Adjustment of State and Municipal Debt
Under Chapter 9 the Bankruptcy Code
J. Robert Stoll
Mayer Brown LLP
Visiting Professor
University of Belgrade Faculty of Law
Aaron Gavant
Mayer Brown LLP
Fall 2013
U.S. Workout/Insolvency Law Course
University of Belgrade Faculty of Law
FALL 2014
Introduction
I.
II.
III.
IV.
Who may file under Chapter 9
Constitutional Issues
Overview of Key Provisions
Advantages/Limitations
1
Who May Be a Debtor under Chapter 9?
• Under §109(c) of the Code, in order to file under Chapter 9, an
entity must
– be a municipality;
– be specifically authorized by state law to file under Chapter 9, in its
capacity as a municipality or by name;
– be insolvent;
– desire to effect a plan to adjust its debts; and
– (i) have obtained the agreement of a majority of claims of each class the
entity intends to impair; or (ii) have negotiated in good faith with
creditors and failed to obtain such a majority; or (iii) have been unable to
negotiate with creditors because such negations would be impracticable;
or (iv) must reasonably believe that a creditor may attempt to obtain a
preferential transfer under § 547 of the Code.
2
Definition of Municipality
• A “municipality” is defined as either a “political subdivision,” a
“public agency,” or an “instrumentality of a state” and does not
include states, the District of Columbia or any territories of the
United States.
• The Bankruptcy Code does not further define any of these terms
and the case law on the topic is sparse. Thus, what actually
constitutes a municipality is “far from clear.”
• That being said, cities, towns, villages, special districts, school
districts, counties, public authorities, public hospitals, and
publicly owned airports are generally considered
“municipalities” for purposes of the Bankruptcy Code.
3
Specific Authorization Under State Law
• Prior to the Bankruptcy Reform Act of 1994, under section
109(c)(2), municipalities were required only to be generally
authorized to be a debtor under Chapter 9 by State law.
–
According to the majority view at the time, this meant that
municipalities could file under Chapter 9 so long as a state gave “some
indication” that the municipality had that power.
• In 1994, Congress amended section 109(c)(2), requiring that
municipalities be specifically authorized to file under Chapter 9.
– 14 states specifically, and unconditionally, authorize municipal
bankruptcies.
– 11 states provide conditional or limited authorization.
– 1 state prohibits filing in all circumstances.
– Remaining states do not have any specific authorization for municipal
bankruptcies.
4
Insolvency Requirement
• The insolvency requirement is particular to Chapter 9, and is one
major factor which may discourage or stand in the way of many
municipalities seeking bankruptcy relief.
• A municipality is considered “insolvent” when it is “generally not
paying its debts as they become due” or “unable to pay its debts
as they become due.”
5
Constitutional Issues
• The Tenth Amendment to the U.S. Constitution states that “[t]he
powers not delegated to the United States by the Constitution,
nor prohibited by it to the States, are reserved to the States
respectively, or to the people,” U.S. CONST. AMEND. X.
– The interest of protecting state sovereignty under the Tenth Amendment
limits the degree to which a federal bankruptcy court can intrude into
municipal and state governance.
– Generally agreed that these constitutional issues have been adequately
addressed in Chapter 9.
6
Constitutional Tensions Recognized and
Addressed in Chapter 9
• Only municipalities that are specifically authorized by a state can file
for bankruptcy.
• Involuntary cases are not permitted under Chapter 9 because to do so
“may constitute an invasion of State sovereignty contrary to the tenth
amendment.” House Report No. 95-595, 95th Cong., 1st Sess. 321
(1977); Senate Report No. 95-989, 95th Cong., 2d Sess. 33 (1978).
• Section 903 of the Bankruptcy Code provides that Chapter 9 “does not
limit or impair the power of a State to control, by legislation or
otherwise, a municipality of or in such State in the exercise of political
or governmental powers of such municipality, including expenditures
for such exercise.”
• Section 904 sets forth limitations on the bankruptcy court’s power in
the administration of a case commenced under Chapter 9.
• Section 941 provides that the Debtor has the exclusive right to
propose a plan for adjustment of debts.
