovery Act have not
been triggered.

Thus, plaintiffs do not allege that any actual

application of the suspension or stay provisions has injured them.
The Court therefore turns to whether the enactment of these
provisions causes a direct injury. Enactment of the suspension and
stay provisions appears to impair plaintiffs’ contractual right to
sue

to

enforce

the

terms

of

the

Trust

Agreement,

see

Agreement § 804, which does impose hardship on plaintiffs.

Trust
But

this showing of hardship is weak - much weaker than the hardship
created by the nullification of the series of rights that supported
jurisdiction of plaintiffs’ preemption and contract clauses claim.
Thus, plaintiffs’ stay of federal court proceedings
claims fail the fitness prong and has a weak showing on the
hardship prong of the ripeness test. The Court therefore concludes
that

these

claims

are

unripe

and

GRANTS

the

Commonwealth

defendants’ motions to dismiss, (Civil No. 14-1518, Docket No. 95;
Civil No. 14-1569, Docket No. 29), as to the stay of federal court
proceedings claims.
C.

Standing
The doctrines of ripeness and standing overlap in many ways.

McInnis-Misenor, 319 F.3d at 71.

Standing, like ripeness, has

roots in Article III’s case or controversy requirement.
Const. Art. III, § 2.
plaintiff

must

See

U.S.

To establish constitutional standing, a

satisfy

three

elements:

“a

concrete

and

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

27

particularized injury in fact, a causal connection that permits
tracing the claimed injury to the defendant’s actions, and a
likelihood that prevailing in the action will afford some redress
for the injury.”
Mgmt.

Council,

Weaver’s Cove Energy, LLC v. R.I. Coastal Res.
589

F.3d

458,

467

(1st

Cir.

2009)

(internal

quotation marks and citations omitted).
Plaintiffs meet these three elements as to their preemption
and contract clauses claims against the Commonwealth defendants.
First, as discussed above, the Recovery Act’s nullification of
several statutory and contractual security rights is a direct
injury to the plaintiff bondholders.11

Second, this injury was

caused by the Commonwealth’s enactment of the Recovery Act. Third,
plaintiffs’ desired declaratory judgment that the Recovery Act is
unconstitutional will afford plaintiffs redress for the injury
because it will nullify the Recovery Act, restoring

plaintiffs’

statutory and contractual rights.
As to the Franklin and Oppenheimer Rochester plaintiffs’
claims against PREPA, however, the second element of the standing
test is not met: the elimination of plaintiffs’ security rights is
traceable only to the Commonwealth’s enactment of the Recovery Act
and not to any action by PREPA.

If PREPA’s filing for debt relief

pursuant to the Recovery Act were imminent, this could be a
sufficient injury traceable to PREPA.

11

See supra Part III.B.1.b.

See Katz v. Pershing, LLC,

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

28

672 F.3d 64, 71 (1st Cir. 2012) (explaining that an “imminent
injury” can satisfy the standing injury-in-fact requirement if the
harm is “sufficiently threatening,” but that “it is not enough that
the harm might occur at some future time”).

To support their

allegation that PREPA will file for relief pursuant to the Recovery
Act

imminently,

plaintiffs

point

to

(1)

the

Recovery

Act’s

Statement of Motives, which identifies PREPA as the “most dramatic
example”

of

significant

a

Commonwealth

financial

public

challenges,

corporation

and

(2)

that

market

faces

watchers’

predications from July 2014 that it is highly likely that PREPA
will seek relief pursuant to the Recovery Act in the near future.
(Civil No. 14-1518, Docket No. 85 at ¶¶ 18-19.)

Without more,

these two factual allegations merely support speculation that PREPA
will file for relief at some future time; they do not support the
conclusion that the filing is imminent.
Accordingly, because the Franklin and Oppenheimer Rochester
plaintiffs have not sufficiently alleged any injury traceable to an
action by PREPA, they lack standing to assert their claims against
PREPA.

The Court therefore GRANTS PREPA’s motion to dismiss,

(Civil No. 14-1518, Docket No. 97), as to all claims to the extent
that they are asserted against PREPA, and DISMISSES PREPA from
Civil Case No. 14-1518.
The Court proceeds to the merits of plaintiffs’ preemption and
contract clauses claims.

The Court will then address the ripeness

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

29

and merits of the Franklin and Oppenheimer Rochester plaintiffs’
Takings Clause claim.
IV. PREEMPTION
Plaintiffs seek a declaratory judgment that the Recovery Act
in its entirety is preempted by the federal Bankruptcy Code and
violates the Bankruptcy Clause of the United States Constitution.
(Civil No. 14-1518, Docket No. 85 at ¶ 59; Civil No. 14-1569,
Docket No. 20 at ¶ 83(a).)

The Commonwealth defendants move to

dismiss, (Civil No. 14-1518, Docket No. 95; Civil No. 14-1569,
Docket

No.

29),

and

the

Franklin

and

Oppenheimer

Rochester

plaintiffs cross-move for summary judgment, (Civil No. 14-1518,
Docket No. 78). The Court first addresses the appropriate standard
of review and then discusses the merits of plaintiffs’ preemption
claims.
A.

Rule 12(b)(6) Motion to Dismiss and Rule 56(a) Motion for
Summary Judgment Standards
The Commonwealth defendants’ motions to dismiss are governed

by Federal Rule of Civil Procedure 12(b)(6) (“Rule 12(b)(6)”). See
Fed. R. Civ. P. 12(b)(6).

Pursuant to Rule 12(b)(6), the Court

construes the well-pleaded facts in the plaintiffs’ complaints in
the light most favorable to the plaintiffs and will dismiss the
complaints if they fail to state a plausible legal claim upon which
relief can be granted.

Ocasio-Hernandez v. Fortuño-Burset, 640

F.3d 1, 7, 12-13 (1st Cir. 2011).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

30

The Franklin and Oppenheimer Rochester plaintiffs’ motion for
summary judgment is governed by Federal Rule of Civil Procedure 56.
See Fed. R. Civ. P. 56.

The Court will grant summary judgment if

plaintiffs show “that there is no genuine dispute as to any
material fact” and that they are “entitled to judgment as a matter
of law.”

Id.

The parties agree that the preemption claim is purely legal
and involves no disputed issues of material fact.

(Civil No. 14-

1518, Docket Nos. 79 at p. 7 & 95-2 at pp. 1-2.)

The Court

therefore resolves the preemption issues presented in the parties’
motions as ones of law.
B.

Preemption Principles
The

Supremacy

Clause

of

the

United

States

Constitution

mandates that federal law “shall be the supreme Law of the Land;
and the Judges in every State shall be bound thereby, any Thing in
the

Constitution

notwithstanding.”

or

Laws

of

any

State

U.S. Const. art. VI, cl. 2.

to

the

Contrary

Pursuant to this

mandate, “Congress has the power to preempt state law,” Crosby v.
Nat’l Foreign Trade Council, 530 U.S. 363, 372 (2000), and a “state
law that contravenes a federal law is null and void,” Tobin v. Fed.
Exp. Corp., No. 14-1567, 2014 WL 7388805, at *4 (1st Cir. Dec. 30,
2014).

“For preemption purposes, the laws of Puerto Rico are the

functional equivalent of state laws.”

Antilles Cement Corp. v.

Fortuño, 670 F.3d 310, 323 (1st Cir. 2012).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

31

A federal statute can preempt a state law in three ways:
express preemption, conflict preemption, and field preemption.
Arizona v. United States, 132 S. Ct. 2492, 2500-01 (2012).

Here,

plaintiffs raise arguments pursuant to all three.
C.

Express Preemption by Section 903(1) of the Federal Bankruptcy
Code
“Express

preemption

occurs

when

congressional

intent

to

preempt state law is made explicit in the language of a federal
statute.”

Tobin, 2014 WL 7388805, at *4.

Here, Chapter 9 of the

federal Bankruptcy Code contains an express preemption clause in
section 903(1). Section 903, in its entirely, provides as follows:
This chapter does not limit or impair the
power of a State to control, by legislation or
otherwise, a municipality of or in such State
in
the
exercise
of
the
political
or
governmental powers of such municipality,
including expenditures for such exercise, but–
(1)

a State law prescribing a method of
composition of indebtedness of such
municipality may not bind any
creditor that does not consent to
such composition; and

(2)

a judgment entered under such a law
may not bind a creditor that does
not consent to such composition.

11 U.S.C. § 903 (emphasis added).

Thus, by enacting section

903(1), Congress expressly preempted state laws that prescribe a
method

of

composition

nonconsenting creditors.

of

municipal

indebtedness

that

binds

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

32

The existence of this express preemption clause “does not
immediately end the inquiry,” however, because the Court must still
ascertain “the substance and scope of Congress’ displacement of
state law.”

See Altria Grp., Inc. v. Good, 555 U.S. 70, 76 (2008).

“Congressional intent is the principal resource to be used in
defining the scope and extent of an express preemption clause,” and
courts look to the clause’s “text and context” as well as its
“purpose and history” in this endeavor.

Brown v. United Airlines,

Inc., 720 F.3d 60, 63 (1st Cir. 2013).
Accordingly, to determine whether section 903(1) preempts the
Recovery Act, the Court first examines the clause’s text and then
considers its history, purpose, and context.
1.

