Background
Puerto Rico’s Electric Power Authority issued revenue bonds secured by PREPA’s revenues. Although the Commonwealth was not liable for principal or interest, Puerto Rico had enacted a statutory covenant promising not to limit or alter PREPA’s rights and powers until the bonds were repaid. After Puerto Rico entered PROMESA Title III proceedings and PREPA defaulted, U.S. Bank, as bond trustee, filed an $8.5 billion claim in the Commonwealth’s case alleging impairment of the covenant and violations of the federal and Puerto Rico Takings and Contracts Clauses.
The Commonwealth’s confirmed adjustment plan provided no distribution for claims subordinated under Bankruptcy Code § 510(b), while general unsecured claims could receive a partial recovery. The district court allowed the Financial Oversight and Management Board to amend its earlier objection and classified the trustee’s claim as a § 510(b) subordinated claim because the asserted damages arose from the bondholders’ purchases of PREPA securities.
The Court’s Holding
The First Circuit affirmed. It held that § 510(b), which subordinates damages claims arising from the purchase or sale of a debtor’s or affiliate’s securities, is not categorically limited to wrongdoing occurring when securities are purchased. A later, independent wrong may fall outside the statute, but post-purchase misconduct remains covered when the securities transaction has the required causal relationship to the claimed injury.
That causal nexus existed here because the trustee itself alleged that the statutory covenant and related protections materially induced investors to purchase PREPA bonds and that the Commonwealth later impaired those same protections. The constitutional labels attached to some causes of action did not remove the claim from § 510(b), and constitutional avoidance did not justify a different construction. The court also found no abuse of discretion in allowing the Board to amend its timely objection and held that the bondholders waived their separate argument about the proper level of subordination by failing to raise it below.
Key Takeaways
- Section 510(b) can reach claims based on misconduct occurring after a securities purchase; it is not confined to issuance-related fraud or wrongdoing at the time of sale.
- A claim falls within § 510(b) when its own allegations establish a sufficient causal nexus between the securities purchase and the asserted damages, as the trustee’s inducement allegations did here.
- Pleading statutory or constitutional theories does not create an exception to § 510(b), though the court did not decide whether a taking occurred or what compensation might be constitutionally required.
Why It Matters
The ruling leaves the trustee’s $8.5 billion claim in the Commonwealth’s nonpaying subordinated class rather than the general unsecured class, while leaving potential claims against PREPA to PREPA’s separate Title III proceeding. More broadly, it confirms in the First Circuit that § 510(b) may apply to post-purchase injuries tied closely to protections that induced an investment, including claims involving an affiliate’s securities.