Following Judge Swain’s Ruling in ERS Perfection Dispute, Focus Shifts to Appeals Pending Before First Circuit

On Friday, Aug. 17, Judge Laura Taylor Swain issued her much-anticipated ruling in the dispute in the Title III adversary proceeding between the Employees Retirement System of the Government of the Commonwealth of Puerto Rico, or ERS, on the one hand, and ERS bondholders, on the other hand. The ruling was the latest in a series of significant rulings in recent weeks both by the Title III court and the U.S. Court of Appeals for the First Circuit. The U.S. Court of Federal Claims also issued a ruling in mid-July regarding the ERS bondholders’ Takings Clause litigation that is interrelated with several pending matters, including the Appointments Clause litigation and the various ERS matters.

Apart from those recently issued rulings, there are also several significant opinions that are the subject of appeals pending before the First Circuit, including two matters currently scheduled for oral argument on Nov. 5 at 8:30 a.m. ET in San Juan, Puerto Rico.

The recent rulings and upcoming appeals are summarized below.

Recent Opinions (Title III Court)

ERS Dispute

In her Aug. 17 opinion, Judge Swain concluded that Uniform Commercial Code, or UCC, filings - the UCC-1 financing statements filed in 2008 and the UCC-3 amendments filed in 2015 and 2016 - were insufficient to perfect the bondholders’ claimed security interest. As a result, Judge Swain found that the ERS bondholders did not have a perfected security interest in any of the pledged property at issue. Judge Swain also concluded that Bankruptcy Code section 544(a) applies in a Title III case, stressing that interpreting “Section 544 of the Bankruptcy Code - and, by implication, the additional avoidance powers that Congress specifically incorporated through Section 301 of PROMESA - prospectively only would render such tools unavailable for use in Puerto Rico’s Title III debt readjustment process.” According to the ruling, any security interest held by the ERS bondholder defendants in the pledged property, including alleged security interests in the employee loans, the employee loan payments and the monies deposited pursuant to the applicable stipulation, was invalid and unenforceable against ERS pursuant to section 554(a).

Addressing the ERS’ requested declaration that Bankruptcy Code section 552(a) prevents any security interest from attaching to revenue received by ERS during the postpetition period, Judge Swain concluded that it was not necessary to consider separately the postpetition effect of any such security interest because of the court’s conclusion that the security interest claimed by the bondholders is invalid and unenforceable against ERS by virtue of section 544(a). According to the opinion, there was no ripe controversy with respect to the operation of section 552, and therefore, Judge Swain denied both parties’ motions for summary judgment as to the relevant count - Count Three - of the complaint. To the extent, however, that the ERS bondholder defendants sought summary judgment and a declaration that any lien they possess on postpetition revenue remains operative, Judge Swain denied such request on the basis that section 544(a) invalidates the lien.

The ruling comes just over eight months after Judge Swain heard oral argument on the competing summary judgment motions on Dec. 13, 2017.

In conjunction with her opinion, Judge Swain also issued an order to show cause as to why the remaining claims that were not disposed of by summary judgment should not be dismissed.

Written submissions from ERS and the ERS bondholders is due Aug. 31 at 5 p.m. ET. Replies, if necessary, are due Sept. 7 at 5 p.m. ET.

On Tuesday, Aug. 21, Judge Swain entered an order denying the ERS bondholders’ adequate protection motion on the basis that her Aug. 17 summary judgment ruling resolves it. The order preserves the ERS bondholders’ right to appeal “this Order and the August 17 Order on any grounds and without prejudice to the Oversight Board, on behalf of ERS, and the Retiree Committee opposing any appeal on any grounds,” adding that “[a]ll parties’ rights are reserved in full.”

A full summary of the pending disputes and appeals related to ERS is available HERE.

Opinion Regarding Oversight Board’s Motion to Dismiss Governor Rosselló’s Adversary Proceeding

On Aug. 7, less than two weeks after hearing oral argument, Judge Swain also granted in part and denied in part the oversight board’s motion to dismiss the litigation filed by Gov. Ricardo Rosselló and the Puerto Rico Fiscal Agency and Financial Advisory Authority, or AAFAF, over what the governor and AAFAF called the oversight board’s “unlawful attempts to usurp the Commonwealth of Puerto Rico’s political and governmental powers and right to home rule.”