Section 903(1) Textual Analysis
(a)

“A State law”
By its terms, section 903(1) applies to “State”

laws.

11 U.S.C. § 903(1).

Thus, an initial inquiry is whether

Congress intended for section 903(1) to apply to Puerto Rico laws.
The federal Bankruptcy Code provides in section 101(52) that “[t]he
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.”

Id. § 101(52).

Therefore, Puerto Rico

is a “State” within the meaning of section 903(1) unless section
903(1) fits into the narrow exception of “defining who may be a
debtor under chapter 9.”

See id.

Section 903(1) prohibits state

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

33

composition laws that bind nonconsenting creditors; it says nothing
of who may be a Chapter 9 debtor.

Id. § 903(1).12

Thus, it is

clear from the text that Puerto Rico is a “State” within the
meaning of section 903(1).
To
Commonwealth

refute

defendants

this
argue

very
that

plain
“the

conclusion,
[Bankruptcy]

the
Code

specifically excludes Puerto Rico (as well as the District of
Columbia) from the definition of ‘State’ for purposes of Chapter
9.”

See Civil No. 14-1518, Docket No. 95-1 at p. 16.

If Congress

intended to exclude Puerto Rico from the definition of “State” for
purposes of all Chapter 9 provisions, then section 101(52) would
likely read as follows: “The term ‘State’ includes the District of
Columbia and Puerto Rico, except under chapter 9 of this title.”
But Congress included ten more words in section 101(52) that the
Commonwealth defendants attempt to, but cannot, ignore: “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

12

Section 109 of the federal Bankruptcy Code, titled “Who may be a debtor,”
contains a subsection defining who may be a Chapter 9 debtor. 11 U.S.C. § 109(c)
(“An entity may be a debtor under chapter 9 of this title if and only if such
entity-- (1) is a municipality; (2) is specifically authorized, in its capacity
as a municipality or by name, to be a debtor under such chapter by State law, or
by a governmental officer or organization empowered by State law to authorize
such entity to be a debtor under such chapter; (3) is insolvent; (4) desires to
effect a plan to adjust such debts; and (5) (A) has obtained the agreement of
creditors holding at least a majority in amount of the claims of each class that
such entity intends to impair under a plan in a case under such chapter; (B) has
negotiated in good faith with creditors and has failed to obtain the agreement
of creditors holding at least a majority in amount of the claims of each class
that such entity intends to impair under a plan in a case under such chapter; (C)
is unable to negotiate with creditors because such negotiation is impracticable;
or (D) reasonably believes that a creditor may attempt to obtain a transfer that
is avoidable under section 547 of this title.”).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
this title.”

34

See 11 U.S.C. § 101(52) (emphasis added).

In other

words, Congress expressly defined “State” as including Puerto Rico
and then enumerated a single, specific exception where the term
“State” does not include Puerto Rico.

To infer that Congress

intended an additional or broader exception - i.e., that Congress
intended to exclude Puerto Rico from the definition of “State” for
purposes of section 903(1) or for all of Chapter 9 - would violate
the canon of expressio unius est exclusio alterius.

See TRW Inc.

v. Andrews, 534 U.S. 19, 28 (2001) (explaining that where Congress
explicitly enumerates a single exception, additional exceptions are
not to be implied absent evidence of contrary legislative intent).
The Commonwealth defendants’ textual argument on this point thus
holds no water.
(b)

“Prescribing
indebtedness”
Section

a

903(1)

method

applies

of

to

composition

state

“prescrib[e] a method of composition of indebtedness.”
§ 903(1).

laws

of

that

11 U.S.C.

A “composition” is an “agreement between a debtor and

two or more creditors for the adjustment or discharge of an
obligation for some lesser amount.”

Black’s Law Dictionary 346

(10th ed. 2014).
Chapter 2 of the Recovery Act permits an eligible
public corporation to “seek debt relief from its creditors,”
Recovery Act § 201(b), through “any combination of amendments,
modifications, waivers, or exchanges,” which may include “interest

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
rate

adjustments,

maturity

extensions,

35
debt

relief,

or

other

revisions to affected debt instruments,” id. Stmt. of Motives, § E;
see id. § 202(a).
eligible

public

Chapter 3 of the Recovery Act permits an

corporation

“to

defer

debt

repayment

decrease interest and principal” owed to creditors.
Motives, § E; see id.

and

to

Id. Stmt. of

§§ 301, 307-308, 310, 315.

Thus, both Chapters 2 and 3 of the Recovery Act
create procedures for indebted public corporations to adjust or
discharge their obligations to creditors.

Therefore, the Recovery

Act prescribes a method of composition of indebtedness, which is
exactly what section 903(1) prohibits.
(c)

“Of such municipality”
Section 903(1) applies to state laws addressing the

indebtedness of a state “municipality.”

11 U.S.C. § 903(1).

A

“municipality” is a “political subdivision or public agency or
instrumentality of a State.”

Id. § 101(40).

The Recovery Act applies to debts of “any public
sector obligor.” Recovery Act § 104. A “public sector obligor” is
defined as a “Commonwealth Entity,” subject to three exclusions.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
Id. § 102(50).13

36

A “Commonwealth Entity” includes “a department,

agency, district, municipality, or instrumentality (including a
public corporation) of the Commonwealth.”

Id. § 102(13).

Thus, the Recovery Act applies to the debts of
Commonwealth “instrumentalities,” which are “municipalities” for
purposes of section 903(1).
(d)

“May not bind any creditor that does not consent to
such composition”
Finally, section 903(1) applies to state laws that

bind nonconsenting creditors.

11 U.S.C. § 903(1).

Pursuant to Chapter 2 of the Recovery Act, if
creditors representing at least fifty percent of the debt in a
given class vote on whether to accept the proposed debt amendments,
and at least seventy-five percent of participating voters approve,
then the court order approving the debt relief transaction binds
the entire class.

Recovery Act §§ 115(b), 202(d), 204.

Pursuant

to Chapter 3 of the Recovery Act, if “at least one class of
affected debt has voted to accept the plan by a majority of all
votes cast in such class and two-thirds of the aggregate amount of

13
A “public sector obligor” is a “Commonwealth Entity, but excluding: (a) the
Commonwealth; (b) the seventy-eight (78) municipalities of the Commonwealth; and
(c) the Children’s Trust; the Employees Retirement System of the Government of
the Commonwealth of Puerto Rico and its Instrumentalities; GDB and its
subsidiaries, affiliates, and entities ascribed to GDB; the Judiciary Retirement
System; the Municipal Finance Agency; the Municipal Finance Corporation; the
Puerto Rico Public Finance Corporation; the Puerto Rico Industrial Development
Company, the Puerto Rico Industrial, Tourist, Educational, Medical and
Environmental Control Facilities Financing Authority; the Puerto Rico
Infrastructure Financing Authority; the Puerto Rico Sales Tax Financing
Corporation (COFINA); the Puerto Rico System of Annuities and Pensions for
Teachers; and the University of Puerto Rico.” Recovery Act § 102(50).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

37

affected debt in such class that is voted,” then the court order
confirming the debt enforcement plan binds all of the public
corporation’s

creditors,

regardless

of

their

class.

Id.

§§

115(c), 315(e).
Thus, because they do not require unanimous creditor
consent, the compositions prescribed in Chapter 2 and 3 of the
Recovery Act may bind nonconsenting creditors.
2.

Section 903(1) History, Purpose, and Context
The legislative history of section 903(1) and of its

predecessor, section 83(i) of the Bankruptcy Act of 1937 (“section
83(i)”), further supports the conclusion that Congress intended to
preempt Puerto Rico laws that create municipal debt restructuring
procedures that bind nonconsenting creditors.

In 1946, Congress

added the following language, which is nearly identical to the
language in section 903(1), to section 83(i): “[N]o State law
prescribing

a

method

of

composition

of

indebtedness

of

such

agencies shall be binding upon any creditor who does not consent to
such composition.”
(1946).

Pub. L. No. 481, § 83(i), 60 Stat. 409, 415

Congress explained why it added this prohibitory language

to section 83(i) in a House Report:
[A] bankruptcy law under which bondholders of
a municipality are required to surrender or
cancel their obligations should be uniform
throughout the 48 States, as the bonds of
almost every municipality are widely held.
Only under a Federal law should a creditor be
forced to accept such an adjustment without
his consent.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
H.R. Rep. No. 79-2246, at 4 (1946).14

38
Congress reaffirmed this

intent when it enacted section 903(1) three decades later:
The proviso in section 83, prohibiting State
composition procedures for municipalities, is
retained.
Deletion of the provision would
“permit all States to enact their own versions
of Chapter IX”, . . . which would frustrate
the
constitutional
mandate
of
uniform
bankruptcy laws.
S. Rep. No. 95-989, at 110 (1978).
It is evident from this legislative history that, because
municipal bonds are widely held across the United States, Congress
enacted section 903(1) to ensure that only a uniform federal law
could force nonconsenting municipal bondholders to surrender or
cancel part of their investments.

