Puerto Rico v. Franklin California Tax-Free Trust

In response to a severe fiscal crisis, Puerto Rico enacted the Public Corporation Debt Enforcement and Recovery Act, which allowed certain public utilities to restructure their debts through a bankruptcy-like process. A group of bondholders led by Franklin California Tax-Free Trust sued, arguing the Recovery Act was preempted by the U.S. Bankruptcy Code. Specifically, Section 903(1) of the Code explicitly bars Puerto Rico from authorizing its municipalities to seek bankruptcy relief under Chapter 9. The Supreme Court granted certiorari and, in a 5-2 decision delivered by Justice Clarence Thomas, agreed with the bondholders. The Court held that the federal Bankruptcy Code preempts Puerto Rico's Recovery Act because Congress had occupied the field of municipal bankruptcy and had deliberately excluded Puerto Rico from its coverage. This ruling eliminated Puerto Rico's primary restructuring mechanism, leaving its $20 billion debt without an orderly adjustment pathway and pressing Congress to act swiftly.

The U.S. Supreme Court affirmed the First Circuit, ruling 5-2 that the Recovery Act is preempted by the federal Bankruptcy Code and is therefore void. Justice Thomas wrote the majority opinion, joined by Chief Justice Roberts and Justices Kennedy, Breyer, and Alito. Justice Sotomayor dissented, joined by Justice Ginsburg. The Court concluded that Congress intended to establish uniform federal bankruptcy law and explicitly barred Puerto Rico from enacting any law providing for municipal debt adjustment, thus rendering the Recovery Act unenforceable.

Whether the Puerto Rico Public Corporation Debt Enforcement and Recovery Act is preempted by the federal Bankruptcy Code, particularly 11 U.S.C. § 903(1), which prohibits states and territories from authorizing municipal bankruptcy proceedings, and whether Puerto Rico, as a territory, retains any residual authority to enact its own municipal bankruptcy regime despite Congress's express preclusion.

The decision worsened Puerto Rico's liquidity crisis by eliminating its homegrown restructuring framework, forcing it toward a disorderly default. It immediately increased pressure on the U.S. Congress to intervene, resulting in the passage of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) on June 30, 2016, which established a federal oversight board and a court-supervised debt adjustment process. The ruling underscored the plenary power of Congress over U.S. territories in bankruptcy matters, sent shockwaves through the municipal bond market, and highlighted the legal vulnerabilities of heavily indebted U.S. territories lacking full sovereignty to address fiscal emergencies.