By Jess Bravin and Andrew Scurria 

WASHINGTON -- The Supreme Court on Tuesday appeared likely to uphold the special board that Congress created to resolve Puerto Rico's debt crisis, despite claims from creditors that its members were wrongly appointed.

The dispute turns on whether the oversight board supervising Puerto Rico's finances is best considered a federal agency whose members must be presidential nominees confirmed by the Senate, or an entity structured by Congress under its authority to administer the U.S. territories. So far, it has functioned as the latter.

The stakes are high, with the past three years of effort to resolve the nation's largest municipal bankruptcy on the line.

Bondholders include Aurelius Capital Management LP, a hedge-fund manager that bet on Puerto Rico's debt. Aurelius sued to try to disrupt the bankruptcy proceedings begun by the board to restructure roughly $125 billion in bond and pension debt.

On Tuesday, Justice Samuel Alito questioned what the investor hoped to accomplish. "I'd like to know what's really going on here," he asked Theodore Olson, a lawyer representing Aurelius. "Are you and your client here just to defend the integrity of the Constitution, or would one be excessively cynical to think that something else is involved here involving money?"

Mr. Olson wouldn't identify a particular decision the board made or a dollar figure at issue. But the board has proposed a settlement that would pay back hundreds of millions of dollars in general obligation bonds held by Aurelius and other creditors at 35 to 45 cents on the dollar, below their current market value.

"My client is being subjected to a process that is governed by officials that were appointed in violation of the separation of powers," Mr. Olson said.

Tuesday's case involved a constitutional provision that grants Congress power over the organization of territories, similar to its control of the District of Columbia. It has used such power to grant home rule to Washington, D.C., and significant autonomy to Puerto Rico and other territories that lack voting representation in Congress.

Justice Brett Kavanaugh suggested that if the creditors' definition of a federal officer requiring Senate confirmation was correct, it could put territorial self-government in jeopardy.

"What would that do for home rule and the territories with elected governors?" he said. "What would it do for the District of Columbia with the elected mayor, city council, the judges' appointments?"

Mr. Olson suggested that his theory would leave home rule intact for local matters -- "speed limits, zoning and things of that nature, as opposed to federal statutes that deal with a national crisis," he said.

The arguments largely revolved around whether the board's functions were akin to those of a state or local agency rather than a federal one.

The board's lawyer, Donald Verrilli, pointed out that Congress specifically invoked its territorial powers in creating the board, directed it to work in Puerto Rico's interest and insulated its members from political interference by giving them three-year terms during which they could be removed only for cause.

On the other hand, Justice Sonia Sotomayor observed, the three million Puerto Ricans who must live under the board's decisions had no say in its creation.

"How you can label this a territorial officer as opposed to a federal officer...when none of the people of Puerto Rico have voted?" she asked.

Mr. Verrilli said the idea that the Constitution gives territorial residents the right to a say in their government was "not consistent with the history of this country." For years, he said, even the mayors of Washington, D.C., were presidential appointees rather than elected by those they governed.

Mr. Olson, though, said the board's powers are "national in scope," including bringing lawsuits against financial institutions located in the mainland U.S., reporting its decisions to federal officials and recommending changes to federal law.

A federal appeals court in Boston ruled in February that the board's members were federal officers requiring Senate confirmation. But it also found that the structural flaw could be remedied if the Senate voted to confirm the members -- President Obama's appointees who, as a backstop, subsequently were nominated by President Trump. A confirmed board could then simply ratify its past actions.

"So what you're talking about is a delay of possibly days while the Senate gets its act together to confirm the people that they already recommended?" said Justice Stephen Breyer. "That's what this case is about?"

Justice Department lawyer Jeffrey Wall said a ruling against the board would offer creditors opportunities to delay Puerto Rico's recovery in hopes of getting more money from the ultimate settlement.

"We're litigating for years on that view. It's just a question of how much we're going to have to litigate with them if the court decides we're wrong," Mr. Wall said.

A decision in the case, Financial Oversight and Management Board for Puerto Rico v. Aurelius Investment LLC, is expected by June.

Write to Jess Bravin at jess.bravin@wsj.com and Andrew Scurria at Andrew.Scurria@wsj.com

(END) Dow Jones Newswires

October 15, 2019 17:28 ET (21:28 GMT)