Nothing in its legislative

history indicates that Congress intended to exempt Puerto Rico from
section 903(1)’s expressly universal preemption purview.
The

Commonwealth

defendants

nonetheless

section 903(1) does not apply to Puerto Rico laws.
attempt

to

rebut

the

provision’s

clear

argue

that

They do not

legislative

history,

however, and instead present arguments based on logic and context.
First,

the

Commonwealth

defendants

contend

that

it

would

be

“anomalous” to read the federal Bankruptcy Code as both precluding

14

See also Hearings on H.R. 4307 Before the Special Subcomm. on Bankr. & Reorg.
of the H. Comm. on the Judiciary, 79th Cong. 10 (1946) (statement of Millard
Parkhurst, Att’y at Law, Dallas, Tex.) (“Bonds of a municipality are usually
distributed throughout the 48 States. Certainly any law which would have the
effect of requiring the holders of such bonds to surrender or cancel a part of
their investments should be uniform Federal law and not a local law.”).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
Puerto

municipalities15

Rico

from

39

participating

in

Chapter

9

proceedings and preempting Puerto Rico laws that govern debt
restructuring for Puerto Rico municipalities.
Docket No. 95-1 at p. 17.)

(Civil No. 14-1518,

But Puerto Rico municipalities are not

unique in their inability to restructure their debts.

This is

because Chapter 9 is available to a municipality only if it
receives

specific

109(c)(2),

and

legislation.16

authorization
many

states

from
have

its
not

state,
enacted

11

U.S.C.

§

authorizing

Congress’s decision not to permit Puerto Rico

municipalities to be Chapter 9 debtors, see 11 U.S.C. 101(52),17
reflects

its

considered

judgment

to

retain

control

restructuring of municipal debt in Puerto Rico.

over

any

Congress, of

course, has the power to treat Puerto Rico differently than it
treats the fifty states.

See 48 U.S.C. § 734 (providing that

federal laws “shall have the same force and effect in Puerto Rico
as in the United States” “except as . . . otherwise provided”);

15
“Municipality,” as used in this discussion, includes a “public agency or
instrumentality.” See 11 U.S.C. § 101(40).
16

See James E. Spiotto, et al., Chapman & Cutler LLP, Municipalities in
Distress? How States and Investors Deal with Local Government Financial
Emergencies 51-52 (2012) (identifying twelve states with statutes that
specifically authorize municipalities to file a Chapter 9 petition, twelve states
that conditionally authorize it, three states that grant limited authorization,
two states that prohibit filing (although one has an exception to the
prohibition), and twenty-one states that are either unclear or have not enacted
specific authorization).
17

Congress enacted section 101(52) as part of the 1984 amendments to the federal
Bankruptcy Code. Prior to those amendments, the Bankruptcy Code contained no
definition of the term “State.” Compare Pub. L. No. 95-598, 92 Stat. 2549, 254954 (Nov. 6, 1978) (no definition of “State”), with Pub. L. No. 98-353, 98 Stat.
333, 368-69 (July 10, 1984) (adding definition of “State”).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

40

Antilles Cement Corp., 670 F.3d at 323 (“Congress is permitted to
treat Puerto Rico differently despite its state-like status.”).
Next, the Commonwealth defendants contend that section
903 does not apply to Puerto Rico because that section “addresses
the impact of ‘[t]his chapter’ - i.e., Chapter 9 - on States’
authority

to

regulate

[municipalities].”
20.)

the

debt

restructuring

of

their

own

(Civil No. 14-1518, Docket No. 95-1 at pp. 19-

They reason that because Puerto Rico municipalities are not

eligible to participate in Chapter 9 bankruptcy proceedings, “it
follows that [s]ection 903 does not apply.”

Id.

The Commonwealth

defendants misread section 903, which first clarifies that Chapter
9 “does not limit or impair the power of a State to control” the
political or governmental powers of its municipalities, 11 U.S.C.
§ 903, and then qualifies that statement by prohibiting state laws
that bind nonconsenting creditors to a composition of indebtedness
of a municipality, and prohibiting judgments entered pursuant to
those laws that bind nonconsenting creditors, id. § 903(1)-(2).
Nothing in the text, context, or legislative history of section 903
remotely supports the Commonwealth defendants’ inferential leap
that Congress intended the prohibition in section 903(1) to apply

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

41

only to states whose municipalities are eligible to file for
Chapter 9 bankruptcy.18
Finally, the Commonwealth defendants argue that section
903 “by its terms is limited to the relationship between an
‘indebted[]’ municipality and its ‘creditors’ in Chapter 9 cases,”
and that “[u]nless a municipality can qualify as a ‘debtor’ under
Chapter 9, it obviously cannot be an ‘indebted[]’ municipality with
a ‘creditor’ under Chapter 9.” (Civil No. 14-1518, Docket No. 95-1
at p. 20.)

The Commonwealth defendants rely on the Bankruptcy

Code’s definition of “creditor” to support their strained reading,
but nothing in that definition indicates that the term “creditor”
is limited to entities eligible to bring claims pursuant to Chapter
9.

See 11 U.S.C. § 101(10) (defining “creditor” as (1) an “entity

that has a claim against the debtor,” (2) an “entity that has a
claim against the estate,” or (3) “an entity that has a community

18

The Commonwealth defendants cite to an journal article by Thomas Moers Mayer
for support. (Civil No. 14-1518, Docket No. 108 at p. 10.) The article states
as follows in a tangential footnote: “Section 903(1) . . . appears as an
exception to [section] 903’s respect for state law in [C]hapter 9 and thus
appears to apply only in a [C]hapter 9 bankruptcy. It is not clear how it would
apply if no [C]hapter 9 case was commenced.”
Thomas Moers Mayer, State
Sovereignty, State Bankruptcy, and a Reconsideration of Chapter 9, 85 Am. Bankr.
L.J. 363, 386 n.84 (2011). But reading section 903(1) as applying only when a
Chapter 9 bankruptcy has commenced would deprive section 903(1) of any practical
effect: a municipal debtor that has already invoked federal bankruptcy law has
no need to employ state bankruptcy laws. More significantly, this reading is
contrary to the legislative history of section 903(1) and its predecessor, which
unequivocally indicates that Congress’s intent in enacting the provision was to
ensure that a “bankruptcy law under which bondholders of a municipality are
required to surrender or cancel their obligations [is] uniform throughout the
[United] States” because “[o]nly under a Federal law should a creditor be forced
to accept such an adjustment without his consent.” H.R. Rep. No. 79-2246, at 4
(1946).
The Commonwealth defendants’ reliance on Mr. Mayer’s conjectural
observation is therefore unavailing.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

42

claim”); id. § 101(5) (defining “claim” as a “right to payment”).
Thus, the Commonwealth defendants’ attempt to read a “Chapter 9
eligibility” requisite into the scope of section 903(1) is wholly
without textual support, and the legislative history of that
section supports a contrary, universal reading of the prohibition.19
3.

Express Preemption Conclusion
The Court recognizes that federal preemption of a state

law “is strong medicine” and “will not lie absent evidence of clear
and manifest congressional purpose.”

Mass. Ass’n of Health Maint.

Orgs. v. Ruthardt, 194 F.3d 176, 178-79 (1st Cir. 1999).
this high bar, this is not a close case.

Despite

Section 903(1)’s text and

legislative history provide direct evidence of Congress’s clear and
manifest purpose to preempt state laws that prescribe a method of
composition of municipal indebtedness that binds nonconsenting
creditors, see 11 U.S.C. § 903(1), and to include Puerto Rico laws
in this preempted arena, see id. § 101(52).

19

The Recovery Act is

The Commonwealth defendants rely on another academic article for support.
(Civil No. 14-1518, Docket No. 108 at p. 10.) The article, by Stephen J. Lubben,
looks to the statutory definitions of “creditor” as an “entity that has a claim
against the debtor,” 11 U.S.C. § 101(10)(A), and of “debtor” as a “person or
municipality concerning which a case under this title has been commenced,” id.
§ 101(13), to conclude that “section 903 was only intended to apply to debtors
who might actually file under [C]hapter 9.” Stephen J. Lubben, Puerto Rico and
the Bankruptcy Clause, 88 Am. Bankr. L.J. 553, 576 (2014).
This narrow
construction of section 903(1) flies in the face of section 903(1)’s legislative
history, which Mr. Lubben and the Commonwealth defendants totally ignore. The
Senate Report accompanying section 903(1)’s enactment indicates that Congress
sought to avoid states “enact[ing] their own versions of Chapter [9], . . . which
would frustrate the constitutional mandate of uniform bankruptcy laws.” S. Rep.
No. 95-989, at 110 (1978).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

43

such a law and is therefore unconstitutional pursuant to the
Supremacy Clause of the United States Constitution.
D.

Conflict and Field Preemption
Unlike their Franklin and Oppenheimer Rochester counterparts,

who plead that section 903(1) is an express preemption clause,
plaintiff BlueMountain raises many of the same section 903(1)
arguments but frames them as “conflict preemption” and “field
preemption.”
Conflict

(Civil No. 14-1569, Docket No. 20 at pp. 13-18.)
preemption

occurs

“when

federal

‘irreconcilable conflict’ with state law.”

law

is

in

Telecomm. Regulatory

Bd. of P.R. v. CTIA-Wireless Ass’n, 752 F.3d 60, 64 (1st Cir. 2014)
(quoting Barnett Bank of Marion Cnty., N.A. v. Nelson, 517 U.S. 25,
31 (1996)).
Bankruptcy

As explained above, section 903(1) of the federal
Code

prohibits

state

laws

that

create

composition

procedures for indebted municipalities that bind nonconsenting
creditors, and the Recovery Act is such a law.20

Section 903(1) of

the federal Bankruptcy Code and the Recovery Act are thus in
“irreconcilable conflict.”
Conflict preemption also occurs “when the state law stands as
an obstacle to the accomplishment and execution of the full
purposes and objectives of Congress.”

