Aurelius Capital Sues to Dismiss (Our Colony) Puerto Rico’s Bankruptcy Case Based on the Appointments Clause

By Lambert Strether of Corrente.

Aurelius Capital is a hedge fund chaired by Mark Brodsky, a lawyer formerly employed by Paul Singer’s Elliott Associates (yes, that Paul Singer). Aurelius, bless their hearts, is trying avoid taking a haircut on some Puerto Rican bonds they vultured, but in the process the extremely smart lawyers they’ve hired (chief among them Theodore B. Olson, of Gibson, Dunn & Crutcher) have come up with some amazing arguments with broad potential implications, regarding both the appointments clause and Puerto Rico’s colonial status. Here is a link to the key filing (Case: 17-03283-LTS): “In re: THE FINANCIAL OVERSIGHT AND MANAGEMENT BOARD FOR PUERTO RICO, as representative of THE COMMONWEALTH OF PUERTO RICO et al. Debtors: OBJECTION AND MOTION OF AURELIUS TO DISMISS TITLE III PETITION (PDF)[1]. And here is the Financial Oversight and Management Board’s (FOMB’s) response: THE FINANCIAL OVERSIGHT AND MANAGEMENT BOARD FOR PUERTO RICO’S OPPOSITION TO THE MOTION TO DISMISS TITLE III PETITION (PDF).

Now, I should state at the outset that I’m not a lawyer, have never been a lawyer, and don’t play one on TV, so I’m not going to attempt to assess the legal merits of Aurelius’s claims. Nor will I attempt to trace the progress of the case through the docket. However, I’ve got to say that as a layperson, I wish that what Olsen et al. are claiming is correct, even if the courts ultimately don’t accept their argument. (This is distinct from the question of whether I wish Puerto succumbs to the tender gnawings of a vulture fund; I don’t[2].) I should also state that I began this post thinking I’d be looking at Puerto Rico’s financial status under the FOMB after Hurrricane Maria, but when I ran across this case doing my research, I thought I’d better bring it to your attention, given Brodsky and Singer’s success in vulturing Argentinian bonds. All that said, first I’ll briefly look at the background of the case, then I’ll look at the public policy aspects of the Appointments Clause and the Insular Cases, and conclude.[3]

Background of the Case

The Times covered the Aurelius filing on August 7:

A hedge fund sued on Monday to have Puerto Rico’s bankruptcy case thrown out, arguing that the federal oversight board [the FOMB] guiding the island’s financial affairs was unconstitutionally established.

In a lawsuit filed in United States District Court in San Juan, the hedge fund, Aurelius Capital, cited the “appointments clause” of the United States Constitution, which calls for all principal officers of the federal government to be appointed by the president, and then confirmed by the Senate.

Aurelius Capital was among the firms that fought Argentina in court for years over its sovereign debt default, and ultimately succeeded in pressuring the government there to pay.

The oversight board was established last year, when Puerto Rico was sinking under $123 billion of public debt and pension obligations that it amassed by years of borrowing to plug deficits. The federal bankruptcy code bans Puerto Rico from declaring bankruptcy, and by 2016, it was defaulting haphazardly on payment after payment, without any way to take shelter from the many resulting creditor lawsuits.

Aurelius Capital sued in its capacity as a holder of Puerto Rico’s general obligation bonds. When those bonds were issued, over many years, Puerto Rico’s Constitution in effect guaranteed them, saying that if money ever became tight on the island, the bondholders would have first call on the “available resources” of the territory’s government.

Some of Puerto Rico’s bondholders argue that they bought the bonds on the understanding that their repayments and interest were by law the government’s first priority. They were surprised when they found that Puerto Rico’s five-year plan called for deep cuts [a “haircut”] in all bond payments, including payments to the holders of general-obligation bonds. The oversight board wants to use the savings to finance government operations for the five-year recovery period.