In her ruling, Judge Swain granted the oversight board’s motion to dismiss with respect to certain claims pursuant to Rule 12(b)(6) for failure to state a claim upon which relief may be granted. In addition, the judge separately dismissed other claims pursuant to Rule 12(b)(1) for lack of subject matter jurisdiction, including claims relating to the measures on proposed agency consolidation and reduction of employee benefits because those measures are not mandatory and therefore did not present a justiciable case or controversy. Judge Swain declined, however, to dismiss claims relating to challenged provisions of the fiscal plan and budget resolutions relating to automatic budget reductions and corrective measures, as well the injunctive-relief count of the complaint.

Notable aspects of the Title III court’s opinion include its discussion of PROMESA section 106(e), which provides that courts do not have jurisdiction to review challenges to the oversight board’s certification determinations, as well as the framework of PROMESA sections 201, 202 and 205.

Although as indicated in Judge Swain’s opinion in Ambac, the oversight board has exclusive authority to certify fiscal plans, the judge explained that the lawsuit focused on the impact, and not the propriety, of the oversight board’s certification of the fiscal plan and budget, and that section 106(e) thus did not preclude the Title III court from exercising jurisdiction over the matter.

Addressing the recommendation process, Judge Swain explained that PROMESA section 205 establishes a process for the oversight board to submit, and for the government to respond to, recommendations relating to “actions the territorial government may take to ensure compliance with the Fiscal Plan, or to otherwise promote the financial stability, economic growth, management responsibility, and service delivery efficiency of” the government. Section 201, which governs fiscal plans covering periods of five or more fiscal years, contemplates the governor formulating and proposing a plan to the oversight board, the oversight board recommending revisions and the governor proposing revisions, the opinion states. The opinion also notes that section 202, which governs the development of budgets covering at least one fiscal year, allocates initial responsibility for developing a proposed budget consistent with a certified fiscal plan to the governor and the legislature.

Consistent with PROMESA’s framework, the opinion explained that the oversight board may “make binding policy choices for the Commonwealth, notwithstanding the Governor’s rejection of Section 205 recommendations.” Noting, however, that PROMESA requires the oversight board to “look first to the elected government for fiscal plan and budgetary direction” and requires certain communications where potential PROMESA violations are raised, Judge Swain explained that the oversight board’s power does not “render the elected Governor irrelevant or toothless.” The judge emphasized that the oversight board’s ability to impose a rejected policy should not be “exercised lightly” and that the oversight board “has not been given power to affirmatively legislate.” Although PROMESA’s governance structure infringes on the scope of the government’s power, Congress wrote that structure into law, the opinion notes.

Opinion Regarding Oversight Board’s Motion to Dismiss Legislative Assembly’s Adversary Proceeding

In an opinion issued on Aug. 7, the same day as her ruling in Rossello and AAFAF’s lawsuit, Judge Swain also dismissed in its entirety the lawsuit filed by the Puerto Rico legislature. By the lawsuit, Sen. Thomas Rivera-Schatz, as senate president and on behalf of the Puerto Rico Senate, and Rep. Carlos J. Méndez-Núñez, as speaker and on behalf of the Puerto Rico House of Representatives, sought to prevent the oversight board from implementing the certified budget for fiscal 2019.

In granting the oversight board’s motion to dismiss, Judge Swain emphasized that the oversight board has “the final say when there is conflict regarding budgetary allocations.” The opinion acknowledged that the oversight board may use its powers with the aim of “incentiviz[ing] assent” to the oversight board’s policy goals and that the legislature may “decline to accede” to legislation inconsistent with the legislature’s policy goals but encouraged the parties “to find a common vision” in light of the “collaboration on fiscal plan and budgetary matters” contemplated by PROMESA.

On Aug. 13, Méndez-Núñez, on the House of Representatives’ behalf, appealed Judge Swain’s dismissal of the legislative assembly lawsuit. The following day, Aug. 14, Rivera-Schatz, on behalf of the Puerto Rico Senate, also appealed the dismissal.