Telecomm. Regulatory Bd. of

P.R., 752 F.3d at 64 (internal quotation marks and citation
omitted). Again, as previously discussed, the text and legislative

20

See supra Part IV.C.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

44

history of section 903(1) indicate that Congress intended to ensure
that only pursuant to a uniform federal law would nonconsenting
creditors

be

forced

to

accept

municipal

compositions.21

The

Recovery Act stands as an obstacle to achieving this purpose
because it prescribes municipal composition procedures that are
outside of the federal Bankruptcy Code and are available only to
Puerto Rico “municipalities.”
Field preemption occurs when states “regulat[e] conduct in a
field that Congress, acting within its proper authority, has
determined

must

be

regulated

by

its

exclusive

governance.”

Arizona, 132 S. Ct. at 2501. Congressional intent to preempt state
law in an entire field “can be inferred from a framework of
regulation ‘so pervasive . . . that Congress left no room for the
States to supplement it’ or where there is a ‘federal interest . .
. so dominant that the federal system will be assumed to preclude
enforcement of state laws on the same subject.’” Id. (quoting Rice
v. Santa Fe Elevator Corp., 331 U.S. 218, 230 (1947)).

Here,

however, the Court need not resort to these modes of inference
because

Congress

enacted

an

express

preemption

clause

that

delineates the parameters of the field it intended to preempt.
Thus, the Court goes no further than finding that, by enacting
section 903(1), Congress expressly preempted the field of municipal

21

See supra Part III.C.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

45

composition procedures that bind nonconsenting creditors.

See 11

U.S.C. § 903(1).
E.

“Dormant Bankruptcy Clause” Preemption
“Wholly apart” from their section 903(1) express preemption

claim, the Franklin Oppenheimer and Rochester plaintiffs raise a
somewhat novel argument that the Bankruptcy Clause of the United
States Constitution, by itself, preempts the Recovery Act.
No. 14-1518, Docket No. 79 at pp. 21-23.)

(Civil

The plaintiffs contend

that the United States Supreme Court has long held that the
Bankruptcy Clause grants the power to authorize a discharge to the
federal government alone, and that states therefore are prohibited
from enacting bankruptcy discharge laws.

Id. at p. 21.

The

Supreme Court cases that plaintiffs cite, however, indicate that
the constitutional prohibition on state bankruptcy discharge laws
arises not from the Bankruptcy Clause, but from the Contract
Clause.

See Sturges v. Crowninshield, 17 U.S. 122, 199 (1819)

(“The constitution does not grant to the states the power of
passing bankrupt laws, . . . [but restrains states’ power] as to
prohibit the passage of any law impairing the obligation of
contracts.

Although, then, the states may, until that power shall

be exercised by congress, pass laws concerning bankrupts; yet they
cannot constitutionally introduce into such laws a clause which
discharges

the

obligations

the

bankrupt

has

entered

into.”

(emphasis added)); Ry. Labor Execs.’ Ass’n v. Gibbons, 455 U.S.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
457,

472

n.14

(1982)

(“Apart

from

and

46
independently

of

the

Supremacy Clause, the Contract Clause prohibits the States from
enacting debtor relief laws which discharge the debtor from his
obligations.”).

The

Court

therefore

rejects

the

Franklin

Oppenheimer and Rochester plaintiffs’ “dormant Bankruptcy Clause”
preemption argument and will address the Contract Clause issues in
Part V of this opinion.
F.

Preemption Conclusion
Section 903(1) of the federal Bankruptcy Code preempts the

Recovery Act.

The Recovery Act is therefore unconstitutional

pursuant to the Supremacy Clause of the United States Constitution.
Accordingly, the Court DENIES the Commonwealth defendants’ motions
to dismiss plaintiffs’ preemption claims, (Civil No. 14-1518,
Docket No. 95; Civil No. 14-1569, Docket No. 29), and GRANTS the
Franklin and Oppenheimer Rochester plaintiffs’ cross-motion for
summary judgment on their preemption claim, (Civil No. 14-1518,
Docket No. 78).
V. CONTRACT CLAUSES
Plaintiffs seek a declaratory judgment that the Recovery Act
violates the Contract Clause of the United States Constitution by
impairing the contractual obligations imposed by the Authority Act
and the Trust Agreement.

(Civil No. 14-1518, Docket No. 85 at ¶

66; Civil No. 14-1569, Docket No. 20 at ¶ 83(b).)

Plaintiff

BlueMountain seeks an additional declaratory judgment that the

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

47

Recovery Act violates the Contract Clause of the Puerto Rico
Constitution for the same reason.

(Civil No. 14-1569, Docket No.

The Commonwealth defendants move to dismiss.22

20 at ¶ 83(c).)

(Civil No. 14-1518, Docket No. 95; Civil No. 14-1569, Docket No.
29.)
The Commonwealth defendants’ motions to dismiss are again
governed

by

Rule

12(b)(6),

and

the

Court

will

dismiss

the

complaints if they fail to state a plausible legal claim upon which
relief

can

be

granted.

See

Fed.

Ocasio-Hernandez, 640 F.3d at 12-13.

R.

Civ.

P.

12(b)(6);

The Court “must assume the

truth of all well-pleaded facts and give the plaintiff[s] the
benefit of all reasonable inferences therefrom.”

United Auto.,

Aerospace, Agric. Implement Workers of Am. Int’l Union v. Fortuño,
633 F.3d 37, 39 (1st Cir. 2011) [hereinafter UAW] (quoting Thomas

22

In their motions to dismiss, the Commonwealth defendants contend that the
plaintiffs “are mounting a facial challenge” to the Recovery Act and that
therefore the plaintiffs “must show that the [Recovery Act] cannot
constitutionally be applied not only to their contracts, but to any contracts
[sic].” (Civil No. 14-1518, Docket No. 95-1 at p. 23.) Plaintiffs, however,
specifically challenge the Recovery Act as it applies to the contractual
relationships between plaintiffs, PREPA, and the Commonwealth created in the
Authority Act and the Trust Agreement. See Civil No. 14-1518, Docket No. 85 at
¶ 71(ii) (seeking declaration that the Recovery Act violates the Contract Clause
“insofar as it permits the retroactive impairment of Plaintiffs’ rights under the
contracts governing the PREPA bonds”); Civil No. 14-1518, Docket No. 20 at ¶
83(b) (same). Accordingly, the Court interprets plaintiffs’ contract clause
claims as “as-applied” challenges. Cf. John Doe No. 1 v. Reed, 561 U.S. 186, 194
(2010) (noting that when “the relief that would follow” from a claim “reach[es]
beyond the particular circumstances of the[] plaintiffs,” plaintiffs must satisfy
the standards for a facial challenge); Asociacion de Suscripcion Conjunta del
Seguro de Responsabilidad Obligatorio v. Juarbe-Jimenez, 659 F.3d 42, 48 (1st
Cir. 2011)(where plaintiffs request a declaration that a regulation is
unconstitutional, rather than a declaration that a particular interpretation or
application of the regulation is unconstitutional, plaintiffs mount a facial
challenge).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

48

v. Rhode Island, 542 F.3d 944, 948 (1st Cir. 2008)).
considers

“only

facts

and

documents

that

are

The Court

part

of

or

incorporated into the complaint[s].” Id. (quoting Trans-Spec Truck
Serv., Inc. v. Caterpillar Inc., 524 F.3d 315, 321 (1st Cir.
2008)).

The

Court

accordingly

examines

both

the

factual

allegations in plaintiffs’ complaints and the Trust Agreement,
which plaintiffs incorporated by reference into their complaints.
See Civil No. 14-1518, Docket No. 85 at ¶ 3; Civil No. 14-1569,
Docket No. 20 at ¶ 14.
The Contract Clause of the Puerto Rico Constitution, P.R.
Const. art. II, § 7, is analogous to the Contract Clause of the
United States Constitution, U.S. Const. art. I, § 10, cl. 1, and
provides

at

least

the

same

level

of

protection

impairment of the obligation of contracts.

against

the

Bayron Toro v. Serra,

119 P.R. Offic. Trans. 646, 661-62 (P.R. 1987). The parties do not
dispute this.

See Civil No. 14-1569, Docket Nos. 20 at ¶ 74 & 29-1

at p. 22 n.1.

Plaintiff BlueMountain’s invocation of the Puerto

Rico

Clause

Contract

therefore

adds

nothing

to

the

Court’s

analysis.
A.

Contract Clause Principles
The Contract Clause of the United States Constitution provides

that “No State shall . . . pass any . . . Law impairing the

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
Obligation of Contracts . . . .”

49

U.S. Const. art. I, § 10, cl. 1.23

“Despite its unequivocal language, this constitutional provision
does not make unlawful every state law that conflicts with any
contract.”

UAW, 633 F.3d at 41 (internal quotation marks and

citation omitted).

