Chapter 17 Restructuring a Municipality under Chapter 9

• Jurisdiction: United States

17. Restructuring a Municipality under Chapter 9

Written by:

Francisco Vazquez

Chadbourne & Parke LLP; New York

Eric Daucher

Chadbourne & Parke LLP; New York

Most young and new bankruptcy lawyers understand that the U.S. Bankruptcy Code provides certain procedures for individuals and corporations to liquidate their assets under chapter 7 or reorganize under either chapter 11 or chapter 13. Some may also be aware that chapter 12 provides for the reorganization of a family farmer or a fisherman. However, it may come as a surprise to many young bankruptcy lawyers that the Code also addresses the restructuring of a municipality's debts. Given the challenging economic conditions that have pushed the finances of many municipalities to the breaking point, young lawyers may wish to become more familiar with chapter 9.

In enacting the Bankruptcy Code, Congress foresaw that a financially distressed munici-pality might need to reorganize its debts through a court procedure; hence, a municipality may be a debtor pursuant to § 109(a). Congress, however, understood that a municipality may have different needs than similarly distressed individuals or corporate entities, not to mention different rights and obligations. Accordingly, Congress did not rely on chapter 7 or 11 to provide relief for municipalities but instead created chapter 9.

In designing chapter 9, Congress created a special procedure pursuant to which a financially distressed municipality may restructure its debts through a plan approved by creditors and confirmed by a bankruptcy court. This article provides a brief primer on chapter 9 and highlights some of the areas where the rules governing a municipality's bankruptcy depart from the rules applicable to more typical bankruptcy cases.

A. Eligibility Requirements

Section 109(c) sets forth the eligibility requirements for becoming a debtor under chapter 9. In particular, an entity may be eligible to be a debtor under chapter 9 only if it is (1) a municipality, (2) authorized to be a debtor under chapter 9 by state law, (3) insolvent and (4) willing to adjust its debts by implementing a plan. Additionally, a municipal debtor must satisfy a fifth requirement by demonstrating one of the following: (1) it has obtained the agreement of creditors holding at least a majority in amount of the claims of each class that will be impaired under the plan; (2) it has negotiated in good faith with creditors but has failed to obtain the agreement of creditors holding at least a majority in amount of the claims of each class that will be impaired under the plan; (3) it is unable to negotiate with creditors because such negotiation is impracticable; or (4) it reasonably believes that a creditor may try to be the recipient of a transfer (e.g., payment) that would otherwise be avoidable as a preference.

Given that the fifth requirement is generally regarded as merely supplementing and reinforcing the fourth requirement (i.e., the debtor is willing to adjust its debts by implementing a plan),¹ this point will not be expanded upon within this article. The following briefly describes each of the first four eligibility requirements, all of which must be satisfied in order to qualify for relief under chapter 9 of the Bankruptcy Code.

1. Municipality

The Code defines a municipality as a "political subdivision or public agency or instrumentality of a State."² In general, a political subdivision of a state includes a county, parish, city, town, village, borough or township.³ A public agency or instrumentality generally refers to an entity that is organized for the purpose of constructing, maintaining and operating revenue-producing enterprises.⁴ The source of the revenue may be taxes, assessments or income-producing property.⁵ School districts, hospital districts, highway authorities and gas authorities are examples of public agencies or instrumentalities.⁶

2. Authority to Be a Debtor

In order to be eligible for relief under chapter 9, a municipality must be specifically authorized to file for bankruptcy by its state. Such authorization may come from either state law or any authority appropriately empowered by state law.⁷ Approximately half of the states explicitly allow their municipalities to become chapter 9 debtors, while the remainder either offer little guidance or explicitly ban access to bankruptcy relief. Certain states, such as California, are currently contemplating legislation that would sharply curtail access to chapter 9.⁸

3. Insolvent

Section 101 defines "insolvent" differently based upon the nature of the relevant entity.⁹ Under the Bankruptcy Code, a municipality is "insolvent," if it is:

1. generally not paying its debts as they become due, unless such debts are the subject of a bona fide dispute; or
2. unable to pay its debts as they become due.¹⁰

Under the first formulation, a court would rely on evidence that the municipality is not paying its debts rather than on budgets that reflect a cash flow shortfall.¹¹ In general, nonpayment of undisputed amounts that a municipality can pay, nonpayment...