On July 25, after being denied intervention in the legislature’s now-dismissed lawsuit, various members of the Popular Democratic Party, or PDP, including certain members of the House of Representatives, certain members of the Senate and several town mayors, had separately filed a lawsuit against the oversight board that mirrors the respective lawsuits filed by the legislature, by the governor and AAFAF and by Assured Guaranty. Noting the overlapping issues among the lawsuits, U.S. Magistrate Judge Dein ordered the parties in the PDP lawsuit to submit a status report, including an agreed schedule for responding to the complaint, on or before Aug. 24.

Opinion Dismissing UTIER Appointments Clause Litigation

Last week, Judge Swain also dismissed in its entirety the adversary proceeding filed by the PREPA union known as Unión de Trabajadores de la Industria Eléctrica y Riego, or UTIER, which challenged the appointment of the PROMESA oversight board’s members. According to UTIER, the process established by Congress to select members of the PROMESA oversight board "collides directly” with the Appointments Clause of the U.S. Constitution, which provides for the president to nominate and appoint, with the advice and consent of the Senate. UTIER asked the Title III court to declare all board acts and determinations taken from the time of their appointments to the present to be unconstitutional and invalid.

Judge Swain previewed her decision regarding the UTIER Appointments Clause proceeding in her opinion denying the motion by Aurelius to dismiss the commonwealth’s Title III petition. Although the motion to dismiss the UTIER litigation raises “issues substantially similar to those argued” in connection with the Aurelius motion, a footnote in the Aurelius opinion indicated her intent to address the motion to dismiss the UTIER litigation “in a separate decision.”

In her opinion dismissing the UTIER litigation, Judge Swain concluded that the U.S. Constitution’s Territories Clause was the source of authority for Congress to approve Puerto Rico’s Constitution, enact PROMESA and make and amend rules and regulations for Puerto Rico. The opinion held that UTIER’s claims for declaratory and injunctive relief sought to bar the oversight board “from exercising powers specifically granted to it by PROMESA” in contravention of the Territories Clause. The judge did find, however, that UTIER had constitutional standing to file the adversary proceeding.

The ruling repeatedly refers to the reasoning in the Title III court’s previous decision relating to the Aurelius Appointments Clause challenge.

UTIER subsequently filed a notice of appeal regarding the ruling.

Recent Opinions (First Circuit)

Peaje

On Aug. 8, the First Circuit ruled that Peaje Investments does not hold a statutory lien on certain toll revenue of the Puerto Rico Highways and Transportation Authority, or the HTA. The opinion rejected Peaje’s contention that it has a statutory lien pursuant to the 1965 Enabling Act, which created the HTA. In resolving Peaje’s appeal of the Title III court’s September 2017 opinion, the First Circuit affirmed the “primary grounds” for Judge Swain’s denial of Peaje’s requests for a preliminary injunction and for relief from the automatic stay.

In addition, the First Circuit held that Judge Swain did not abuse her discretion in "limiting Peaje to its argument that it holds a statutory lien” and preventing Peaje from arguing that it holds a nonstatutory lien. The First Circuit vacated, however, the judge’s alternative reasons for denying Peaje’s requested relief - that Peaje failed to establish irreparable harm and that the defendants established adequate protection of Peaje's interests - and remanded those issues to the Title III court for further proceedings.

In the Title III court, Peaje had sought an order directing HTA to resume depositing the underlying toll revenue with the fiscal agent and prohibiting the commonwealth from interfering with the execution of such order. In denying Peaje’s preliminary injunction request as well its alternative requests for relief from the automatic stay and adequate protection, Judge Swain found, among other things, that Peaje failed to demonstrate a likelihood of success on its argument that the 1968 bonds are secured by an involuntary statutory lien arising “by operation of law” from the HTA Enabling Act and the 1968 resolution.

PREPA Ad Hoc Group / Insurers

In another significant ruling for the Title III cases, the First Circuit vacated Judge Swain’s Sept. 14, 2017, opinion and order denying the stay relief motion filed by the ad hoc group of PREPA bondholders and several bond insurers - National Public Finance Guarantee, Assured Guaranty and Syncora Guarantee. The First Circuit remanded the matter to the Title III court for further proceedings. By their motion, the movants sought relief from the automatic stay in order to sue PREPA to enforce their statutory right to appointment of a receiver. Although the First Circuit held that sections 305 and 306 of PROMESA did not preclude the Title III court from granting the requested stay relief, it emphasized that it was leaving to the Title III court’s discretion whether, and on what terms and conditions, stay relief might be granted consistent with the First Circuit’s ruling.