Rather, courts must “reconcile the strictures

of the Contract Clause” with the state’s sovereign power to
safeguard the welfare of its citizens.

Id. (internal quotation

marks and citation omitted).
Accordingly, Contract Clause claims are analyzed pursuant to
a two-pronged test.

Id.

The first question is whether the state

law “operate[s] as a substantial impairment of a contractual
relationship.”

Id. (quoting Energy Reserves Grp., Inc. v. Kansas

Power & Light Co., 459 U.S. 400, 411 (1983)).

If the contractual

relationship is substantially impaired, then the second question is
whether that impairment is “reasonable and necessary to serve an
important public purpose.”

Id. (quoting U.S. Trust Co. of N.Y. v.

New Jersey, 431 U.S. 1, 25 (1977)).
B.

Substantial Impairment of a Contractual Relationship
The question of whether a state law operates as a substantial

impairment of a contractual relationship includes three components:
“whether there is a contractual relationship, whether a change in
law

23

impairs

that

contractual

relationship,

and

whether

the

The Commonwealth defendants do not contest that the Contract Clause applies
to Puerto Rico, even though it is not a state. (Civil No. 14-1518, Docket No.
95-1 at p. 22 n.1.)

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
impairment is substantial.”

50

Gen. Motors Corp. v. Romein, 503 U.S.

181, 186 (1992).
1.

Contractual Relationship
Plaintiffs

claim

that

the

Recovery

Act

impairs

the

contractual relationships created by the Trust Agreement and the
Authority Act.
plaintiffs’

The Commonwealth defendants do not contest the

allegations

that

the

Trust

Agreement

creates

a

contractual relationship between PREPA and PREPA bondholders, and
that bondholders relied on PREPA’s promises in the Trust Agreement
when they acquired PREPA bonds.

See Civil No. 14-1518, Docket No.

85 at ¶ 42; Civil No. 14-1569, Docket No. 20 at ¶¶ 14-17.
The Commonwealth defendants also do not deny that the
Authority

Act

creates

a

contractual

Commonwealth and PREPA bondholders.

relationship

between

the

The Authority Act’s statutory

language makes clear the intent to form a contract.

See P.R. Laws

Ann. tit. 22 § 215 (“The Commonwealth Government does hereby pledge
to,

and

agree

with,

any

person,

firm

or

corporation

.

.

.

subscribing to or acquiring bonds of [PREPA] . . . .”); cf. U.S.
Trust Co., 431 U.S. at 18 (finding that New York and New Jersey’s
intent to make a contract with bondholders is clear from the
following statutory language: “The 2 States covenant and agree with
each other and with the holders of any affected bonds . . .”).
Even absent this statutory language, the Trust Agreement is assumed
to incorporate the terms of the Authority Act because the Authority

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

51

Act was in place when PREPA and the bondholders agreed to the Trust
Agreement. See U.S. Trust Co., 431 U.S. at 19 (“The obligations of
a contract long have been regarded as including not only the
express terms but also the contemporaneous state law pertaining to
interpretation and enforcement. . . . This principle presumes that
contracting parties adopt the terms of their bargain in reliance on
the law in effect at the time the agreement is reached.”); Ionics,
Inc. v. Elmwood Sensors, Inc., 110 F.3d 184, 188 (1st Cir. 1997)
(“Every contract is assumed to incorporate the existing legal norms
that are in place.”).
2.

Impairment
Plaintiffs allege that the Recovery Act impairs the

contractual relationships and obligations created in the Authority
Act and the Trust Agreement in the following specific ways:24
(a)

In the Authority Act, the Commonwealth guaranteed
PREPA bondholders that it would not “limit or alter
the rights or powers . . . vested in [PREPA] until
all such bonds at any time issued, together with
any

interest

discharged.”

thereon,

are

fully

met

P.R. Laws Ann. tit. 22 § 215.

and
PREPA

similarly guaranteed in the Trust Agreement that
“no contract or contracts will be entered into or

24

See Civil No. 14-1518, Docket No. 85 at ¶¶ 42-48; Civil No. 14-1569, Docket
No. 20 at ¶ 56.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

52

any action taken by which the rights of the Trustee
or

of

the

diminished.”

bondholders

might

be

impaired

Trust Agreement § 709.

or

PREPA also

promised to pay principal and interest on the bonds
Id. § 701.

when they are due.
Agreement

prohibits

both

Finally, the Trust

the

extension

of

the

maturity date of principal or interest due on the
PREPA bonds and the reduction of the principal or
interest rate of PREPA bonds.

Id. § 1102.

The

Recovery Act impairs all of these obligations and
guarantees by permitting PREPA to modify its debts
without creditor consent.

Recovery Act §§ 115,

202, 206, 304, 312, 315, 322.
(b)

In the Trust Agreement, PREPA promised that it
would not create liens on PREPA revenues that would
take priority over the bondholders’ lien.
Agreement §§ 712, 1102.
this

promise

by

Trust

The Recovery Act impairs

allowing

PREPA

to

encumber

collateral with liens senior to the bondholders’
lien.
(c)

Recovery Act § 322.

The Trust Agreement prohibits PREPA from selling
any

part

of

its

electrical-power

system.

The

Recovery Act impairs this contractual prohibition
by permitting the special court to authorize the

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

53

sale of PREPA assets free and clear of liens.
Recovery Act § 307.
(d)

The Trust Agreement contains an ipso facto clause
providing that PREPA is deemed in default if (1) it
institutes a proceeding effectuating a composition
of debt with its creditors, or (2) an order or
decree is entered effectuating a composition of
debt between PREPA and its creditors or for the
purpose of adjusting claims that are payable from
PREPA revenues.
Recovery

Act

Trust Agreement § 802(f)-(g).
renders

this

ipso

facto

The

clause

unenforceable by providing that “[n]otwithstanding
any contractual provision . . . to the contrary, a
contract of a petitioner may not be terminated or
modified, and any right or obligation under such
contract may not be terminated or modified . . .
solely because of a provision in such contract
conditioned on” a default due to the corporation’s
insolvency

or

the

filing

of

a

section 301 of the Recovery Act.

petition

under

Recovery Act §

325.
(e)

The Trust Agreement provides that holders of at
least 10 percent of PREPA bonds are entitled to
request that the Trustee bring an action to compel

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
PREPA

to

set

and

54

collect

rates

sufficient

to

maintain its promises both to pay current expenses
and to maintain at least 120 percent of upcoming
principal and interest payments in its general
fund.

Trust Agreement § 502.

The Trust Agreement

also entitles bondholders to accelerate payments if
PREPA defaults, id. § 803, and to sue in equity or
at

law

to

Agreement

enforce

if

PREPA

the

remedies

defaults,

of

id.

the

Trust

§

804.

The

Recovery Act impairs bondholders’ rights to these
remedies

both

during

the

suspension

and

stay

provisions, Recovery Act §§ 205, 304, and after the
special court approves a plan pursuant to Chapter 2
or 3, id. §§ 115(b)(2), 115(c)(3).
(f)

Section 17 of the Authority Act grants bondholders
the right to seek appointment of a receiver if
PREPA defaults.

P.R. Laws Ann. tit. 22 § 207.

This right is incorporated into section 804 of the
Trust Agreement, which guarantees that bondholders
have

the

right

to

seek

“the

appointment

of

a

receiver as authorized by the Authority Act” if
PREPA

defaults.

Trust

Agreement

§

804.

The

Recovery Act expressly eliminates the right to seek
the appointment of a receiver.

Recovery Act §

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
108(b)

(“This

Act

55

supersedes

and

annuls

any

insolvency or custodial provision included in the
enabling or other act of any public corporation,
including Section 17 of [the Authority Act].”).
The United States Supreme Court has long held that the
Contract Clause prohibits states from passing laws, like the
Recovery Act, that authorize the discharge of debtors from their
obligations.

See Ry. Labor Execs.’ Ass’n, 455 U.S. at 472 n.14

(“[T]he Contract Clause prohibits the States from enacting debtor
relief laws which discharge the debtor from his obligations.”);
Stellwagen v. Clum, 245 U.S. 605, 615 (1918) (“It is settled that
a state may not pass an insolvency law which provides for a
discharge of the debtor from his obligations.”);

Sturges, 17 U.S.

at 199 (Contract Clause prohibits states from introducing into
bankruptcy laws “a clause which discharges the obligations the
bankrupt has entered into.”).
The Commonwealth Legislative Assembly cites Faitoute Iron
& Steel Co. v. City of Asbury Park, New Jersey, 316 U.S. 502
(1942), as support for the Recovery Act’s “constitutional basis.”
Recovery Act, Stmt. of Motives, § C.

In Faitoute, the Supreme

Court sustained a state insolvency law for municipalities in the
face of a Contract Clause challenge.
law

was

narrowly

tailored

in

316 U.S. at 516.

three

important

The state

ways:

(1)

it

explicitly barred any reduction of the principal amount of any

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

56

outstanding obligation; (2) it affected only unsecured municipal
bonds that had no real remedy; and (3) it provided only for an
extension to the maturity date and a decrease of the interest rates
on the bonds.

Id. at 504-07.

The Supreme Court was careful to

state: “We do not go beyond the case before us.

