Here's the latest in an issue we've been following for a while. You recall that several years ago, a divided panel of the Ninth Circuit held there's nothing particularly special about an unresolved takings claim for just compensation that sets it apart from other creditor claims in a government bankruptcy.
The Ninth Circuit majority held that owners who assert their property was taken by the debtor-government before the bankruptcy -- but who have not been compensated -- are just unsecured creditors who must "share[] the pain" of the government going broke and sloughing off debt, even if it means that as a result the owner has had its property taken without just compensation. See "Ninth Circuit: Inverse Condemnation Plaintiff Must "Share The Pain" - City Can Shed Obligation To Pay Just Compensation In Bankruptcy, Which Is 'Purely A Monetary Claim'."
Next up, Round 2: In In re Financial Oversight & Management Board for Puerto Rico v. Cooperative de Ahorro y Credito Abraham Rosa, No. 22-1119 (July 18, 2022), the First Circuit went the other way.
Here's the setup. Puerto Rico property owners had claims for just compensation against the Commonwealth. One set of owners was (allegedly) owed compensation for the straight-up eminent domain-ing of their land by quick-take; they claimed the deposits didn't cover the actual amount of compensation. The other group of owners had inverse claims. The court noted that "[f]or purposes of this appeal, all parties agree that the Commonwealth ... took private property from at least some of the takings claimants before petitioning for [bankruptcy]." Slip op. at 18. That agreement would have consequences in the court's later analysis, so remember this point.
The Commonwealth's petition ("perhaps the largest and most consequential public bankruptcy in the nation's history") sought relief for "sovereign debt ... under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act." Slip op. at 8. The Commonwealth's reorganization plan proposed to treat the claims of the property owners as general unsecured debt, payable "at a pro-rata share of the overall recovery for general unsecured creditors." Slip op. at 12. In other words, likely pennies on the dollar, if that.
The property owners objected: hold on, we have had our property taken without compensation, and our claims are not plain-old unsecured debt because the constitution says we get just (full) compensation. Thus, a claim for compensation can't be wiped out in bankruptcy. Confirming the plan would leave us holding the bag, and thus, the court can't confirm the plan with our claims listed as unsecured debt.
And guess what? The Title III court agreed, and "directed the Board to modify the plan of adjustment to provide for full payment of any valid eminent domain and inverse condemnation claims if the Board wished to make the plan confirmable." Slip op. at 12-13. The Board did so (while reserving its right to appeal, which it eventually did).
The First Circuit started off by noting that the "appeal raises important questions about the interplay between the power to equitably restructure debts in bankruptcy and the Constitution's requirement that just compensation be paid whenever the government takes private property for public use." Slip op. at 8. Let's get to the holding first:
[O]therwise valid Fifth Amendment takings claims arising prepetition cannot be discharged in Title III bankruptcy proceedings without payment of just compensation.
Slip op. at 9. And by "just" compensation, the court meant whatever full compensation is owed to the owners. How did the court reach this result? Read on.
First, the court rejected the federal government's argument that this isn't a constitutional right vs bankruptcy power issue at all, but that the Article III court's holding was merely it exercising its equitable powers. No, the court concluded, "we read the Title III court's ruling to say precisely what it appears to say: that discharging valid, prepetition takings claims for less than just compensation would violate the Fifth Amendment and render a plan providing for such discharge unconfirmable under PROMESA." Slip op. at 16.
Next, having rejected the feds' invitation to avoid the constitutional question, the court concluded, "we move on to assessing whether the Fifth Amendment precludes the impairment or discharge of prepetition claims for just compensation in Title III bankruptcy. For the following reasons, we conclude that it does." Slip op. at 18. Can bankrupt governments "eliminate their obligation to pay just compensation and instead pay only reduced amounts based on a formula applicable to most creditors[?]" Slip op. at 19. The court held no.
First, "the Supreme Court has been very clear: the bankruptcy laws are subordinate to the Takings Clause." Slip op. at 20. Bankruptcy laws are subject to the Fifth Amendment.
