First Circuit Court of Appeals

Lex Claims Oral Argument April 4, 2017

On April 4, 2017, Judges Howard, Lynch and Barron heard oral arguments in the Lex Claims case, where Judge Besosa had decided the PROMESA stay did not apply to some of the claims, including the validity of COFINA and its alleged lien. 

As usual, right from the start of the Supervisory Board’s argument, the Judges started asking pointed questions. Judge Barron started asking technical questions that boiled down to whether the stay applied to a declaration that Governor Garcia Padilla’s executive order were invalid or preempted. Judge Howard asked if some or all of the causes of action arose after PROMESA was approved. The Board’s lawyers denied this but clearly the Judges are not convinced. Judge Lynch seemed concerned about other cases arising but was assured there are none.


Judge Howard asked about mediation and was assured it would start next week. When Senior COFINA lawyers started their argument, Judge Barron asked why the declaration of the Executive order was preempted. COFINA had to admit that such declaration is not an issue of control.


Ambac came next for appellants and likened the Lex complaint to a bank in state court attempting to determine where income should go for a bankruptcy debtor but this did not bar Judge Barron from asking the same question as to declaratory judgment. We can see a pattern there.


Once Lex Claims came to argue, it invoked section 303(3) of PROMESA claiming this was not precluded by the stay. Judge Lynch, who seems intent on preserving the stay, asked if there was explicit language that pointed that way. Lex conceded there was none but that the overall interpretation of PROMESA showed that. Lynch did not seem convinced. Lex continued arguing that they did not seek control, but Judge Barron challenged this view. Judge Lynch went to the offensive and asked if you filed your complaint, why should we relieve you of it in clear reference to the second amended complaint. Lex answered that it could amend the complaint.


From this we may surmise that as the Circuit Court’s stay order stated, the Judges will decide the stay will apply to all of the Lex Claims’ complaint, although Judge Barron could file a partly dissenting opinion or convince them it does not apply to the declaratory judgment sought by appellee. Since I assume the panel will be as swift as it was in the Peaje case, a decision could come down by next week or earlier. If it comes down by next Tuesday, April 11, there would only be 19 days left of the stay.


This brings us to another issue. Since it is clear negotiations will start later than April 10, the PROMESA stay which was enacted to afford PR an opportunity to attempt to restructure its debt consensually has been instead used by the Government and the Board to pick and choose winners among bondholders. This may have serious repercussions in the coming Title III as I will discuss in an upcoming posting.





Today, the First Circuit decided the case of Peaje v. García Padilla. It affirmed Judge Besosa’s denial of lifting the stay in Peaje, reversed the decision in Altair and reversed him on the issue of the Board’s intervention. These are the important issues it decided.


  1. Burden of proof as to “cause shown” is at all times on movants, different from bankruptcy sec. 362.


In light of Congress’s decision not to transplant the Bankruptcy Code’s express alteration of the pre-Code burden regime into PROMESA, we hold that PROMESA, like the pre-Code regime, places the burden on creditors to establish cause, including lack of adequate protection.” Page 15


  1. Cause will include the depletion of a lien as it does in bankruptcy

In the bankruptcy context, Congress’s explicit designation of lack of adequate protection as cause to lift a stay was based, at least in part, on constitutional concerns. See H.R. Rep. No. 95-595, at 339 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6295 (explaining that the concept of adequate protection “is derived from the [F]ifth [A]mendment protection of property interests”). Indeed, prior to the enactment of the current bankruptcy stay provision, the Supreme Court had recognized that creditors are constitutionally entitled to protection “to the extent of the value of the[ir] property.” Wright v. Union Cent. Life Ins. Co., 311 U.S. 273, 278 (1940); see also United States v. Sec. Indus. Bank, 459 U.S. 70, 75-78 (1982)(applying principle of constitutional avoidance to provision of Bankruptcy Code where a contrary reading “would result in a complete destruction of the property right of the secured party” in its collateral). The PROMESA stay implicates these same constitutional concerns. Under the Appellees’ reading of the statute, the Commonwealth could expend every penny of the Movants’ collateral, leaving the debt entirely unsecured. Because we doubt the constitutionality of such a result, we hold that lack of adequate protection for creditors constitutes cause to lift the PROMESA stay.” Pages 11-12


  1. The decision on Peaje seems to be based more on what the filings did not say than anything else.


“Because Peaje failed even to make a legally sufficient claim that it lacked adequate protection, we conclude that the district court did not commit reversible error in denying its lift-stay motion without an evidentiary hearing.” Page 10.


“Nowhere in its district court filings did Peaje claim that the current diversion of toll revenues would leave that interest inadequately protected. In light of Peaje’s admitted security interest in future toll revenues, this omission was fatal.” Page 18


  1. But with Altair this was not the case.

“The Altair Movants’ allegations as to the insufficiency of future funds to protect their interest in repayment of the debt entitled them to a hearing.” Page 18. But see footnote 5 at page 19 where the Court gives the parties a hint on how they can avoid a hearing and a decision contrary to PR


“We note that the Altair Movants’ request for adequate protection here appears to be quite modest. They ask only that the employer contributions collected during the PROMESA stay be placed “in an account established for the benefit of Movants.” In light of ERS’s representation that it is not currently spending the funds, but instead simply holding them in an operating account, this solution seems to be a sensible one. At oral argument, ERS expressed concern that transferring the contributions to an account subject to the Altair Movants’ lien might violate the Moratorium Act. But this concern may not present an obstacle to ERS’s ability to settle or otherwise resolve this federal action. See, e.g., Badgley v. Santacroce, 800 F.2d 33, 38 (2d Cir. 1986) (“When the defendants chose to consent to a judgment . . . the result was a fully enforceable federal judgment that overrides any conflicting state law . . . .”); Brown v. Neeb, 644 F.2d 551, 563 (6th Cir. 1981) (“A federal court’s power under the Supremacy Clause to override conflicting state laws . . . is well established.”). Of course, this is not the only path to a finding that the Altair Movants’ interest is adequately protected. An equity cushion is not the “sine-qua-non for adequate protection,” which is a “flexible concept to be tailored to the facts and circumstances of each case.” In re Smithfield Estates, Inc., 48 B.R. 910, 914 (Bankr. D.R.I. 1985); see also Collier ¶ 362.07[3][f]. Again, we leave the existence of adequate protection to the district court to assess on remand.”