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Constitutionality of Specific Actions Taken in
Chapter 9
• Caselaw indicates that by authorizing municipalities to file for
bankruptcy, states also authorize municipalities not to comply
with certain state laws.
– See, e.g., In re City of Columbia Falls, Montana, Special Improvement
District No. 25, 143 B.R. 750, 759 (Bankr. D. Mont. 1992) (allowing
municipality not to comply with state law which required it to fund a
revolving fund until all bonds and interests were fully paid and
discharged)
• Rejection of Contractual Obligations
– The Bankruptcy Code authorizes a debtor to reject executory contracts,
such as collective bargaining agreements, in bankruptcy.
– Questions have arisen with regard to whether bankrupt municipalities
must comply with state law provisions governing these contracts.
8
Overview of Chapter 9
• Chapter 9 case is commenced by the voluntary filing of a petition
by a municipality.
– The body that has the authority under state law to act for the
municipality at issue, also has the authority to file the Chapter 9 petition
(assuming, that state law otherwise specifically authorizes the entity to
file).
• Objections to filing
– Section 921(c) of the Bankruptcy Code permits objections to a municipaldebtor’s Chapter 9 petition. See 11 U.S.C. § 921(c).
– Pursuant to that section, the court may dismiss the petition, after notice
and a hearing, if the debtor did not file the petition in good faith or if the
debtor failed to otherwise meet the requirements of Chapter 9 discussed
above.
9
Overview of Chapter 9 – Cont’d
• The automatic stay is applicable in Chapter 9.
– Automatic stay protects not only the debtor itself, but also any “officer or
inhabitant of the debtor” and precludes the “enforcement of a lien on or
arising out of taxes or assessments owed to the debtor.”
• Due to the restrictions placed on bankruptcy courts by sections
903 and 904, municipalities are given broad powers to operate
as usual while functioning under Chapter 9.
– “The municipal debtor has broad powers to use its property, raise taxes,
and make expenditures as it sees fit.” See 6A WEST'S FED. FORMS,
Bankruptcy Courts § 10251 (4th ed. 2010).
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Overview of Chapter 9 – Cont’d
• Under Chapter 9, a municipal debtor has the exclusive right to
file a plan for the adjustment of its debts.
• Section 941 assumes that in the ordinary case, a plan of
adjustment will be filed with the petition.
– Assumption grew out of earlier versions of Chapter 9 which required the
plan to be filed at that time.
– If plan is not filed with the petition, the court is free to set the time for its
filing a plan either on its own motion on the request of the petitioner,
though due to the debtor’s exclusive right to propose a plan, most agree
that the court should not be overly demanding in fixing a short time
period
11
Overview of Chapter 9 – Cont’d
• Under section 943(b), a court must confirm a debtor’s plan of
adjustment if
– the plan complies with the provisions of Chapter 9 (and other provisions
of the Bankruptcy Code which are incorporated into Chapter 9);
– all amounts owed for expenses incurred during the case, or incident to
the plan, have been fully disclosed and are reasonable;
– the debtor is not prohibited by law from taking any action necessary to
carry out the plan;
– the plan provides for payment in full of administrative claims, except to
the extent that the holders of such claims agree to different treatment;
– The regulatory and/or electoral approval necessary under applicable nonbankruptcy law in order to carry out the plan has been obtained; and
– the plan is in the best interests of creditors and is feasible.
12
Benefits of a Chapter 9 Filing
• Power to amend or terminate collective bargaining agreements
and pensions
• Plan of adjustment binding on all creditors; cram-down powers
• Automatic Stay
• A single, known forum and procedures
• Familiarity and experience of bankruptcy courts in dealing with
similar issues
• Leverage in negotiations with creditor constituencies
• Way to force politically unpopular decisions
• Avoid legislative process
13
Limitations of a Chapter 9 Filing
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•
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Limited number of municipalities authorized to file
Impact on credit markets
Cost
Time
Distraction
Stigma
Lack of Precedent
14
Alternatives to a Chapter 9 Filing
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•
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•
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Raise taxes and cut spending
Issue more debt; privatize assets and services
Negotiate pay cuts and higher benefit contributions from unions
Legislation to curtail public-employee bargaining rights
Federal bailout
15