Different

considerations may come into play in different situations. Thus we
are not here concerned with legislative changes touching secured
claims.”

Id. at 516.

Unlike the state law in Faitoute, the

Recovery Act (1) permits the reduction of principal owed on PREPA
bonds, (2) affects secured bonds that have meaningful remedies,
including

the

appointment

of

a

receiver,

and

(3)

permits

modifications to debt obligations beyond the extension of maturity
dates

and

adjustment

of

interest

rates.

Thus,

Faitoute

is

factually distinguishable and provides no support for the Recovery
Act’s constitutionality.
The Commonwealth defendants raise only one argument as to
why the Recovery Act does not impair a contractual relationship.
They insist that there is “no way to know whether a contract will
be impaired . . . unless and until the [Recovery Act] is invoked
and the debts covered by the contract are restructured in a way
that gives creditors less value than they could reasonably expect
to receive without the [Recovery Act].” (Civil No. 14-1518, Docket
No. 95-1 at p. 23.)

This argument is unpersuasive.

When a state

law authorizes a party to do something that a contract prohibits it

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

57

from doing, or when a state law prohibits a party from doing
something that a contract authorizes it to do, the state law
“impairs” a contractual relationship, independent of whether or how
the party acts pursuant to the state law.

See, e.g., U.S. Trust

Co., 431 U.S. at 19-21 (where statutory covenant prohibited Port
Authority from spending revenues securing bonds, state law that
repealed the covenant - authorizing Port Authority to spend revenue
securing bonds - impaired the contractual relationship between the
state and bondholders, regardless of whether Port Authority spent
the revenues).
3.

Substantial Impairment
To determine whether a state law’s impairment of a

contractual relationship is sufficiently “substantial” to trigger
the Contract Clause, courts look to whether the impaired rights
were the seller’s “central undertaking” in the contract and whether
the rights “substantially induced” the buyer to enter into the
contract.

City of El Paso v. Simmons, 379 U.S. 497, 514 (1965).

Courts also look to how the contract right was impaired - whether
it was “totally eliminated” or “merely modified or replaced by an
arguably comparable” provision.

U.S. Trust Co., 431 U.S. at 19,

accord Richmond Mortgage & Loan Corp. v. Wachovia Bank & Trust Co.,
300 U.S. 124, 128-29 (1937) (“The Legislature may modify, limit, or
alter the remedy for enforcement of a contract without impairing
its obligation, but in so doing, it may not deny all remedy or so

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

58

circumscribe the existing remedy with conditions and restrictions
as seriously to impair the value of the right.

The particular

remedy existing at the date of the contract may be altogether
abrogated if another equally effective for the enforcement of the
obligation remains or is substituted for the one taken away.”)
Here, PREPA’s obligation to pay principal and interest on
the bonds when due was its central undertaking in the Trust
Agreement.

See

Trust

Agreement

§

701.

This

promise

also

substantially induced the bondholders to purchase the bonds from
PREPA: if there were no promise that they would receive a return on
their investment, they likely would not have invested.

The

Recovery Act does not make a single or modest impairment to PREPA’s
obligation. For example, it does not permit PREPA merely to extend
the maturity dates or to lower interest rates on its bonds.

Cf.

Faitoute, 316 U.S. at 507 (state law providing for an extension of
the maturity dates and a decrease in the interest rates found not
to violate Contract Clause).

Rather, the Recovery Act permits

PREPA to modify its debts in a variety of ways, including discharge
of principal and interest owed, without creditor consent.
The promise of numerous remedies - including (1) the
right to a senior lien on revenues, (2) the prohibition on PREPA
selling its electrical-power system, (3) an ipso facto clause
triggering default remedies, (4) the right to bring an action to
compel PREPA to set and collect rates, (5) the right to accelerate

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

59

payments, (6) the right to sue to enforce the remedies, and (7) the
right to seek the appointment of a receiver - likely substantially
induced the bondholders to purchase bonds from PREPA because these
are valuable security provisions that encourage investment. See
W.B. Worthen Co. v. Kavanaugh, 295 U.S. 56, 62 (1935) (finding
state

law

“viewed

modifications

in

combination”

to

several

are

“an

bondholder
oppressive

remedies,
and

when

unnecessary

destruction of nearly all the incidents that give attractiveness
and value to collateral security”).

U.S. Trust Co., 431 U.S. at

19 (finding state repeal of covenant that assured bondholders that
the revenues and reserves securing their bonds would not be used
for purposes other than those specifically delineated in the
covenant impaired the obligation of the state’s contract because it
“totally

eliminated

an

important

security

provision”).

The

Recovery Act does not merely modify these remedies or replace them
with comparable security provisions, it completely extinguishes all
of them.
The Commonwealth defendants argue for the first time in
their replies to the plaintiffs’ oppositions to the motions to
dismiss that any impairment of plaintiffs’ contractual rights is
not substantial because the impaired rights were not central to the
parties’ undertaking.
16.)

(Civil No. 14-1518, Docket No. 108 at p.

The Commonwealth defendants rely on City of Charleston v.

Public Service Commission of West Virginia, 57 F.3d 385 (4th Cir.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

60

1995), for this contention, but even that case supports the
opposite conclusion.

In City of Charleston, the Fourth Circuit

Court of Appeals concluded that the modification of the bond
contracts such that “one remedy - the right to impose liens - was
removed as to one relatively small group” was not substantial.
F.3d at 394.

57

Here, plaintiffs enumerate not one, but at least

seven remedies that the Recovery Act eliminated.

Even more, the

Recovery Act nullified PREPA’s promise to pay full principal and
interest and the Commonwealth’s promise to not alter the rights
vested in PREPA until the bonds and interest are fully paid and
discharged.
Thus, because the Recovery Act totally extinguishes
significant and numerous obligations, rights, and remedies, the
Court easily concludes that the impairment caused by the Recovery
Act is substantial.
C.

Reasonable and Necessary to Serve an Important Government
Purpose
The second prong of the Contract Clause test is whether the

impairment is “reasonable and necessary to serve an important
government purpose.”
431 U.S. at 25).

UAW, 633 F.3d at 41 (quoting U.S. Trust Co.,

“[T]he reasonableness inquiry asks whether the

law is reasonable in light of the surrounding circumstances, and
the necessity inquiry focuses on whether [the state] imposed a
drastic impairment when an evident and more moderate course would
serve its purposes equally well.” Id. at 45-46 (internal quotation

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
marks and citations omitted).

61

The First Circuit Court of Appeals

places the burden of establishing a lack of reasonableness and
necessity on the plaintiff and explains as follows regarding how
the plaintiff can carry that burden:
[A] plaintiff with reason to believe that a
state action was unreasonable or unnecessary
can, in the complaint, list the state's
articulated motive(s), and then plead facts
that undermine the credibility of the those
stated motives or plead facts that question
the reasonableness or necessity of the action
in advancing the stated goals. For example,
if a state purports to impair a contract to
address a budgetary crisis, a plaintiff could
allege facts showing that the impairment did
not save the state much money, the budget
issues were not as severe as alleged by the
state,
or
that
other
cost-cutting
or
revenue-increasing measures were reasonable
alternatives to the contractual impairment at
issue.
Id. at 45.
Here, the Commonwealth Legislative Assembly indicates in the
Recovery Act’s Statement of Motives that the Recovery Act addresses
the “current state of fiscal emergency” in Puerto Rico.
Act, Stmt. of Motives, § A.

Recovery

It avers that the downgrade to

non-investment grade of Puerto Rico’s general obligation bonds
“places the economic and fiscal health of the people of Puerto Rico
at risk, and improperly compromises the credit of the Central
Government and its public corporations.”

Id.

The Commonwealth

Legislative Assembly further explains that Puerto Rico’s three main
public corporations have a combined debt adding up to $20 billion,

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

62

and if “public corporations were to default on their obligations in
a manner that permits creditors to exercise their remedies in a
piecemeal way, the lack of an effective and orderly process to
manage the interests of creditors and consumers[] would threaten
the ability of the Commonwealth’s government to safeguard the
interests of the public to continue receiving essential public
services and promote the general welfare of the people of Puerto
Rico.”

Id.

Because the Commonwealth is alleged to have impaired a public
contract, “where the impairment operates for the state’s benefit,”
the

Court

gives

limited

deference

to

the

Commonwealth’s

determination of reasonableness and necessity. See Parella v. Ret.
Bd. of R.I. Employees’ Ret. Sys., 173 F.3d 46, 59 (1st Cir. 1999)
(internal quotation marks and citations omitted); accord McGrath v.
R.I. Ret. Bd., 88 F.3d 12, 16 (1st Cir. 1996) (“[A] state must do
more than mouth the vocabulary of the public weal in order to reach
safe harbor; . . . [an] objective . . . that reasonably may be
attained without substantially impairing the contract rights of
private parties[] will not serve to avoid the full impact of the
Contracts Clause.”).
The plaintiffs plead the following facts, which the Court
accepts as true at this stage in the litigation, to demonstrate
that

other

cost-cutting

and

revenue-increasing

measures

are

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

63

reasonable alternatives to the Recovery Act’s drastic impairment of
contract rights:25
1.

PREPA could modestly raise its rates.

It has not

increased its basic charges since 1989.
2.

PREPA could collect the $640.83 million currently owed to
it by the Commonwealth.

