Court: United States Court of Appeals for the First Circuit

Filed: 2026-09-23

The First Circuit affirmed the district court’s order classifying a $8.5 billion proof of claim filed by the PREPA bondholders’ trustee against the Commonwealth of Puerto Rico as a “Section 510(b) Subordinated Claim” under the Commonwealth’s Title III restructuring plan, thereby excluding the claim from any distribution to general unsecured creditors. The court held that 11 U.S.C. § 510(b), which mandates the subordination of claims for damages arising from the purchase or sale of a security, applies to the trustee’s claim because the Commonwealth allegedly impaired statutory and constitutional protections that served as a material inducement for investors to purchase the PREPA revenue bonds. Rejecting the bondholders’ argument that § 510(b) is limited to misconduct occurring at the exact moment of the securities transaction, the court applied a causal nexus standard consistent with other federal circuits, concluding that the claim sought damages arising from the purchase because the alleged post-transaction impairment targeted rights specifically granted to induce that purchase. The court further rejected the bondholders’ alternative arguments that the canon of constitutional avoidance required a narrower reading of the statute and that the claim should only be subordinated to claims senior or equal to the bonds rather than fully subordinated, noting the latter issue was waived for failure to raise it in the district court. As a practical consequence, the bondholders’ claim receives no recovery under the Commonwealth Plan’s Class 64 classification, which provides zero distribution to subordinated claims, while general unsecured creditors (Class 58) will recover approximately twenty percent of their claims rather than the reduced five percent they would have received had the $8.5 billion claim been classified as a general unsecured claim.

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