I think “were surprised” translates to: The vultures thought that the FOMB was their friend, were enraged at the haircut, and became eager to share their feelings with others. (Aurelius is a “holder” of the bonds, but as a vulture, they picked them up at pennies on the dollar; they are not the original holders. But if Aurelius, through the courts, can turn those pennies into nickels, say, Ted Olsen will have more than earned his handsome fee.)

Law 360 summarizes the state of play on November 6, after the government filed its response to Aurelius:

The U.S. will defend the constitutionality of the Puerto Rico Oversight, Management, and Economic Stability Act, commonly known as PROMESA, against efforts to dismiss the bankruptcy-like cases brought under the statute to restructure the debts of the territory’s government and public entities. With its notice to the judge presiding over the commonwealth’s cases, the U.S. Department of Justice signaled it will intervene to prevent the unraveling of what amounts to the largest-ever municipal bankruptcy case.

On Friday, the oversight board, Puerto Rico’s local government, an official committee of unsecured creditors and others filed court briefs arguing that the appointments clause does not govern Congress’ creation of territorial offices and is of no consequence in the matter at hand….

Even if the court concludes that the appointments clause was violated, it could still rule that the best course is to endorse the board’s completed actions as de facto valid, attorneys for Puerto Rico’s fiscal advisory agency argued.

“Given these proceedings’ urgency and the disruption an abrupt termination would engender, the court should follow that course here,” they said.

(“De facto valid.” Not a confidence builder. The idea that a court decision might cause “disruption” isn’t a confidence builder either.) So, let’s look at the appointments clause, which figures largely in Aurelius’s original filing, and then at the Insular Cases, which figure in the government’s response.

The Appointments Clause

Back in the day when I was a policy debater, we had a concept called “A Magic Board.” In constructing a case for change, we had to give reasons why the status quo inherently couldn’t solve the problem we had identified. But in that case, where was the solution to come from? Obviously, from outside the system, via a deus ex machina, a Magic Board that would simply impose our solution.[4] The FOMB looks an awful lot like a Magic Board, to me. Aurelius writes in the Objection and Motion to Dismiss, in the “Preliminary Statement”:

The Board is composed of seven voting members who have no superior officer save the President, yet were never subject to Senate confirmation. Moreover, six of them were effectively hand-picked by individual members of Congress pursuant to an intricate system of Balkanized lists designed to severely constrain the President’s appointment powers. There are no “historical analogues for this novel structure.”

They then go on to describe the details of this “intricate system of Balkanized lists”:

Instead, PROMESA established unprecedented procedures for the appointment of the seven voting members. See 48 U.S.C. § 2121.4 The Act provides that six members be selected from lists of pre-approved individuals submitted to the President by House and Senate leaders. One “Category A” member and one “Category B” member would be selected from separate lists submitted by the Speaker of the House of Representatives; two “Category C” members would be selected from a single list submitted by the Majority Leader of the Senate; a “Category D” member would be selected from a list submitted by the Minority Leader of the House of Representatives; and a “Category E” member would be selected from a list submitted by the Minority Leader of the Senate. Id. §§ 2121(e)(2)(A)(i)–(v), (e)(2)(B). Only the seventh member, “Category F,” could be selected in the President’s sole discretion. Id. § 2121(e)(2)(A)(vi). PROMESA further provided that if the President chose from those lists, the nominees would not require Senate confirmation. Id. § 2121(e)(2)(E). “Off-list” nominations—nominations of individuals not included on a list for a given category—require Senate Confirmation.

And here is the Appointments Clause, from Article II, Section 2 of the United States Constitution:

He shall have power, by and with the advice and consent of the Senate, to make treaties, provided two thirds of the Senators present concur; and he shall nominate, and by and with the advice and consent of the Senate, shall appoint ambassadors, other public ministers and consuls, judges of the Supreme Court, and all other officers of the United States, whose appointments are not herein otherwise provided for, and which shall be established by law: but the Congress may by law vest the appointment of such inferior officers, as they think proper, in the President alone, in the courts of law, or in the heads of departments.

The Aurelius Objection and Motion to Dismiss then goes on to argue that the members of the FOMB are, in fact, “officers of the United States”; this layperson buys their argument that FOMB members are not “inferior officers” — the Government’s “Opposition to the Motion” argues that they are — in substance, no matter what they may be in form. So that’s one for the judges.