According to the First Circuit, while section 305 prevents the Title III court from exercising certain political powers, it does not prevent the Title III court from granting stay relief “when the facts establish a creditor's entitlement to the appointment of a receiver in a different court in order to protect a creditor's collateral should that protection otherwise be necessary and appropriate.” In acknowledging the Title III court’s concerns regarding the potential “deleterious impact” that a receivership appointment might have in the Title III case, the First Circuit noted that the Title III court could potentially tailor appropriate relief that would allow the creditors to seek a receiver with limited powers necessary to protect their collateral.

With respect to section 306, which gives the Title III court exclusive jurisdiction over the debtor's property, the First Circuit noted that under the Bankruptcy Code analogue to section 306, bankruptcy courts had, in sales and other contexts, allowed other courts to act on a debtor’s property without threatening the bankruptcy court’s exclusive jurisdiction.

Addressing Judge Swain’s determination that there was no “cause” for stay relief because the “balance of harms” weighed against such relief, the First Circuit explained that her discussion of the merits of stay relief was insufficient. The First Circuit therefore instructed the Title III court to elaborate on the factors considered in evaluating the stay relief request, adding that the bondholders should file a “new and updated” stay relief motion so that the Title III court and the parties can address the merits “free of any thought that the request is categorically precluded.”

Recent Opinions (Court of Federal Claims)

The ERS bondholders are also involved in a separate legal challenge against the United States in which the bondholders assert a cause of action based on the Takings Clause of the U.S. Constitution. The dispute is currently pending before the U.S. Court of Federal Claims. Chief Judge Susan Braden heard oral argument on the federal government’s motion to dismiss the litigation in June.

In an opinion issued in July, Judge Braden denied the federal government’s motion to dismiss and concluded that the Federal Claims court has jurisdiction to adjudicate the Takings Clause claim. Judge Braden also concluded that the PROMESA oversight board is an entity of the federal government.

Judge Braden rejected the federal government’s argument that PROMESA “unambiguously” withdrew Tucker Act jurisdiction to adjudicate the ERS bondholders’ claim, finding that PROMESA includes no evidence of any such “unambiguous intention.” The opinion also explains that PROMESA does not pre-empt Tucker Act jurisdiction “because it did not contain either a comprehensive remedial scheme or monetary relief equivalent to ‘just compensation.’” Judge Braden also found that the amended complaint properly alleged “each of the requisite elements to establish that Plaintiffs have standing to seek an adjudication of their Fifth Amendment Takings Clause claim.”

Although she did not dismiss the Takings Clause litigation, Judge Braden stayed the litigation until a decision and final judgment is entered in the ongoing separate Appointments Clause proceedings involving UTIER and Aurelius, respectively. On the day that Judge Braden ruled, Judge Swain had earlier that day issued her ruling denying the Aurelius Appointments Clause challenge but did not issue her opinion on UTIER’s motion to dismiss until Aug. 15.

After the Title III court’s Aurelius ruling, Assured Guaranty commenced its own Appointments Clause challenge in order to allow Assured to participate in any subsequent appeals on the decision before the First Circuit. Assured’s litigation was resolved by way of a stipulated judgment entered by Judge Swain on Aug. 3.

Each of the Appointments Clause challenges allege that the members of the PROMESA oversight board were appointed in violation of the Appointments Clause. Aurelius, Assured and UTIER have each appealed the respective opinions denying their Appointments Clause challenges. On Aug. 15, the U.S. Court of Appeals for the First Circuit entered orders granting the request for leave to appeal, consolidating the Aurelius and Assured appeals and scheduling expedited briefing on the matter. Judge Braden’s stay lasts until “final judgment” in the cases, which appears to leave room for the stay to last until all appeals have been exhausted. The UTIER litigation is discussed above, and the Aurelius and Assured matters are discussed together below.

Notably, the Federal Claims court also concluded that the PROMESA oversight board is an entity of the federal government. According to the opinion, “[T]he Takings Clause claim alleged in the October 31, 2017 Amended Complaint is not an action against the Oversight Board; instead, it is an action against the United States.” Judge Braden’s decision in the U.S. Court of Federal Claims litigation was issued later on the same day as Judge Swain’s ruling in the Title III case. Judge Braden’s holding that the oversight board is a federal government entity stands in sharp contrast to Judge Swain’s conclusion in her July 13 opinion that the oversight board is an instrumentality of the territory of Puerto Rico, as discussed below. Judge Braden’s opinion did not reference Judge Swain’s ruling.

