First Circuit backs Oversight Board in PREPA bondholder fight, upholds subordination of $8.5B claim

By THE STAR STAFF

The U.S. Court of Appeals for the First Circuit has upheld a ruling that strips Puerto Rico Electric Power Authority (PREPA) bondholders of any recovery from the Commonwealth of Puerto Rico’s bankruptcy-style restructuring, concluding that their $8.5 billion claim must be subordinated under Section 510(b) of the Bankruptcy Code.

In a decision issued September 23, 2026, a three‑judge panel affirmed U.S. District Judge Laura Taylor Swain’s determination that the bondholders’ claim, filed by U.S. Bank as trustee, “ultimately relate[d]” to the purchase of PREPA revenue bonds and therefore falls squarely within the statute’s mandatory subordination provision. Section 510(b) requires that claims “for damages arising from the purchase or sale” of a debtor’s or affiliate’s securities be paid only after all senior claims.

The trustee had sought $8.5 billion from the Commonwealth, arguing that Puerto Rico violated statutory and constitutional protections tied to PREPA’s 1974 Trust Agreement and the 1941 Authority Act. The proof of claim alleged that the Commonwealth impaired PREPA’s ability to repay bondholders—particularly by limiting PREPA’s rate‑setting authority—and asserted violations of the Takings and Contracts Clauses. It also stated that the Commonwealth’s statutory covenant not to interfere with PREPA’s repayment powers served as a “material inducement for investors to purchase” the bonds.

That allegation proved decisive. The appellate panel highlighted the trustee’s own framing, noting that the claim sought damages rooted in promises made to encourage investors to buy PREPA bonds. Because PREPA is an affiliate of the Commonwealth and the bonds qualify as securities under the Bankruptcy Code, the court found that Section 510(b) applied.

The ruling preserves the structure of the Commonwealth’s confirmed Plan of Adjustment, which places Section 510(b) claims in Class 64—a category that receives no distribution. Had the trustee’s claim been treated as a Class 58 general unsecured claim, recoveries for other unsecured creditors would have dropped from roughly 20 percent to about 5 percent.

Bondholders argued that Section 510(b) should not apply because their claims stemmed from “post‑sale malfeasance,” not misconduct at the time of purchase. The First Circuit rejected that interpretation, joining other federal circuits in holding that the statute covers claims with a causal link to the securities transaction, even when the alleged wrongdoing occurs years later.

The court also dismissed procedural objections, finding no abuse of discretion in the district court’s decision to treat the Oversight Board’s filing as an amended, timely objection.

The decision leaves PREPA bondholders without recourse against the Commonwealth, though they continue to pursue claims in PREPA’s separate Title III case.