From a public policy perspective, however, that system of forcing the Executive to pick nominees from list provided from by the Legislature is about the most crazypants thing I’ve seen in a long time. It’s late Roman Republic stuff, and imagine if Congress got in the habit of doing it. Suppose a Democrat President is in power and you’re a Democrat: Imagine that the pension system of a large state (say, Illinois) is about to go belly-up, and that a Magic Board needs to be appointed to Do Something, and that the Republican Congress proposes to force the President to pick the Board members from their list, which turns out to in essence hand Illinois over to the vulture funds, and all without hearings. How would you like that? Or suppose a Democratic President was in power and you’re a Republican: Imagine that the membership of the Office of Financial Stability — under TARP, responsible for $700 billion — was chosen from a list provided by a Democratic Congress, again without hearings, instead of with the advice and consent of the Senate. How would you like that? I think this is a terrible way to appoint officials, which is why I wish Aurelius wins.

The Insular Cases

On to the insular cases. From The Hill:

If the appointment of a seven-member control board with carte blanche to run the finances of the country’s biggest territory is not the appointment of primary federal officers, what is?

But the [FOMB] board members have an answer. Puerto Rico is, according to century-old Supreme Court precedents, an “unincorporated territory.” That means that the board members are territorial officers under the territorial clause of the Constitution, not federal officers subject to the appointments clause. The former clause gives Congress the power to “make all needful rules and regulations respecting the territory or other property belonging to the United States.” A plenary authority is not subject to the usual constraints of the separation of powers.

That those Supreme Court precedents, the much-reviled Insular Cases, are still part of American law is an embarrassment. They were written by the same basic lineup of justices who penned Plessy v. Ferguson, and are tainted by a stunningly racist and colonial mindset. Plessy v. Ferguson is the infamous case that held that “separate but equal” was constitutional, and it was explicitly overturned by Brown v. Board of Education. The Insular Cases, by contrast, remain good law and are still the basis of Puerto Rico’s form of sovereign limbo.

The federal district court in San Juan is therefore presented not simply with an aggrieved creditor, but with a claim that goes right to the heart of Puerto Rico’s legal status. The core question, in a way, is whether Puerto Rico, more than a century after it was acquired through conquest, remains still a distant colony, as the Insular Cases held, or has truly become part of the United States.

More on the insular cases from Slate:

Legal scholars disagree about how many Insular Cases there are—some say six; others include more than two dozen—but the general view is that they begin with Downes v. Bidwell in 1901….

[Downes v. Bidwell] centered on a question of whether shipments from Puerto Rico to New York were interstate or international, established a new hierarchy of territories: They were now either “incorporated” with the United States or “unincorporated,” with only the former having the full protections of the Constitution. The court reasoned that Puerto Rico and the other new territories were “inhabited by alien races,” so governing them “according to Anglo-Saxon principles may for a time be impossible.” These islands, then, were “foreign in a domestic sense.”

“Anglo-Saxon principles.” Hoo boy. Nevertheless, from the Government’s “Opposition to the Motion”:

In unincorporated territories, only “fundamental” constitutional rights apply, absent express direction to the contrary from Congress. Boumediene, 553 U.S. at 758; Trailer Marine Transp. Corp. v. Rivera Vazquez, 977 F.2d 1, 7 (1st Cir. 1992).¹⁴ As a result, even if it were not the case that Congress’s exercise of its Article IV authority is unconstrained by the Appointments Clause, that Clause would still be inapplicable here because Puerto Rico is an unincorporated territory and the Appointments Clause is not “fundamental” within the meaning of the Court’s decisions.

And:

¹⁴The first Supreme Court cases to distinguish between incorporated and unincorporated territories were the Insular Cases. E.g., Dorr v. United States, 195 U.S. 138 (1904); Downes, supra. Though these cases have been criticized for “rest[ing] on anachronistic views of race and imperialism,” “the Court has continued to invoke the Insular framework when dealing with questions of territorial and extraterritorial application.” Tuaua v. United States, 788 F.3d 300, 307 (D.C. Cir. 2015).