In supplemental pleadings filed after the Federal Claims court’s ruling, the U.S. and the ERS bondholders asserted their positions on the relevance of Judge Swain’s July 13 ruling in the Title III cases regarding the Appointments Clause. The U.S. argued that Judge Swain’s ruling is “entirely relevant” to the issues before the Federal Claims Court, while the ERS bondholders maintained that Judge Swain’s ruling “is not relevant to the questions before [the Federal Claims] Court” and “has no bearing on [the Federal Claims] Court’s holding that it has jurisdiction to adjudicate Plaintiffs’ Fifth Amendment Takings Claim against the United States.”

The Federal Claims court also evaluated the oversight board members in the context of the U.S. Supreme Court’s recent decision in Lucia v. S.E.C., which held that the SEC’s administrative law judges, or ALJs, were “Officers of the United States,” subject to the U.S. Constitution’s Appointments Clause. Judge Braden found that the oversight board members “hold a continuing office established by Congress that specifies their ‘duties ... and means of appointment.’” Drawing comparisons with the ALJs in Lucia, the Federal Claims court observed that the oversight board members “exercise ‘significant discretion’ in carrying out their ‘important functions.’” According to Judge Braden, “Although the special trial judges in Freytag and the ALJs in Lucia were engaged in different and much more limited duties than those exercised by Oversight Board members, there is little doubt that the latter are also federal civil officials with responsibility for an ongoing statutory duty.”

Judge Swain had observed in her opinion that the Supreme Court’s ruling in Lucia, which was recently submitted as part of a supplemental brief from Aurelius, was “inapposite” because it “involved a distinction between an officer of the United States and an employee.” Both the oversight board and the U.S. argued that Aurelius’ reliance on Lucia was “meritless.”

Pending Appeals

Aurelius/Assured Guaranty

The First Circuit issued an order on Aug. 15 consolidating two appeals by Assured and Aurelius regarding Judge Swain’s July 13 denial of the challenge to the appointment of the oversight board’s members under the Appointments Clause.

In her opinion, Judge Swain had concluded that the members of the oversight board are not “Officers of the United States” subject to the Appointments Clause in the U.S. Constitution. The judge wrote in her opinion, “Affording substantial deference to Congress … the Court finds that the Oversight Board is an instrumentality of the territory of Puerto Rico, established pursuant to Congress’s plenary powers under Article IV of the Constitution, that its members are not ‘Officers of the United States’ who must be appointed pursuant to the mechanism established for such officers by Article II of the Constitution, and that there is accordingly no constitutional defect in the method of appointment provided by Congress for members of the Oversight Board.”

As noted above, Assured filed its Appointments Clause challenge on July 23, a little over a month after Judge Swain’s ruling on the Aurelius motions. Assured acknowledged in its pleadings that it was seeking to participate in the appellate process regarding the Aurelius decision. On July 30, Judge Swain granted the joint motion of Aurelius, the FOMB and the United States requesting certification of an immediate appeal of the Title III court’s Aurelius Appointments Clause decision to the First Circuit. On Aug. 3, the judge entered a stipulated judgment in the Title III case in favor of the PROMESA oversight board in Assured Guaranty’s Appointments Clause challenge.

Ambac/HTA

Ambac’s appeal of Judge Swain’s Feb. 27 opinion dismissing Ambac’s adversary proceeding against the HTA and other commonwealth defendants remains pending before the First Circuit. Ambac had filed the lawsuit as a challenge to the fiscal plan certified by the oversight board, which Ambac argued was unconstitutional, and requested relief under the Bankruptcy Code on the theory that toll revenue and excise taxes are pledged special revenue with respect to HTA bonds that are insured by Ambac. Judge Swain’s decision granted the defendants’ motion to dismiss the adversary proceeding based on the absence of subject matter jurisdiction for some claims and failure to state a claim upon which relief can be granted for others.

