Aaron M. Kaufman 2016-12-20 17:56:21
The U.S. Bankruptcy Code generally provides the exclusive means for debt restructuring, whether compulsory or cooperative. As such, the code basically preempts states and municipalities from enacting their own debt restructuring schemes but, instead, allows them to file Chapter 9 bankruptcies— as many have done in recent years, including (perhaps, most notably) the city of Detroit.1 In Puerto Rico, unemployment rates, municipal bond obligations, and budget deficits have led some to compare the small island territory to Greece.2 However, an unexplained 1984 amendment to the Bankruptcy Code expressly excluded Puerto Rico and its municipalities from Chapter 9 bankruptcy eligibility, removing the bankruptcy option all together. In response, local authorities enacted the Puerto Rico Public Corporation Debt Enforcement and Recovery Act in 2014, to provide a legislative solution to allow “consensual” debt restructuring for the territory’s municipal obligations. In an effort to prevent cram-down under the Recovery Act, a group of creditors challenged the law, leading the U.S. Supreme Court, in Puerto Rico v. Franklin California Tax-Free Trust,3 to strike it down in a 5-2 decision. Justice Clarence Thomas, writing for the majority, held that a straightforward reading of the Bankruptcy Code required a conclusion that Puerto Rico remained a “State” for purposes of preemption but was still ineligible for Chapter 9 bankruptcy, at least, “until Congress intervenes.” Justice Sonia Sotomayor, writing for the two-vote dissent, warned that the majority’s overly mechanical application of the 1984 amendment (which contained no legislative history) unwisely left the territory waiting for congressional intervention, with no means to help its 3.5 million citizens through the financial crisis in the interim. In June, Congress passed the Puerto Rico Oversight, Management, and Economic Stability Act, or PROMESA, which, among other things, allows the island to engage in a bankruptcy- like restructuring process.4 Another key decision from the high court in 2016 concerned fraudulent transfers and dischargeability. In Husky International Electronics, Inc. v. Ritz,5 the court resolved a circuit split and potentially gave creditors a powerful tool against debtors who may have engaged in asset transfers before bankruptcy. In this decision, the court rejected the 5th Circuit’s historically narrow definition of “actual fraud” as used in 11 U.S.C. § 523(a)(2) and agreed that “actual fraud” can be shown under that provision without evidence of a debtor’s false representations. Finally, here in Texas, in Janvey v. Golf Channel, Inc.,6 the Texas Supreme Court answered a certified question posed by the 5th Circuit last year7 and explained that an unsuspecting recipient of payments from a Ponzi scheme has a viable “good faith” defense when it: “(1) fully performed under a lawful, arm’s-length contract for fair market value, (2) provided consideration that had objective value at the time of the transaction, and (3) made the exchange in the ordinary course of the transferee’s business.” In this case, Golf Channel could show that it gave reasonably equivalent value to the R. Allen Stanford entities in exchange for the $5.9 million it received for marketing services (including PGA sponsorship naming rights), even though the Stanford entities turned out to be a fraudulent Ponzi scheme with no legitimate business to benefit from such marketing services. The Texas Supreme Court ruling—setting in motion the reversal of the 5th Circuit’s earlier decision—seems to have alleviated concerns over the future vitality of the “value in good faith” defense in the Ponzi scheme context. Notes 1) See, e.g., In re City of Detroit, Michigan, Case No. 13-53846 (Bankr. E.D. Mich.), docket available at kccllc.net/detroit (last visited Nov. 1, 2016). 2) Alan Gomez, Is Puerto Rico the Next Greece? Nest Eggs Could Suffer, USA Today (Nov. 7, 2013), http://www.usatoday.com/story/news/world/ 2013/11/06/puerto-rico-economic-crisis/3314639/ (last visited Oct. 31, 2016). 3) __ U.S. __, 136 S.Ct. 1938, 195 L.Ed.2d 298 (June 13, 2016). 4) See https://www.washingtonpost.com/news/powerpost/wp/2016/06/09/puerto-ricofiscal-rescue-is-poised-to-pass-house-as-july-deadline-looms/?utm_ term=.f64e9f59a95c (last visited December 9, 2016). 5) __ U.S. __, 136 S.Ct. 1581, 194 L.Ed.2d 655 (May 16, 2016). 6) 487 S.W.3d 560 (Tex. 2016). 7) See Janvey v. Golf Channel, Inc., 792 F.3d 539, 547 (5th Cir. 2015). AARON M. KAUFMAN is a member in the Dallas office of Dykema Cox Smith, where he specializes in commercial bankruptcy and insolvency matters. His practice includes representation of debtors, committees, trustees, secured and unsecured creditors, buyers, and other stakeholders in a wide variety of bankruptcy issues. He also authors the “Benchnotes” column of the American Bankruptcy Institute Journal and frequently contributes to the institute’s VOLO Circuit Court Opinion First Responder.
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