  1. As to intervention


“Accordingly, denial of a motion to intervene based solely on the movant’s failure to attach a pleading, absent prejudice to any party, constitutes an abuse of discretion.” Page 21


  1. If there is no agreement with Altair, Judge Besosa has to expedite a hearing.


“The case is remanded for further proceedings consistent with this opinion. In conducting such proceedings, the district court should be mindful of Congress’s explicit direction to “expedite” its disposition of the matter “to the greatest possible extent.” 48 U.S.C. § 2126(d).” Page 23


Now let’s see what happens.





On January 4, 2017, the First Circuit Court heard oral arguments on the appeals by Peaje, Altair, Brigade, and the Supervisory Control Board. The panel was composed of Judges Thompson, Howard and Kayatta. Judge Howard was one of the Judges in the Franklin California v. Commonwealth case and Judges Thompson and Kayatta were involved in the Wal-Mart v. Commonwealth, the first case that interpreted PROMESA. Many of the arguments were very technical in nature, dealing with the takings clause of the Fifth Amendment as well as lifting of stay in bankruptcy (11 U.C.S. §362) I will concentrate here on the questions posed by the Judges which is the better gauge of what is on their mind.


At the start of the argument, Peaje claimed that the burden of proof was on defendants to show, once plaintiff proved it had a lien and that its lien was being depleted, that it had sufficient revenues that would prevent the collateral from being depleted or exhausted. Judge Kayatta asked if there was any evidence of this in the proceedings below and asked that he be told where specifically in the record they were alleged or claimed. Also, Judge Howard asked what flexibility the Court has with PROMESA. None of the answers were very clear. Subsequent filings on these subjects were requested by the Judges.


Altair came in and was asked by Judge Kayatta whether the reduction of the collateral was sufficient enough that the debt was in jeopardy. The attorney answered that PR had stated that said payments were not safe, although the island was not using them and had the funds in a discretionary account. She stated that if it was placed in an account that could not be used by the island, there would not be litigation. Judge Kayatta mentioned that the Moratorium Act did not prohibit the transfer of these funds but seems to suspend the obligation. Judge Kayatta again asked who had the burden of proof.


When the individual PR defendants took their turn, they mentioned in passing that Judge Besosa’s order was an interlocutory order and not appealable. No judge said a word of this, so probably it will not be an issue. Again Judge Kayatta asked about the depletion of collateral. He was told there was ample collateral but, even if it was exhausted, plaintiffs could sue for damages. Judge Kayatta countered that then they would not be secured but rather unsecured creditors (secured creditors get paid first to the extent of their security in bankruptcy). He also asked for any cases in bankruptcy that held that the depletion of collateral could be allowed if a cause of action for damages was available. No cases were mentioned by defendant and Judge Kayatta mentioned that that was tantamount to closing the barn door after the horse had escaped. He had great difficulty with the proposition that the Government could have 7 months to destroy collateral without the certainty of recovery. Judge Kayatta then asked how do we deal with sec. 405(k) of PROMESA (the section states that it does not affect or discharge an obligation). The answer was lacking in what I think the Judge was asking, to wit, can the Court allow the destruction of a collateral? At this point, Judge Howard asked if there shouldn’t have been a hearing, which of course defendants said no. Judge Thompson followed up and asked if there was evidence of a cushion for the collateral.


Defendants kept hammering that adequate protection, the standard used by Judge Besosa to decide on the lifting of the stay, was incorrect; that PROMESA did not adopt this standard in Title IV. They want a balancing of equities but, as plaintiffs stated in the rebuttal, under that standard, there never would be a lifting of the stay. The Employee Retirement Fund claimed that non-governmental contributions (municipalities) to the fund were enough to maintain the collateral.


The Financial Oversight Board claimed that it did not file an answer to the complaints because it did not want to state its position on the constitutional and statutory claims made by plaintiffs before they sat at the negotiating table. Again, the Board claims it has the statutory mission to conduct said negotiations.


In rebuttal, Peaje said the burn rate of the collateral was 100% and their experts would state there was a likelihood there would not be sufficient funds in the future to maintain the collateral. As to the ERS non-governmental contributions, Altair said defendants said they were uncertain in the Fiscal Plan.


What can we conclude from this? The Judges are disturbed by the lack of hearing. There is evidence that the issue of depletion of the collateral is vital to the determination and that would be done in an evidentiary hearing. In addition, sec. 405(e)(2) requires a hearing. Hence, I believe that the Judges will reverse the Peajes decision by Judge Besosa and require a hearing. This could be important since it is likely that the stay will be extended by the Board to May 1, 2017. As to the other issues, I did not get a feeling one way or the other of what is on the Judges minds. Let’s wait and see. Since PROMESA requires that the issues be treated in an expedited manner, we could expect a decision by the end of the month or sooner.