Ambac has filed an opening brief in the First Circuit appeal, arguing that the challenged acts - the moratorium laws and orders, the fiscal plan and the commonwealth’s compliance with them - are unlawful executive orders pre-empted by PROMESA section 303(3). The brief also contends that the special revenue provisions of the Bankruptcy Code - sections 922 and 928 - require the postpetition application of the pledged special revenue to the HTA bonds. Ambac also asserts that its Contracts Clause and Takings Clause claims should not have been dismissed. In addition, Ambac raises concerns over the Title III court’s ruling with respect to PROMESA section 106(e) and whether it prohibits judicial review of the fiscal plan for compliance with the requirements of PROMESA section 201(b)f.

In light of the pending First Circuit appeal regarding Judge Swain’s ruling in the Ambac litigation, Judge Dein entered an order on Aug. 13 staying separate litigation filed by Assured/FGIC, which sought a declaration that the oversight board cannot use the revised commonwealth fiscal plan as the basis for proposing a plan of adjustment. Assured/FGIC asserted that the plan is unlawful and unconstitutional. In her order, Judge Dein said that the issues in the Ambac appeal are sufficiently related to those raised in the Assured/FGIC complaint such that “[t]he parties and the Court will benefit from awaiting a decision from the First Circuit” on certain issues.” The order staying the case provides that “the deadline for Defendants to file a motion to dismiss or otherwise respond to the complaint shall be thirty (30) days after the First Circuit renders an opinion in Ambac.”

Insurers/HTA

Bond insurers Assured Guaranty, National Public Finance Guarantee and Financial Guaranty Insurance Co. have appealed Judge Swain’s Jan. 30 opinion dismissing their lawsuit against several commonwealth defendants and the PROMESA oversight board in connection with HTA-issued bonds. The appeal is pending in the First Circuit.

The insurers contend in their opening brief that Judge Swain misinterpreted Bankruptcy Code section 922(d) or section 928(a), which they say require or empower the Title III court to order payment of pledged special revenue to HTA bondholders. According to the insurers, U.S. municipalities will need approximately $3.6 trillion to maintain their infrastructure in the next two years. The insurers assert that Judge Swain’s decision “jeopardizes the market for municipal revenue bonds by adopting an unprecedented interpretation of key provisions added to the United States Bankruptcy Code in 1988 to protect this critical source of municipal funding.” The National Federation of Municipal Analysts, or NFMA, and the Securities Industry and Financial Markets Association each filed amicus briefs in support of the insurers.

The commonwealth parties, however, maintain in their brief that sections 922(d) or 928(a) do not require the turnover of HTA revenue. They warn that diverting HTA revenue to the insurers would “undermine critical infrastructure (Puerto Rico’s highways and transportation system) and push the Island’s economy into a nosedive.” Agreeing with the commonwealth parties, the official committee of unsecured creditors in its brief urges the First Circuit to affirm Judge Swain’s decision as consistent with the applicable statutes, adding that the insurers “grossly exaggerate the potential impact of the district court’s decision.”

With the filing of the insurers’ reply brief on Aug. 8, briefing in the appeal is complete and oral argument is scheduled for Nov. 5 at 8:30 a.m. ET.

GO Special Revenue

Briefing is complete in the ad hoc group of GO bondholders’ appeal of Judge Swain’s Jan. 30 ruling dismissing the GO bondholders’ clawback and special property tax revenue-related lawsuit against the PROMESA oversight board and the commonwealth. In dismissing the litigation, Judge Swain concluded that PROMESA section 305 precluded granting the requested declaratory and injunctive relief requested in the complaint.

In its appellate briefs, the GO ad hoc group challenges the Title III court’s ruling that it did not have subject matter jurisdiction over certain of the claims, arguing that Judge Swain erred in concluding both that certain claims constituted non-justiciable requests for an advisory opinion and that the plaintiffs’ Takings Clause claim was unripe. The GO ad hoc group also challenges the Title III court’s conclusion that PROMESA section 305 barred other claims. Contesting the appeal, the commonwealth and oversight board defendants maintain that Judge Swain was correct in dismissing the GO ad hoc group’s complaint in its entirety. The official retiree committee, which filed an intervenor brief, also contends that the First Circuit should affirm the lower court’s ruling.

The First Circuit is scheduled to hear oral argument on the appeal on Nov. 5 at 8:30 a.m. ET.