3.

PREPA could reduce the amount of funds currently diverted
to municipalities and subsidies.

PREPA is exempt from

taxation but is required to set aside 11 percent of its
gross revenues each year to pay “contributions in lieu of
taxes” to municipalities and other subsidies.

These

contributions are expected to total almost $1 billion
from 2014 to 2018.
4.

PREPA could cut costs and correct inefficiencies in its
management. PREPA has been reported to have (1) a highly
overstaffed human resources and labor department compared
to

peer

corporations,

(2)

high

costs

for

customer

service, (3) under-competitive bidding procedures for its
equipment, (4) surplus equipment and other inventory
above

that

needed

for

storm

preparedness,

(5)

high

overtime charges from employees and lenient timekeeping
standards, and (6) weak accounting controls.

25

See Civil No. 14-1518, Docket No. 85 at ¶¶ 50-54; Civil No. 14-1569, Docket
No. 20 at ¶¶ 57-64.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
5.

64

PREPA could improve its standing in the global capital
markets and take other measures to improve relationships
with creditors.

PREPA has not been reported to have

hired a capital markets investment banker since its 2013A
bonds were issued, it has not presented publicly to
investors

since

May

2013,

and

it

has

not

publicly

disclosed any intention to apply for a federal guarantee
under the “Advanced Fossil Energy Projects” solicitation
issued by the United States Department of Energy in
December 2013.
6.

PREPA could negotiate with creditors to restructure its
debts on a voluntary basis.
before

any

meaningful

The Recovery Act was passed

attempt

to

engage

in

such

negotiations.
The Court has no reason to doubt that the Commonwealth enacted
the Recovery Act to address Puerto Rico’s current state of fiscal
emergency.

But even when acting to serve an important government

purpose, the Commonwealth can impair contractual relationships only
through reasonable and necessary measures.

The Court infers from

plaintiffs well-pled and numerous factual allegations that the
Recovery Act imposes a “drastic impairment” when several other
“moderate

course[s]”

financial crisis.

are

available

to

address

Puerto

Rico’s

See U.S. Trust Co., 431 U.S. at 31 (“[A] State

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

65

is not free to impose a drastic impairment when an evident and more
moderate course would serve its purposes equally well.”)
D.

Contract Clauses Conclusion
For the foregoing reasons, the plaintiffs state a plausible

claim pursuant to the contract clauses of the United States and
Puerto Rico constitutions.

The Court accordingly DENIES the

Commonwealth defendants’ motions to dismiss, (Civil No. 14-1518,
Docket No. 95; Civil No. 14-1569, Docket No. 29), as to plaintiffs’
contract clauses claims.
VI. TAKINGS CLAUSE
The Franklin and Oppenheimer Rochester plaintiffs seek a
declaratory judgment that the Recovery Act violates the Takings
Clause of the United States Constitution by taking without just
compensation

(1)

plaintiffs’

contractual

right

to

seek

the

appointment of a receiver, and (2) plaintiffs’ liens on PREPA
revenues.

(Civil No. 14-1518, Docket No. 85 at ¶¶ 32-39, 62-63.)

The Commonwealth defendants move to dismiss on ripeness grounds
pursuant to Rule 12(b)(1) and for failure to state a claim pursuant
to Rule 12(b)(6).
A.

(Civil No. 14-1518, Docket No. 95.)

Plaintiffs State a Plausible Claim for Relief Based on the
Taking of Their Contractual Right to Seek the Appointment of
a Receiver
Plaintiffs first seek a declaratory judgment that section

108(b) of the Recovery Act effectuates a taking without just
compensation of plaintiffs’ right to seek the appointment of a

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

66

receiver in violation of the Takings Clause.
Docket No. 85 at ¶ 63.)

(Civil No. 14-1518,

Section 17 of the Authority Act grants

bondholders the right to seek appointment of a receiver if PREPA
defaults.

P.R.

incorporated

Laws

into

Ann.

section

tit.

804

22

of

the

§

207.
Trust

This

right

Agreement,

is

which

guarantees that bondholders have the right to seek “the appointment
of

a

receiver

defaults.

as

authorized

by

Trust Agreement § 804.

the

Authority

Act”

if

PREPA

Section 108(b) of the Recovery

Act eliminated this statutory and contractual right: “This Act
supersedes

and

annuls

any

insolvency

or

custodial

provision

included in the enabling or other act of any public corporation,
including Section 17 of [the Authority Act].”
108(b).26

Recovery Act §

The Recovery Act does not provide for any means of

compensation for taking this contractual right.
Plaintiffs’ claim falls squarely within the United States
Supreme Court’s definition of a facial takings challenge: “a claim
that the mere enactment of a statute constitutes a taking,” as
opposed to an as-applied claim “that the particular impact of
government action on a specific piece of property requires the
payment of just compensation.”

Keystone Bituminous Coal Ass’n v.

DeBenedictis, 480 U.S. 470, 494 (1987).

Accordingly, plaintiffs’

facial takings claim became ripe the moment the Recovery Act was

26
Because plaintiffs’ contractual right to seek the appointment is nothing more
than the incorporation of plaintiffs’ statutory right, section 108(b)’s annulment
of the statutory right consequently eliminated the contractual right.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
passed.

67

See Suitum v. Tahoe Reg’l Planning Agency, 520 U.S. 725,

736 n.10 (1997) (facial takings challenges “are generally ripe the
moment

the

challenged

regulation

or

ordinance

is

passed”);

Asociacion de Suscripcion Conjunta del Seguro de Responsabilidad
Obligatorio v. Juarbe-Jimenez, 659 F.3d 42, 50-51 (1st Cir. 2011)
(facial takings challenge becomes ripe “at the time the offending
statute or regulation is enacted or becomes effective”); accord
Pharm. Care Mgmt. Ass’n v. Rowe, 429 F.3d 294, 307 (1st Cir. 2005).
Having concluded that jurisdiction is proper, the Court turns
to the Commonwealth defendants’ motion to dismiss pursuant to Rule
12(b)(6).

“The sole inquiry under Rule 12(b)(6) is whether,

construing the well-pleaded facts of the complaint in the light
most favorable to the plaintiffs, the complaint states a claim for
which relief can be granted.”

Ocasio-Hernandez, 640 F.3d at 7.

The Takings Clause of the Fifth Amendment provides that
“private property [shall not] be taken for public use, without just
compensation.”
to

the

U.S. Const. amend. V.

Commonwealth

Amendment.

of

Puerto

The Takings Clause applies

Rico

through

the

Fourteenth

Fideicomiso De La Tierra Del Caño Martin Peña v.

Fortuño, 604 F.3d 7, 12 (1st Cir. 2010).

The purpose of the

Takings Clause regime is to bar the government “from forcing some
people alone to bear public burdens which, in all fairness and
justice, should be borne by the public as a whole.”

Lingle v.

Chevron U.S.A. Inc., 544 U.S. 528, 537 (2005) (quoting Armstrong v.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
United States, 364 U.S. 40, 49 (1960)).

68
The United States Supreme

Court identifies two categories of takings that require just
compensation: (1) a direct taking, which includes either a “direct
government appropriation or physical invasion of private property,”
and (2) a regulatory taking, which is when a “government regulation
of private property . . . [is] so onerous that its effect is
tantamount to a direct appropriation or ouster.”

Id.

Contracts are a form of property for purposes of the Takings
Clause.

U.S. Trust Co., 431 U.S. at 19 n.16 (“Contract rights are

a form of property and as such may be taken for a public purpose
provided that just compensation is paid.”); Lynch v. United States,
292 U.S. 571, 579 (1934) (“Valid contracts are property” for
purposes of the Takings Clause, “whether the obligor be a private
individual, a municipality, a state, or the United States.”); Adams
v. United States, 391 F.3d 1212, 1221-22 (Fed. Cir. 2004) (“When
the Government and private parties contract . . .

the private

party usually acquires an intangible property interest within the
meaning of the Takings Clause in the contract.

The express rights

under this contract are just as concrete as the inherent rights
arising from ownership of real property, personal property, or an
actual sum of money.”).
The Commonwealth defendants contend, without citing authority
for support, that “there can be no ‘taking’ of a right that has
never been triggered.”

(Civil No. 14-1518, Docket No. 108 at p.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
18.)

69

They then reason that plaintiffs’ Takings Clause claim fails

because plaintiffs’ contractual right to seek the appointment of a
receiver

is

defaulted.

triggered
Id.

only

The

upon

default

Commonwealth

and

PREPA

defendants’

has

not

argument

is

unpersuasive and misunderstands the basics of contracts law.

A

contract may have a condition, which is an event that must occur
before

performance

pursuant

to

the

contract

becomes

Restatement (Second) of Contracts § 224 (1981).

due.

Here, PREPA

defaulting is a condition on plaintiffs’ contractual right to seek
the appointment of a receiver.
Trust Agreement § 804.

See P.R. Laws Ann. tit. 22 § 207;

Accordingly, plaintiffs may not seek the

appointment of a receiver until PREPA defaults (i.e., they may not
seek performance of the contract until the condition is met). This
condition does not affect the existence of plaintiffs’ contractual
right to seek the appointment of a receiver.
right

is

a

promise

they

bargained

for

and

This contractual
relied

upon

when

purchasing PREPA bonds pursuant to the Authority Act and the Trust
Agreement.
The

Commonwealth

defendants

next

attempt

to

regulatory takings analysis to plaintiffs’ claim.
14-1518,

Docket

No.

