The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. Ca., Ret.), analyzing a recent decision of interest:
Agreeing with the reasoning of a dissent in a Ninth Circuit case, the First Circuit Court of Appeals (the Court), ruling in the reorganization case for the Commonwealth of Puerto Rico, held that otherwise valid Fifth Amendment takings claims arising prepetition cannot be discharged in bankruptcy proceedings without payment of just compensation in full. In re Fin. Oversight & Mgmt. Bd. Of Puerto Rico, 2022 WL 2800724 (1st Cir. July 18, 2022).
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The Financial Oversight and Management Board of Puerto Rico (the Board) serves as the representative of debtor the Commonwealth of Puerto Rico in the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), the special legislation which authorized the reorganization of the Commonwealth’s debt through a plan of adjustment. The Title III judge who approved the Board’s plan of adjustment ruled that claimants owed just compensation for taking of real property by the debtor were entitled to receive such payments in full. The Board took issue with that ruling, asserting that the claims were ordinary unsecured claims and should be paid pro rata with other unsecured creditors, resulting in this appeal.
The facts are straight forward. During the PROMESA process, several groups of creditors (the ‘takings claimants”) filed proofs of claim, seeking just compensation for alleged prepetition takings of their private property by the Commonwealth. The takings claims arose either from eminent domain proceedings initiated voluntarily by the Commonwealth prepetition or from inverse condemnation claims, arising from takings in which the Commonwealth allegedly curtailed an owner’s property right without filing an eminent domain proceeding. In some of the eminent domain proceedings, deposits of alleged just compensation had been tendered, but the relevant claimants had rejected those sums as inadequate, resulting in additional claims.
The Board in one of its submitted plans of adjustment proposed to allow secured claims of the eminent domain claimants to the extent that funds had been deposited prepetition. Any claim in excess would be in the class of unsecured creditors, to be paid pro rata at a low percentage, as would all allowed inverse condemnation claims. The Article III court rejected that provision of the plan as a violation of the Fifth Amendment and compelled the Board to submit a plan which provided for full payment of valid takings claims. The Board complied and that provision was in the approved plan. Submitting that it had preserved its right to appeal, the Board cross-appealed the just compensation ruling when other creditors appealed different plan provisions. The Court affirmed the Article III court’s requirement of payment in full.
Rejecting the United State Trustee’s suggestion that it duck the constitutional issue, the Court ruled that the Article III court’s ruling was not an exercise of its discretion but rather was one of law, subject to de novo review. It phrased the issue before it as “whether the Fifth Amendment precludes the impairment or discharge of prepetition claims for just compensation in Title III [here PROMESA] bankruptcy.” It concluded that it does.
Analyzing the relationship between the taking clause of the Fifth Amendment and the bankruptcy laws, the Court observed that the Supreme Court had made it clear that the bankruptcy laws are subordinate, citing numerous authorities from as long ago as 1935. It rejected the Board’s citations to subsequent cases, which addressed whether a taking had actually occurred rather than the obligation to pay just compensation once the taking was established. Here, the Board was not arguing for the purposes of appeal that there were no relevant takings. The Court similarly rejected the Board’s analogies to other circumstances where the Bankruptcy Code permits less than full payment in reorganizations as not calling into play the Fifth Amendment protections.
It considered the precise language of the Fifth Amendment: “private property” shall not “be taken for public use, without just compensation” and concluded that provision was mandatory. That mandatory provision “serves also as a structural limitation on the government’s very authority to take private property for public use.”
Finally, the Court noted that it disagreed with the one other circuit which had addressed the just compensation issue, the Ninth Circuit in In re City of Stockton, 909 F. 3d 1256, 1268 (9th Cir. 2018). The Ninth Circuit in Stockton affirmed the rejection of a claimant’s objection to treatment of its takings claim where the claimant had withdrawn the deposit but asserted it had not received just compensation. The Ninth Circuit concluded that by withdrawing the funds, the claimant had waived all additional claims and had already given up all right to the property taken. In essence the Ninth Circuit had concluded that a just compensation claim could be eliminated by behavior. It also had reasoned that “just compensation” was not equivalent to “full compensation.” The Court here found this reasoning flawed and instead cited with favor the analysis of the dissent in Stockton.
In sum, the Court affirmed the Title III court’s ruling that a just compensation claim under the Fifth Amendment could not be impaired in a reorganization proceeding.
It is tempting to distinguish the City of Stockton ruling on its complex facts, but the dissent there by Judge Friedland did not see it that way, nor did the First Circuit. The Supreme Court’s pronouncements, which elevate the Fifth Amendment’s requirements over the provisions of the bankruptcy laws, seem to compel the conclusions of the First Circuit. Although chapter 9’s are rare, this ruling will have an impact on any public entity which tries to escape paying just compensation for property acquired for public purposes.
This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. Ca., Ret.), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.
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