Amid the most serious fiscal crisis in its history, Puerto Rico’s public utilities are currently insolvent or at risk of becoming insolvent. In 2013, several distressed Puerto Rican public corporations had a combined deficit that totaled $800 million, and a combined debt reaching $20 billion. One avenue for Puerto Rico’s public utilities to restructure their debt, and perhaps the only avenue, is municipal bankruptcy relief. Unlike States, Puerto Rico “may not authorize its municipalities to seek Chapter 9 municipal bankruptcy relief” under title 11 of the United States Code (the “Bankruptcy Code”). An amendment to the Bankruptcy Code in 1984 is responsible for Puerto Rico’s exclusion from Chapter 9 municipal bankruptcy relief. Prior to 1984, however, there was no language banning Puerto Rico from utilizing Chapter 9 because the term “State” was not defined. In fact, from 1938 until the modern Bankruptcy Code was introduced, Puerto Rico could authorize its municipalities to obtain federal bankruptcy relief under Chapter 9. During that time, the recognized definition of “State” under federal bankruptcy law included territories and possessions. However, the amendment in 1984 added Section 101(52), in which the definition of a “State” was changed to “include Puerto Rico, ‘except’ for the purpose of defining who may be a debtor under Chapter 9.” Thus, in an attempt to avoid insolvency, the Commonwealth of Puerto Rico sought to allow its utilities to restructure their debt by enacting its own municipal bankruptcy law, the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (the “Recovery Act”).
In Franklin v. Puerto Rico, the First Circuit held that Puerto Rico’s effort to restructure the debt of its public utilities through the enactment of the Recovery Act was preempted by Section 903(1) of the Bankruptcy Code. According to the court, Section 903(1), which applies to “States,” did not suggest that Puerto Rico was outside of its reach even though Section 101(52) explicitly excluded Puerto Rico from the definition of a “State” when defining who may be a debtor under Chapter 9. Thus, while Puerto Rico was excluded from the benefits of Chapter 9 under Section 101(52), it also remained subject to the burdens of Chapter 9 under Section 903(1).