Puerto Rico's 'Colonial' Power Struggle

A federal judge sees bankruptcy law as exploiting the commonwealth.

Anybody got $9 billion?

Photographer: Christopher Gregory/Bloomberg

On the surface, there was nothing shocking about Monday's decision by the U.S. Court of Appeals for the 1st Circuit to strike down a Puerto Rico law that would’ve let the commonwealth’s municipalities and utilities declare bankruptcy. A federal district court had already held in February that Puerto Rico’s proposed Recovery Act was pre-empted by the federal bankruptcy code.

But from a long-term perspective, the court’s decision was fairly extraordinary. Over an outraged concurrence by Judge Juan Torruella -- the only Puerto Rican on the federal appeals court that's responsible for cases from the island -- the court held that Puerto Rico is uniquely legally disabled from managing its financial problems.

Every state in the union has the right to put its municipalities into bankruptcy under Chapter 9 of the bankruptcy code; Puerto Rico does not. Torruella said that asymmetry was arbitrary and unconstitutional.

The court offered no explanation or justification for why Puerto Rico should be treated differently from the states; it just told Puerto Rico that it would have to ask Congress to change that state of affairs. But as Torruella pointed out, that recommendation was fairly “preposterous” given that Puerto Rico isn’t represented by a voting member in Congress. The whole thing, he argued -- with some reason -- amounts to “business as usual colonial treatment” of the commonwealth.

The judge’s implication was clear: Congress was favoring Puerto Rico’s creditors for no better reason than that Puerto Rico has no representation of its own. By extension, the island’s debt crisis is a product of its colonial status.

From 1933 until 1984, Puerto Rico could allow its municipalities to declare bankruptcy under Chapter 9 the same way the 50 states could, by first getting permission from their states. This is a useful tool for cities or other state authorities, such as utilities, that get into economic trouble.

In 1984, Congress, when amending the bankruptcy code, added a provision saying that Puerto Rico would count as a state for every purpose except for allowing its municipalities to invoke Chapter 9.

Thirty years later, in June 2014, Puerto Rico, facing a huge -- and continuing -- debt crisis, tried to do something about it. Its legislature passed the Recovery Act, which would have enabled its troubled utilities to declare bankruptcy under Puerto Rico law. The stakes were high. The Puerto Rico Electric Power Authority alone has at least $9 billion in debt, now rated CC by Standard and Poor's. That’s a significant chunk of the $73 billion Puerto Rico owes more generally -- and other utilities are struggling, too.

The court held that Puerto Rico lacked the authority to pass the new law. Its core reasoning was that the point of federal bankruptcy law is to create uniform norms across the U.S. To that end, the law pre-empts states from passing their own conflicting bankruptcy codes. Puerto Rico’s proposed Recovery Act conflicted with that uniformity, not only in its specific provisions but also in its very existence.

But if you think about it, there’s something perverse about striking down Puerto Rico’s law because it undermines uniformity. After all, the whole reason Puerto Rico needed to enact the law was that federal bankruptcy law doesn’t treat Puerto Rico uniformly when it comes to Chapter 9 municipal bankruptcy.

Torruella had to admit that, as the doctrine of pre-emption is ordinarily understood, Puerto Rico lacks the authority to enact its own bankruptcy rules. That’s why he filed a concurrence, not a dissent. But the judge went on to say that the true problem was the 1984 law that took away Puerto Rico’s right to use Chapter 9.

One element of his argument was that the Constitution gives Congress the authority to enact “uniform laws on the subject of bankruptcies throughout the United States.” In its original context, one would think, the provision meant that Congress couldn’t enact different bankruptcy regimes for different parts of the country.

The only possible textual response is that Puerto Rico isn’t part of the U.S. But that raises the imponderably complex question of what Puerto Rico’s constitutional status actually is. For some purposes, the law treats it as part of the U.S. -- why not for purposes of the bankruptcy clause?

Torruella’s next argument was that, under existing Supreme Court precedent, Congress may legislate differently for Puerto Rico provided that it has a rational basis to do so. The judge strenuously maintained that there was no plausible rational reason to deny Puerto Rico access to Chapter 9 bankruptcy. The 1984 exclusion was, he said, “arbitrary.”

The judge reserved his greatest scorn for the majority’s suggestion that Puerto Rico go to Congress for a fix. The court, he said, was implicitly approving “a colonial relationship, one which violates our Constitution and the Law of the Land as established in ratified treaties.”

It’s conceivable that Congress may help. Representative Tom Marino said Tuesday that he wanted to advance the needed legislation. Hillary Clinton, on the campaign trail in Iowa, proposed allowing Puerto Rico to invoke Chapter 9, a position Jeb Bush has also supported. But regardless, the judge isn’t wrong. Puerto Rico shouldn’t have a harder time dealing with its debt than do the 50 states.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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