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Reversing the District Court, the First Circuit Says PROMESA Provides for an “Unconditional Right to Intervene,” Deepening Circuit Split on Applicability of 11 U.S.C. § 1109(b) in Adversary Proceedings

Last week, in Assured Guaranty Corp. v. Fin. Oversight and Mgmt. Bd. for Puerto Rico, No. 17-1831, 2017 U.S. App. LEXIS 18387 (1st Cir., Sept. 22, 2017), the U.S. Court of Appeals for the First Circuit issued a noteworthy decision in the Puerto Rico quasi-bankruptcy proceedings.  Overturning the district court’s ruling, the Court of Appeals held that the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”), 48 U.S.C. §§ 2161-2177, provides for a non-discretionary “unconditional right to intervene,” pursuant to Fed. R. Civ. P. 24(a)(1).  Although decided within the context of the Puerto Rico proceedings, the First Circuit’s decision deepens a circuit split on whether the unconditional right to intervene, set forth in 11 U.S.C. § 1109(b), applies to adversary proceedings.

As we previously noted, on May 3, 2017, the Financial Oversight and Management Board for Puerto Rico filed a voluntary petition for relief under PROMESA, seeking to restructure Puerto Rico’s debt under Title III of that statute.  Chief Justice Roberts appointed Judge Swain (who normally sits in the Southern District of New York) to conduct the case. 

The appeal arises out of the attempt by the Official Committee of Unsecured Creditors (“UCC”) to intervene in an adversary proceeding filed in the Title III case.  The same day that Puerto Rico filed its petition for relief, Assured Guaranty Corporation and other insurers of Puerto Rican bonds commenced the adversary proceeding.  These plaintiffs alleged that the Commonwealth’s proposed fiscal plan violated various provisions of PROMESA and the U.S. Constitution, and sought declaratory and injunctive relief to prevent the implementation of that plan. 

After the UCC was formed in June 2017, it sought leave to intervene in that adversary proceeding.  The UCC argued that Fed. R. Civ. P. 24(a)(1), incorporated by Bankruptcy Rule 7024, requires the court to permit intervention by any party “given an unconditional right to intervene by federal statute.” The UCC argued that 11 U.S.C. § 1109(b), which provides that a creditors’ committee “may raise and may appear and be heard on any issue” under chapter 11 of the Bankruptcy Code, afforded it such unconditional right.  Although the Puerto Rican proceedings were filed under Title III of PROMESA, not chapter 11, the UCC observed that Title III had incorporated section 1109(b) into the Puerto Rican proceedings (along with many other subsections of the Bankruptcy Code).  Assured and the other plaintiffs opposed the UCC’s attempt to intervene. 

Judge Swain denied the motion to intervene.  Her decision relied exclusively on a footnote in Kowal v. Malkemus (In re Thompson), 965 F.2d 1136, 1142 n.8 (1st Cir. 1992), which stated that section 1109(b) “does not afford a right to intervene under Rule 24(a)(1).”

On appeal, the First Circuit (which exercises appellate jurisdiction over the District of Puerto Rico) reversed the District Court’s ruling.  The First Circuit noted that the District Court’s ruling was “understandable” because the Thompson footnote appeared on point; however, the Court of Appeals held, that footnote actually was non-binding dicta.  2017 U.S. App. LEXIS 18387, at *7.  Thompson was an appeal concerning a chapter 7 bankruptcy and thus, the Court held, section 1109(b) was “inapplicable on its face.”  Id.

Instead, the First Circuit analyzed whether section 1109(b) confers an unconditional right to intervene in an adversary proceeding.  The Court noted that the Fifth Circuit has held that section 1109(b) does not apply to adversary proceedings.  Id. at *9 (citing Fuel Oil Supply & Terminaling v. Gulf Oil Corp., 762 F.2d 1283 (5th Cir. 1985)).  But the Court also recognized that both the Second and Third Circuits have rejected Fuel Oil, and hold instead that section 1109(b) does apply to adversary proceedings.  Id. at *9-10 (citing Term Loan Holder Comm. v. Ozer Grp., L.L.C. (In re Caldor Corp.), 303 F.3d 161 (2d Cir. 2002) & Phar-Mor, Inc. v. Coopers & Lybrand, 22 F.3d 1228 (3d Cir. 1994)).

Weighing the two sides, the First Circuit found the Second and Third Circuits’ position more persuasive.  The Court emphasized that the statutory text of section 1109(b) applies generally to “cases” filed under chapter 11.  That term encompasses all litigation commenced by the filing of a bankruptcy petition under that chapter.  Because the plain text of this section does not distinguish between litigation in a main bankruptcy case and in an adversary proceeding, the First Circuit held, section 1109(b) applies broadly to permit a creditors’ committee to appear and be heard in any case under chapter 11.

Although the First Circuit’s ruling comes in the context of the PROMESA proceedings, the ruling is not cabined to the interpretation of the PROMESA statute.  Rather, the First Circuit’s opinion, which turns on an interpretation of the section 1109(b) of the Bankruptcy Code, applies generally to all bankruptcy cases within that circuit.  Thus, in addition to being an important win for the UCC in the Puerto Rican case, this decision deepens the overall circuit split on the applicability of intervention under section 1109(b) to adversary proceedings.  It appears that the Fifth Circuit is increasingly in the minority position on this issue.