To which Aurelius responds, in “REPLY IN SUPPORT OF OBJECTION AND MOTION OF AURELIUS TO DISMISS TITLE III PETITION” (PDF, downloads automatically):

4. This Court Should Reject The Opposing Parties’ Calls To Extend The Racist Insular Cases.

[T]he Opposing Parties turn to the controversial Insular Cases. These are a series of decisions from the turn of the last century, in the mold of Plessy v. Ferguson, that applied a different set of constitutional rules for those of “alien races, differing from us.” Downes, 182 U.S. at 279–80 (Brown, J.); id. at 302, 306 (White, J.) (different rules for an “uncivilized race” of “fierce, savage, and restless people”); Dorr v. United States, 195 U.S. 138, 148 (1904) (jury-trial right does not extend to territory of “savages”). Whatever validity those discredited cases retain, they at most prevent the application of a few individual rights in the territory. None has held that structural provisions of the Constitution are inapplicable when Congress legislates with respect to a territory. The Insular Cases held that certain non-fundamental “personal” constitutional rights did not apply in unincorporated territories to the extent they were incompatible with those territories’ “new conditions and requirements.” Balzac v. Porto Rico, 258 U.S. 298, 312–13 (1922). For instance, Puerto Rico had a judicial system that “kn[ew] no juries,” so the Court held that Congress was permitted “to avoid forcing a jury system” on this “civil-law country.” Id. at 310–11. At the same time, the Insular Cases drew a “clear distinction between [those] prohibitions [that] go to the very root of power of Congress to act at all, irrespective of time and place,”—e.g., structural provisions— and those governing individual rights. Downes, 182 U.S. at 277 (Brown, J.). Because “Congress in governing the territories is subject to the Constitution, it results that all the limitations of the Constitution which are applicable to Congress in exercising this authority necessarily limit its power on this subject.” Id. at 291–92 (White, J.). Congress’s powers to legislate with respect to a territory thus remain subject to “constitutional restrictions upon the powers of that body as are applicable to the situation.” Dorr, 195 U.S. at 143. None of the Insular Cases involved the Appointments Clause or any other structural constitutional provision or principle.

Once again, no matter the merits, I’d wish for any legal theories rooted in constructs like “fierce, savage, and restless people”[5] should be ripped up and tossed on the flames.

Conclusion

It’s one of life’s little ironies that I’d support — at least on prima facie grounds; let me give myself an out in case a better lawyer weighs in to persuade me otherwise — a vulture funds super-lawyer because they’re advocating for good governance, and for uprooting a set of horrid legal precedents used to justify the subjection of Puerto Ricans as a colonial people. But it’s been a strange year! And since Aurelius is very well-funded, and since Ted Olsen is a very smart lawyer, I think we can expect to hear much more on this case in the future.

NOTES

[1] There is a second filing, made on the second day and next on the docket: In re: THE FINANCIAL OVERSIGHT AND MANAGEMENT BOARD FOR PUERTO RICO, as representative of THE COMMONWEALTH OF PUERTO RICO et al. Debtors: MOTION OF AURELIUS FOR RELIEF FROM THE AUTOMATIC STAY (PDF).

[2] So far as I can tell, given the state of Puerto Rico’s economy, Aurelius can whistle for their money, even if they win their case.

[3] Allow me to briefly whinge about how awful the mainstream reporting on the case is. The Times, Reuters, and the usual authorities never cited the case name or docket number! Happily, Law360 gave the case number, but the docket is enormous. So I had to resort for Googling a unique-ish string one of them quoted from the filing — “pursuant to an intricate system of Balkanized lists,” fittingly enough — and found the PDF to which I have linked above that way. It’s as if all the reporters assumed I’d accept their authority even though they gave me no way to check them.

[4] “[A]ll citizens will be required to change their underwear every half hour.”

[5] Or “super-predators” (or “deplorables).