The case before the United States Court of Appeals for the First Circuit involves multiple appellants, including various credit cooperatives, against the Financial Oversight and Management Board for Puerto Rico, which represents several Puerto Rican public entities, including the Commonwealth of Puerto Rico, the Puerto Rico Sales Tax Financing Corporation (Cofina), the Employees Retirement System, the Highways and Transportation Authority, and the Electric Power Authority (PREPA). The appellants are challenging decisions made by the Board and other defendants, which include public and private entities involved in the financial oversight and management of Puerto Rico's fiscal affairs. The appeal originates from a ruling by the U.S. District Court for the District of Puerto Rico, presided over by Judge Laura Taylor Swain. Legal representation for both parties includes prominent law firms and attorneys listed in the document. The case encapsulates complex issues relating to Puerto Rico's financial management and the roles of various oversight entities and officials.
Six Credit Unions allege in an adversary proceeding that the Commonwealth of Puerto Rico and its agencies compelled them to invest in worthless government-issued securities, despite the defendants' knowledge of the poor financial condition of Puerto Rico at the time. The Credit Unions claim that through various communications and policy guidance between 2009 and 2015, the defendants misrepresented and withheld critical information regarding the risks associated with these investments. The district court dismissed their claims, which the Circuit Judge Thompson affirmed, emphasizing that all facts were taken from the complaint and accepted as true for the motion to dismiss.
The key defendants include the Corporación Pública para la Supervisión y Seguro de Cooperativas de Puerto Rico (COSSEC), responsible for regulating financial institutions and issuing circular letters that the Credit Unions must follow under threat of penalties. The Government Development Bank (GDB), as a fiscal agent, managed all bond and debt issuance and had specific knowledge of the Commonwealth's financial issues post-2009. The GDB Debt Recovery Authority was established to implement a debt restructuring plan for the GDB. The Credit Unions assert that the GDB and other agencies knowingly enforced regulatory measures that forced them to hold excessive amounts of impaired government securities, negatively impacting their financial stability.
From 2009 to 2015, the Commonwealth, the Government Development Bank (GDB), and the Office of the Commissioner of Financial Institutions (COSSEC) misused regulatory authority over credit unions, coercively directing them to invest in unsafe Puerto Rico Debt Instruments. This was accomplished through circular letters, selective examinations, and threats of legislative retaliation, resulting in the appropriation of significant cash and liquid assets from the Credit Unions without fair compensation.
Circular Letter 09-03, issued in 2009, encouraged cooperatives to purchase bonds from the Commonwealth, misleadingly asserting that these bonds were guaranteed 100% for interest and principal payments, despite knowledge of the government’s inability to meet these obligations due to Puerto Rico's financial struggles. Circular Letter 2012-02 acknowledged the economic recession and increased investment limits for credit unions, leading to an estimated $156 million being taken from them, resulting in heavy investments in Puerto Rican government securities by August 2017.
The Credit Unions claim that this regulatory manipulation was executed with awareness of the inherent risks to Puerto Rico’s public finances, exposing them to undue risk concentrations. They also allege that the GDB and COSSEC neglected their responsibilities to support the stabilization of the financial system as the crisis loomed in 2015, despite the Credit Unions' active involvement in proposing solutions for financial restructuring.
Credit Unions claim that Circular Letter 2012-02 enabled the government to take significant amounts of their funds in exchange for low-value instruments, leading to increased risk in unstable Puerto Rico Debt Securities, which they argue is a detrimental investment strategy. They report damages including losses in income, principal, capital, liquidity, market value, reputation, and overall business. Despite experiencing fraud, the Credit Unions maintain growth and stability during Puerto Rico's financial crisis. In March 2018, they initiated a legal proceeding against multiple governmental entities, including the Commonwealth of Puerto Rico and various financial authorities, seeking exceptions from debt discharge in a Title III proceeding based on two main recovery theories: the alleged fraudulent conduct of the defendants disqualifying them from debt discharge under 11 U.S.C. § 105 and § 944, and a request for a declaratory judgment under PROMESA. The Credit Unions also presented common law claims such as breach of contract and fraud, alongside federal and Puerto Rican statutory claims. In response, the defendants filed motions to dismiss the claims, arguing lack of sufficient grounds and other procedural issues. After disputes over amending the complaint, the district court permitted a second amended complaint (SAC), enhancing the factual basis for the claims.