95-1

at

p.

27.)

“A

apply

the

(Civil No.

regulatory

taking

transpires when some significant restriction is placed upon an
owner’s use of his property for which ‘justice and fairness’
require that compensation be given.”

Philip Morris, Inc. v.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

70

Reilly, 312 F.3d 24, 33 (1st Cir. 2002) (citing Goldblatt v. Town
of Hempstead, N.Y., 369 U.S. 590, 594 (1962)).

Here, there is no

regulation or “restriction” placed on plaintiffs’ contractual right
to seek the appointment of a receiver.

Rather, section 108(b) of

the Recovery Act totally eliminated the contract provision that
gave plaintiffs the right.
the

Recovery

Act,

the

Thus, by enacting section 108(b) of

Commonwealth

appropriated

plaintiffs’

contractual right to seek the appointment of a receiver.
a direct taking.

This is

The Court therefore declines to engage in a

regulatory takings analysis and concludes that plaintiffs plausibly
state a claim for declaratory relief that section 108(b) of the
Recovery

Act

effects

a

taking

without

just

compensation

of

plaintiffs’ property in violation of the Takings Clause.
B.

Plaintiffs’ Takings Clause Claim Based on Their Liens on PREPA
Revenues Fails to State a Claim as a Facial Challenge and is
Unripe as an As-Applied Challenge
Plaintiffs next seek a declaratory judgment that sections

129(d) and 322(c) of the Recovery Act effectuate a taking without
just compensation of their lien on PREPA revenues in violation of
the Takings Clause.

(Civil No. 14-1518, Docket No. 85 at ¶ 62.)

Plaintiffs allege that their PREPA bonds are secured by a pledge of
all or substantially all of the present and future net revenues of
PREPA.

Id. at ¶ 3.

If PREPA files for debt relief pursuant to

Chapter 3 of the Recovery Act, the special court may authorize
PREPA to obtain credit “secured by a senior or equal lien on

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

71

[PREPA’s] property that is subject to a lien” if, among other
things, “the proceeds are needed to perform public functions” or
“there is adequate protection of the interest of the holder of the
[previous] lien.”

Recovery Act § 322(c).

Section 129(d) of the

Recovery Act disposes of the “adequate protection” requirement when
the “police power” justifies it.

Id. § 129(d).

The relief plaintiffs seek indicates that they are bringing a
facial takings challenge: they request a declaration that sections
129(d) and 322(c) of the Recovery Act “effectuate a taking of
the[ir] lien.”

(Civil No. 14-1518, Docket No. 85 at ¶ 62.)

In

other words, they claim that the “mere enactment” of sections
129(d) and 322(c) constitutes a taking.
480

U.S.

at

plaintiffs’

494

(defining

allegations

to

facial
not

See Keystone Bituminous,

takings

support

this

challenge).
claim.

But

Rather,

plaintiffs allege that the Recovery Act authorizes the special
court to authorize PREPA to prime plaintiffs’ lien.

See Civil No.

14-1518, Docket No. 85 at ¶ 33; Recovery Act § 322(c).
not alleged that their lien has been primed.

They have

That is to say,

plaintiffs still today have a senior lien on PREPA revenues.

This

is unlike their contractual right to seek the appointment of a
receiver, which plaintiffs do not have today because section 108(b)
of the Recovery Act expressly eliminated that right.
Part VI.A.

See supra

Thus, when analyzed as a facial takings challenge,

plaintiffs fail to state a claim upon which their sought-after

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

72

declaratory relief (that sections 129(d) and 322(c) of the Recovery
Act effectuate a taking without just compensation) can be granted
because they fail to allege an actual taking.
Characterizing plaintiffs’ claim as an as-applied challenge,
however, leads to a different conclusion.

An as-applied facial

takings challenge is a claim “that the particular impact of
government action on a specific piece of property requires the
payment of just compensation.”
494.

This

definition

fits

Keystone Bituminous, 480 U.S. at
plaintiffs’

factual

allegations:

plaintiffs allege that if PREPA files pursuant to Chapter 3 of the
Recovery Act and the special court authorizes PREPA to grant a lien
on PREPA revenues senior to plaintiffs’ lien, that action by the
special court will amount of a taking of plaintiffs’ lien and will
require the payment of just compensation.

While facial takings

challenges are ripe the moment the challenged law is passed,
Suitum, 520 U.S. at 736 n.10; Asociacion de Suscripcion Conjunta,
659 F.3d at 50-51; Pharm. Care Mgmt. Ass’n, 429 F.3d at 307,
as-applied takings challenges must pass a higher ripeness hurdle.
In Williamson County, the Supreme Court held that plaintiffs
raising

as-applied

takings

challenges

must

meet

two

special

ripeness requirements: (1) that the relevant government entity “has
reached

a

final

decision

regarding

the

application

of

the

regulations to the property at issue,” and (2) that the plaintiffs
pursued any “adequate procedure for seeking just compensation.”

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

73

Williamson Cnty. Reg’l Planning Comm’n v. Hamilton Bank of Johnson
City, 473 U.S. 172, 186, 195 (1985); accord Downing/Salt Pond
Partners, L.P., 643 F.3d at 20-21.

Here, the special court is the

government entity tasked with deciding whether PREPA may prime
plaintiffs’ lien. See Recovery Act § 322(c) (“The [special c]ourt,
after notice and a hearing, may authorize the obtaining of credit
or the incurring of debt secured by a senior or equal lien on the
petitioner’s property that is subject to a lien . . . .”).
Plaintiffs have not alleged that the special court made a final
decision regarding the priming of their lien.

Thus, when analyzed

as an as-applied takings challenge, plaintiffs’ claim fails the
first Williamson County ripeness requirement and is therefore
unripe.27
C.

Takings Clause Conclusion
For the foregoing reasons, the Court DENIES the Commonwealth

defendants’ motion to dismiss, (Civil No. 14-1518, Docket No. 95),
as to the Franklin and Oppenheimer Rochester plaintiffs’ Takings
Clause

claim

based

on

their

contractual

right

to

seek

the

appointment of a receiver, and GRANTS the Commonwealth defendants’
motion to dismiss, (Civil No. 14-1518, Docket No. 95), as to

27
This result is not affected by the fact that plaintiffs seek declaratory
relief, as opposed to money damages. See Garcia-Rubiera v. Calderon, 570 F.3d
443, 451-54 (1st Cir. 2009) (applying both Williamson County ripeness prongs to
takings claim for declaratory and injunctive relief); Golemis v. Kirby, 632 F.
Supp. 159, 164 (D.R.I. 1985) (“[The Williamson County] ripeness analysis would
be completely neutered if its holding were applied to damage claims alone.”).

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)

74

plaintiffs’ Takings Clause claim based on their lien on PREPA
revenues.
VII. CONCLUSION
In Civil Case No. 14-1518, the Court orders as follows:
1.

The Commonwealth defendants’ motion to dismiss, (Docket No.
95), is DENIED as to the Franklin and Oppenheimer Rochester
plaintiffs’ preemption and Contract Clause claims.

2.

The Commonwealth defendants’ motion to dismiss, (Docket No.
95), is GRANTED as to plaintiffs’ stay of federal court
proceedings claim.

The stay of federal court proceedings

claim is unripe and is therefore DISMISSED WITHOUT PREJUDICE.
3.

The Commonwealth defendants’ motion to dismiss, (Docket No.
95), is DENIED as to plaintiffs’ Takings Clause claim based on
their contractual right to seek the appointment of a receiver,
and GRANTED as to plaintiffs’ Takings Clause claim based on
their lien on PREPA revenues.

The Takings Clause claim based

on plaintiffs’ lien on PREPA revenues is DISMISSED WITHOUT
PREJUDICE.
4.

PREPA’s motion to dismiss, (Docket No. 97), is GRANTED as to
all claims to the extent that they are asserted against PREPA.
PREPA is DISMISSED from this case because plaintiffs lack
standing against it.

Civil Nos. 14-1518 (FAB), 14-1569 (FAB)
5.

75

Plaintiffs’ motion for summary judgment, (Docket No. 78), is
GRANTED as to plaintiffs’ preemption claim and DENIED as to
plaintiffs’ stay of federal court proceedings claim.
In Civil Case No. 14-1569, the Commonwealth defendants’ motion

to

dismiss,

(Docket

No.

29),

is

DENIED

as

to

plaintiff

BlueMountain’s preemption and contract clauses claims, and GRANTED
as to BlueMountain’s stay of federal court proceedings claim.

The

stay of federal court proceedings claim is unripe and is therefore
DISMISSED WITHOUT PREJUDICE.
The Recovery Act is preempted by the federal Bankruptcy Code
and is therefore void pursuant to the Supremacy Clause of the
United States Constitution. The Commonwealth defendants, and their
successors in office, are permanently enjoined from enforcing the
Recovery Act.
IT IS SO ORDERED.
San Juan, Puerto Rico, February 6, 2015.
s/ Francisco A. Besosa
FRANCISCO A. BESOSA
UNITED STATES DISTRICT JUDGE