In In re Financial Oversight and Management Board for Puerto Rico, 2019 WL 4667518 (1st Cir. 2019), the United States Court of Appeals affirmed in part and vacated in part the Article III court’s partial denial of Plaintiffs’ requested stay relief. The court held that the Plaintiffs failed to demonstrate that the non-segregated duplicate premiums could be traced and therefore waived their right of ownership to those funds and that remand was warranted to determine the property interests in the segregated funds and reapply the In re Sonnax factors to these funds in light of the property interest determination.

Facts

The Commonwealth of Puerto Rico has a compulsory automobile-insurance law (“Law 253”), which requires all motorists in Puerto Rico to obtain liability insurance either through the Commonwealth or through a private insurer. The Commonwealth adopted procedures to enable motorists who opted for private insurance to avoid paying the Commonwealth premiums, yet many motorists still ended up paying duplicate annual premiums. Law 253 further provided that the premiums be transferred by the Secretary of Treasury to the Compulsory Liability Joint Underwriting Association of Puerto Rico (“JUA”) where they would be kept in a separate reserve account and subject to reimbursement upon request by motorists who had paid the duplicate premiums. Premiums that went unclaimed for seven years were reverted to the Commonwealth.

In 2002 the Puerto Rico legislature altered Law 253 by passing Law 230. Law 230 directed the JUA to transfer duplicate premiums from the reserve account every two years. Additionally, instead of a seven-year term for reacquiring duplicate premiums by motorists, Law 230 lowered it to a five-year term at which point the funds become the property of the Government of Puerto Rico and are thereby transferred to the General Fund of the State’s Treasury. Upon passage of Law 230, the JUA transferred $73 million from the reserve account to the Secretary of Treasury whereupon the Commonwealth used the funds to balance its budget.

A class of motorists who had paid duplicate premiums filed suit in district court, claiming that the Commonwealth’s transfer of the $73 million from the reserve account to the Secretary of Treasury was a violation of the Takings Clause and, since it lacked notice and process, a violation of the Due Process Clause. During the court ordered notice to insureds owed reimbursement in 2013, the court further demanded that “no duplicate premiums shall escheat to the Commonwealth until it has established and complied with a reimbursement procedure which meets the basic requirements of constitutional due process.” This halt on escheatment to the Commonwealth created two separate pools of duplicate premiums; those not yet escheated to the government, which were received during or after 2006 and transferred to the Secretary of Treasury after July 2008, and the non-segregated funds which had previously escheated to the Commonwealth and had already been mixed with the General Fund.

In 2016, Congress passed the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”) and on May 3, 2017, the Financial Oversight and Management Board for Puerto Rico initiated Article III debt-adjustment proceedings on behalf of the Commonwealth, triggering an automatic stay of collection actions against the Commonwealth. This thereby caused the cessation of all reimbursement procedures. In February 2018, the Plaintiffs filed a motion in the Article III debt-adjustment proceeding seeking relief from the automatic stay to allow them to enforce the reimbursement plan in a separate action. Most of the Plaintiffs’ requests were denied by the Article III court.

Decision

The Plaintiffs’ brought their claim on the grounds that the “funds they seek are their own and are being held by the Commonwealth only as a trustee that lacks any equitable interest in the property.” As such, the Plaintiffs emphasize that they are not creditors owed damages but rather seeking the return of their own assets. The Court of Appeals determined that in order to properly weigh the In re Sonnax factors as the Article III court had done in this instance, there needed to first be a preliminary determination of the property interests in the disputed funds.

The court points out that stay relief has often been granted by courts “for cause” after first determining that the debtor has only a legal rather than equitable interest in the property. Furthermore, although the bankruptcy code itself does not define what grounds constitute “cause” qualifying for a lift of an automatic stay, “legislative history indicates that Congress thought stay relief would be warranted when the debtor retains no equitable stake in the property.” The Commonwealth attempted to disprove this conclusion by arguing that PROMESA did not incorporate section 541(d) of the bankruptcy code and without it, legislative history and case law on relief from automatic stays should not be considered in this context. The court here unequivocally debunked this theory and in doing so states, “Congress thought that stay relief should be granted under PROMESA upon a showing that the debtor lacks equity in disputed property is confirmed by Congress’s express decision to incorporate subsection 362(d)(2) of the bankruptcy code into PROMESA.” The effect of this: the reach of the automatic stay is actually broader in the PROMESA and municipal bankruptcy contexts than it is in ordinary bankruptcy cases.

Regarding the non-segregated funds, the Court of Appeals found that the Plaintiffs did not make out a prima facie case for stay relief as it pertains to these funds. The Plaintiffs needed to establish both the existence of a trust relationship and that the trust fund duplicate premiums were traceable. The court applied “the lowest intermediate balance rule” to determine the traceability element and held that the Plaintiffs made no effort to demonstrate that the non-segregated duplicate premiums could be traced. Therefore, the Article III court’s decision was affirmed.

As for the segregated funds, the Court of Appeals found that the prima facie case showing the existence of a trust relationship and traceability had been demonstrated by the Plaintiffs. All parties acknowledged the segregation of the $76.1 million into a separate account and the Plaintiffs use Law 230 to establish the trust relationship by pointing out the Secretary of Treasury’s role in holding duplicate premiums “in its fiduciary capacity.”

The Commonwealth attempted to overcome this determination by claiming no trust relationship exists in the absence of a “notarized public deed” and there is a possibility that other “similarly situated prepetition creditors” might have overlapping claims. The court quashes these two arguments by stating that the notarized public deed requirement being applied to a trust relationship created by statute has not been proven or explained by the Commonwealth and even if it did apply, that would be an Article III court decision. Furthermore, the Commonwealth has made no plausible showing that these potential creditors exist. Therefore, with regards to the segregated funds, the Court of Appeals held that remand is warranted for the Article III court to first determine the property interests in the segregated funds and then conduct their analysis by reapplying the In re Sonnax factors.