The Second Amended Complaint (SAC) alleges seven counts against various defendants, including COFINA, HTA, ERS, and PREPA, with claims of fraudulent actions that affect the plaintiffs’ rights under Title III of PROMESA and bankruptcy laws. Specifically, it asserts: (1) exceptions to discharge under 11 U.S.C. §§ 105 and 944; (2) a request for separate class designation and declaratory judgment under PROMESA; (3) fraudulent actions by the Commonwealth, GDB, and COSSEC under Puerto Rico's Act Against Organized Crime; (4) breach of contractual obligations due to fraudulent misrepresentations causing damages to Credit Unions; (5) civil liability for COSSEC and its directors under Puerto Rico's tort statutes; (6) constitutional violations related to the appropriation of Credit Unions' funds for governmental insolvency; and (7) a claim of unjust enrichment, which is not contested on appeal. The defendants moved to dismiss the SAC, and the district court granted these motions, leading to a final judgment on January 4, 2022. The Credit Unions appealed, focusing on counts 1-6 against the Commonwealth and other entities. The FOMB and various committees joined in the dismissal motions. The appellate review will evaluate the dismissal under Rule 12(b)(1) and 12(b)(6), ensuring the allegations support plausible claims for relief, particularly scrutinizing the fraud-related claims.
The Credit Unions contest specific aspects of the district court's ruling, particularly the dismissal of fraud-based claims (counts 1-5) for failing to meet the heightened pleading standard under Rule 9(b), the dismissal of Puerto Rico law claims (counts 4 and 5) as time-barred, and the takings claim for lack of plausibility. On appeal, the Credit Unions assert that they have adequately alleged fraudulent conduct by the Commonwealth, COSSEC, and GDB, aiming to satisfy Rule 9(b) and overcome the defendants' 12(b)(6) motion to dismiss. The court, however, disagrees, emphasizing that to plausibly allege fraud under Puerto Rico law, plaintiffs must present specific factual allegations regarding four elements: a false representation by the defendant, reasonable reliance by the plaintiff, resulting injury, and intent to defraud. The court highlights that while the Credit Unions provide some factual allegations beyond mere conjecture, they fail to adequately plead the first element of fraud—false representations—due to a lack of specificity. The allegations primarily describe a vague fraudulent scheme involving COSSEC's circular letters and communications among officials, without detailing when these interactions occurred or how they resulted in specific misrepresentations to the Credit Unions. Consequently, the court finds the Credit Unions' claims do not meet the required particularity under Rule 9(b).
The Credit Unions claim that COSSEC's Executive President pressured them to cooperate with government financial needs, but the cited section of the Second Amended Complaint (SAC) only indicates misuse of regulatory authority through meetings involving COSSEC officials and unnamed government representatives, without specifying any direct interaction with the Credit Unions. The SAC further alleges that COSSEC threatened to reevaluate the tax-exempt status of Cooperatives but lacks specifics regarding the timing, the individuals involved, and the exact nature of the threat. Additionally, the Credit Unions allege that COSSEC summoned them to a presentation promoting Puerto Rico bonds shortly after the issuance of a 2009 Circular Letter, which they claim was part of a scheme to secure funding despite the Commonwealth's known financial instability. However, the allegations lack detailed accounts of what was said during this presentation.
The Credit Unions also challenge the accuracy of statements in Circular Letter 09-03 regarding the bonds' advantages, asserting that the defendants were aware of the bonds' impending decline in value. They argue that COSSEC's acknowledgment in the letter that future declines would not constitute regulatory violations indicates knowledge of the bonds' worthlessness. Nonetheless, the district court points out that the bonds were government-backed with guarantees of interest and principal payments, undermining the Credit Unions' claims. The language of the Circular Letter itself suggests that potential benefits from the bonds were not guaranteed, contradicting the Credit Unions' assertions of misleading statements. Moreover, the Credit Unions did not sufficiently demonstrate knowledge of any alleged falsehoods in their claims.