Second, the court rejected the Commonwealth's argument that the Fifth Amendment protects only property held by the owners at the time of the bankruptcy. And because their real property had already been taken by the Commonwealth -- either through expropriation by eminent domain, or inversely taken by seizures -- the only "property" possessed by the owners at the time of the bankruptcy were unsecured claims.
The Commonwealth -- get this -- relied on Knick for that argument. Yes, you read that right. Because the right to compensation "arises at the time of the taking" the theory goes, the claim doesn't arise later when the government denies compensation. And by the time the goverment denies compensation, the owners have already lost their real property: "because the takings at issue here all occurred prepetition, the [Commonwealth] contends, any constitutional violation would have arisen only at the time of the taking." Slip op. at 22. The Commonwealth asserted therefore, that compensation is "untethered from the substantive Takings Clause violation itself." Id.
The First Circuit rightly held no, that Knick does not "cast doubt on the Fifth Amendment's requirement that just compensation be paid." Id. And here's the critical part:
Recognizing that the "right to full compensation arises at the time of the taking," id., does not imply that the subsequent denial of that compensation does not also raise Fifth Amendment concerns. We decline to read Knick as changing the Fifth Amendment right to receive just compensation into a mere monetary obligation that may be dispensed with by statute.
Id.
The court rejected an argument that the Fifth Amendment protects only rights in specific property, and not unsecured claims for money. Slip op. at 23. That isn't looking at the issue the right way, the court noted. This isn't a question of "whether a bankruptcy law has effected a taking of property" (i.e., whether bankruptcy law wiped out the ability to enforce a contract or other claim), but rather "whether the denial of just compensation for a taking" that "no one disputes" has occurred violates the right to compensation. Slip op. at 24.
Having disposed of that argument, the court next rejected the contention that "nothing about a claim for just compensation makes it any different for bankruptcy purposes than a claim for money damages for any other kind of constitutional violation." Slip op. at 25. Relying on the "language and nature of the Takings Clause," the First Circuit held that "compensation is different in kind from other monetary remedies." Slip op. at 26. The court concluded:
Just compensation then does not serve only as a remedy for a constitutional wrong; it serves also as a structural limitation on the government's very authority to take private property for public use. As the Court has stated, "where the government's activities have already worked a taking . . . , no subsequent action by the government can relieve it of the duty to provide compensation." Id. at 321. Simply put, the Fifth Amendment contemplates a "constitutional obligation to pay just compensation."Id. (citing First English, 482 U.S. at 315).
Thus, the court concluded, "payment of just compensation [is] unlike most other instances in which the government engages in a constitutional violation and is required to remedy that violation by paying money." Id.
The court expressly rejected the Ninth Circuit's reasoning in the Stockton case. Instead, the First Circuit found "the dissenting opinion of Judge Friedland in that case to be more persuasive." Slip op. at 27. Dissenting in Stockton, Judge Friedland wrote:
The majority instead holds that Cobb has forfeited all property rights in the condemned parcel under California law, and that his pending claim is "simply" a statutory claim for monetary damages. But the statutory character of Cobb’s claim does not diminish its constitutionally protected status—indeed, a constitutional claim for just compensation is a statutory claim for monetary damages under California law.Here's how the First Circuit wrapped up:
Reduced to its nub, the issue we decide is rather simple. The Fifth Amendment provides that if the government takes private property, it must pay just compensation. Because the prior plan proposed by the Board rejected any obligation by the Commonwealth to pay just compensation, the Title III court properly found that the debtor was prohibited by law from carrying out the plan as proposed.
Slip op. at 30-31.
Naturally, given our view that Stockton was ever-so-wrong, we feel validated by the First Circuit here. So remember that part-and-parcel of the power to take property is the corresponding obligation to, you know, actually pay for it. All of it. And anything that interferes with that right, whether it is, as here, a Congressional bankruptcy statute, a state statute, or anything else must yield to the Just Compensation imperative.
