Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust

Puerto Rico is a “state” for purposes of Federal Bankruptcy Code preemption.

Puerto Rico is in the middle of a fiscal crisis in which most of its debt is contained by public utility companies. In response, Puerto Rico created the Puerto Rico Corporation Debt Enforcement and Recovery Act ("Recovery Act") that allowed Puerto Rico's government owned public utilities to restructure their debt. Petitioners, creditors to the utilities, challenged the Recovery Act and alleged that the Federal Bankruptcy Code preempted Puerto Rico's authority to create a bankruptcy scheme. Respondents, the Commonwealth of Puerto Rico and various government officials, argued that Puerto Rico is not a state for the purposes of Federal Bankruptcy laws, because Congress amended the Bankruptcy Code and excluded Puerto Rico from the definition of debtors. The District Court and First Circuit held that the preemption clause of the bankruptcy code applied and prevented Puerto Rico from implementing the reform act. The Supreme Court held that Puerto Rico cannot create its own bankruptcy scheme and that it is a "state" for purposes of the Bankruptcy Code. The Court reasoned that Puerto Rico may enact its own scheme without running afoul of the Federal Bankruptcy Code and that Puerto Rico is only excluded under the gateway provision, not from the entirety of Chapter 9. The Court further reasoned that Puerto Rico's status under the gateway provision is irrelevant for other provisions of the Code. AFFIRMED.