Allegations regarding the defendants' knowledge of fiscal misrepresentation are deemed overly broad and speculative, as courts require specific facts to establish reasonable belief of awareness regarding material falsity. The plaintiffs assert that they indicated the defendants had knowledge of their statements' falsity; however, lacking specific details about the defendants' knowledge of bond statuses necessitates an unreasonable inferential leap. Plaintiffs must provide concrete facts showing defendants knew their statements were incorrect at the time. To establish fraud by omission in securities cases, plaintiffs must identify specific misleading statements, demonstrate how omissions rendered them misleading, and prove a duty to disclose omitted information. It is not considered a material omission if the information is already known to the market. Circular Letter 2012-02 informed Credit Unions about the Commonwealth's economic recession, suggesting that they were aware of Puerto Rico's economic challenges during their investment decisions. Furthermore, the Credit Unions engaged with the government to address financial issues, leading to a legislative proposal adopted in December 2015. The Credit Unions' failure to provide specific allegations regarding fraud results in insufficient claims, as demonstrated in prior cases where misrepresentation claims were dismissed for lack of detailed allegations regarding the who, what, where, and when of misleading statements. The district court's conclusion on the defendants' misrepresentation related to PREPA's fraud claim stands affirmed.
Allegations of fraud by the Credit Unions were dismissed as they were deemed conclusory, lacking specificity regarding individuals and meetings over a four-year period, failing to meet Rule 9(b) standards. The Credit Unions sought an exception to discharge their Title III bankruptcy claims based on the GDB's 2018 debt restructuring plan approved under PROMESA, which requires a qualifying modification (QM) after consultation between the bond issuer and holders, binding all bondholders regardless of consent. The district court found the Credit Unions' request moot, asserting they were bondholders at the time of the QM approval, a point the Credit Unions contested but was supported by their own admissions during oral arguments. Even if their fraud claims were adequately pled, the completion of the QM process rendered their discharge request moot, as federal courts cannot decide moot issues. Additionally, claims for negligence and fraud against the Commonwealth, COSSEC, and GDB were dismissed due to expiration of statutes of limitations, which the district court found had lapsed before the Credit Unions initiated their proceedings. These limitations include a one-year statute for negligence claims and a two-year statute for securities-related fraud claims.
The district court found that the Credit Unions were aware of potential claims for damages by December 2015, as they had proposed and drafted legislation aimed at stabilizing the financial system. Count 4, labeled "breach of contractual obligations," included allegations of fraudulent inducement and negligence, referencing relevant statutes. The Credit Unions did not contest the applicability of a one- or two-year statute of limitations but sought equitable tolling due to their diligent pursuit of rights and extraordinary circumstances, specifically Hurricane Maria, which hindered timely filing. Despite their claims of ongoing efforts to address the financial crisis with various government entities and the Financial Oversight and Management Board (FOMB), the district court ruled that these efforts did not excuse the failure to pursue litigation regarding known injuries. The court affirmed the dismissal of fraud-related claims in counts 4 and 5 but briefly reviewed non-fraud-related negligence claims, ultimately rejecting the equitable tolling arguments. Equitable tolling applies only in exceptional circumstances, such as when filing deadlines are missed due to factors beyond the plaintiff's control. The Credit Unions cited the hurricane as a reason for equitable tolling; however, since the one-year limitations period for their negligence claims expired before the hurricane in fall 2017, equitable tolling could not prevent the dismissal of these claims. Additionally, the Credit Unions alleged that defendants used regulatory powers to unlawfully appropriate cash and liquid assets, compelling them to purchase impaired government bonds, constituting a takings claim.
The Credit Unions allege that the defendants' actions resulted in both a per se physical taking and a categorical regulatory taking of their property, which they claim has been deprived of significant economic value. Under the Takings Clause of the Fifth Amendment, any government seizure of private property for public use must be accompanied by just compensation. To establish a takings claim, plaintiffs must demonstrate a recognized property interest protected by the Fifth Amendment and show that the government action caused an illegal taking of that interest.
