Bankruptcy Plans Cannot be Used to Circumvent the Fifth Amendment’s Takings Clause

Gillian Deery 

St. John's University School of Law 

American Bankruptcy Institute Law Review Staff

In In re Financial Oversight and Management Board, the First Circuit held that pre-petition claims arising under the Taking Clause of the United States Constitution cannot be discharged in the plan of adjustment for the Commonwealth of Puerto Rico without payment of just compensation. In response to the fiscal crisis in Puerto Rico, Congress enacted the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”). Title III of PROMESA created a “modified version of municipal bankruptcy code for territories and their instrumentalities,” authorizing the Financial Oversight and Management Board of Puerto Rico (the “Board”), serving as representative of Puerto Rico, to seek bankruptcy relief.[1] Under PROMESA, the Board was required to propose a plan of adjustment for Puerto Rico. A plan of adjustment is similar to a typical plan of reorganization prepared in a bankruptcy under chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”).[2] According to Title III, a plan of adjustment can be confirmed if, among other things, “the debtor is not prohibited by law from taking any action necessary to carry out the plan.”[3]

In 2017, the Board filed a series of petitions under Title III to restructure the debts of Puerto Rico and its instrumentalities.[4] With respect to eminent domain claims, under Puerto Rico law, Puerto Rico was able to acquire property by, among other things, depositing an estimated compensation amount with the court. Under the plan of adjustment, Puerto Rico treated these as secured claims entitled to full recovery up to the deposit amount; eminent domain claims in excess of the deposited amount were unsecured.[5] Inverse condemnation claims were treated as general unsecured claims.[6] A group of creditors the “Takings Claimants,” filed proofs of claim seeking just compensation for the alleged prepetition takings of their private property by the Commonwealth.[7] The Takings Claimants alleged the plan violated the Fifth Amendment because it treated their inverse condemnation claims as general unsecured claims, and it was not certain the claimants would be compensated in full.[8] The Claimants argued that this would violate the Takings Clause, which guarantees just compensation.[9] The District Court agreed, and the Board was required to revise their plan to provide full payment for valid pre-petition takings claims.[10] The Board appealed and the First Circuit affirmed the District Court’s decision.[11]

The First Circuit concluded that the Commonwealth of Puerto Rico cannot utilize bankruptcy law to circumvent the guarantee of just compensation provided by the Fifth Amendment. In reaching this decision, the First Circuit analyzed section 944(c)(1) of the Bankruptcy Code, which provides that “[t]he debtor is not discharged . . . from any debt —excepted from discharge by the plan or order confirming the plan.”[12] The First Circuit found that in order to properly interpret section 944(c)(1), they were required to determine whether the Board’s plan violated constitutional law.[13] The court then ruled that the treatment of the takings claims in the plan did not “comport with the requirements of the Takings Clause,” which resulted in Puerto Rico’s violation of the Fifth Amendment.[14] The First Circuit concluded that the Takings Clause precludes the discharge of prepetition claims for just compensation in Puerto Rico’s Title III bankruptcy proceeding.[15] In response to the Board’s argument that bankruptcy law changes their constitutional obligations to creditors, the First Circuit held that bankruptcy law, which was created using constitutional power, is subordinate to the Takings Clause, which is found clearly in the text of the Constitution.[16] Using this textual argument, the First Circuit reasoned that the potential damage to creditors resulting from the Commonwealth’s violation of the Takings Clause is different from other creditors’ damages since the remedy for the Takings Claimants is specified in the Fifth Amendment of the Constitution.[17] The decision in In re Financial Oversight and Management Board ensures the Constitutional rights afforded by the Fifth Amendment are not circumvented by bankruptcy law.