There are two recognized types of takings: physical takings, which involve direct condemnation or appropriation of property, and regulatory takings, which occur when regulations significantly restrict property use to the extent that compensation is warranted. A physical taking requires compensation when the government physically takes possession of property. In contrast, a regulatory taking occurs when a regulation denies all economically beneficial uses of land.
The defendants moved to dismiss the takings claim, arguing that the Credit Unions had not plausibly alleged a taking since the reduction in bond value post-purchase did not constitute a complete loss of value necessary for a taking claim. The district court agreed, noting the permissive nature of the circular letters referenced by the plaintiffs, which indicated that the decision to purchase securities remained with the Credit Unions.
On appeal, the Credit Unions contend that they have sufficiently alleged their takings claim under both theories and argue that the district court failed to connect the dots presented in their complaint, which they assert outlines a comprehensive scheme of coercion. They also reference a non-categorical regulatory taking analysis based on the three-factor test established in Penn Central Transportation Co. v. City of New York.
The Credit Unions assert that their allegations sufficiently support a plausible alternative takings theory, specifically claiming a direct and categorical regulatory taking in their Second Amended Complaint (SAC), but not a non-categorical regulatory taking. Consequently, the court dismisses this aspect of their takings argument. The Credit Unions argue that several components—including two Circular Letters and additional letters from 2009 to 2012, the contents of which are unspecified—should be analyzed collectively to show that these communications exerted coercive pressure on them to purchase bonds. They contend that the letters, despite their language suggesting voluntary compliance, effectively compelled their actions, allowing the defendants to avoid direct commands. The Credit Unions claim this context supports their takings claim, asserting that their property was materially diminished rather than completely taken.
However, the court highlights that established precedent requires a complete deprivation of economically beneficial use for a regulatory taking, which the Credit Unions have not demonstrated, as they have not alleged a total loss of investments but rather a diminished value. The court emphasizes that a plaintiff must establish an independent property right before claiming that the state has taken that right without just compensation. The Credit Unions' focus is on the coercive nature of the circumstances surrounding their bond purchases, suggesting they were forced to pay more than the bonds' worth due to the pressure from COSSEC and the circular letters.
Allegations in the Second Amended Complaint (SAC) regarding a decline in bond value post-purchase do not inherently prove that the bonds were overvalued at the time of purchase. Claims about the government's knowledge of the bonds' value are deemed conclusory and lack substantial detail, failing to provide adequate notice to the defendants as required by Rule 8(a). The Credit Unions have not established that they were compelled to purchase the bonds to the maximum limit as suggested by the circular letters, which used permissive language and did not mandate purchases. The letters imply that defendants encouraged Credit Unions to invest up to 30% of their liquid assets, but do not support claims of coercion. The Credit Unions' argument about mandatory compliance is countered by the fact that many did not purchase the bonds, undermining claims of constitutional taking. Consequently, the takings claim was dismissed under Rule 12(b)(6), and additional arguments raised by the Credit Unions were found unpersuasive.
The Credit Unions assert that the district court abused its discretion by dismissing their second amended complaint (SAC) shortly before confirming the Title III final plan of adjustment for the debts of the Commonwealth, the Employees Retirement System (ERS), and the Public Building Authority (PBA). They argue that this dismissal deprived them of due process because it was not a final ruling when used to dismiss their objections to the Title III plan, hindering their ability to litigate claims against the defendants. The court notes that the Credit Unions failed to substantiate their claims of error regarding the dismissal, leading to a waiver of this issue due to insufficient argumentation. Additionally, the Credit Unions contend that the dismissal allowed the Title III debtors to escape accountability for fraudulent actions, implying that a favorable outcome in their adversary proceeding would entitle them to an exception from discharge under Title III. However, this argument is already central to their appeal regarding the confirmation order in a separate Title III case, and thus the court does not address it further. The judgment of the district court is affirmed, with each party responsible for their own costs.
