Municipal debt adjustment under the bankruptcy court.

• Author: Kupetz, David S.

The rights and powers of the debtor, the state, the court, and the creditors in a chapter 9 case in bankruptcy court.

Chapter 9 of the Bankruptcy Code (the "Code") provides a mechanism for eligible governmental entities to restructure debt. Chapter 9 is designed to enable a financially distressed municipality to continue to provide essential services to residents while working out a plan to adjust its debts. The general policy considerations underlying chapter 9 are the same as those in chapter 11 bankruptcy reorganization for nongovernmental entities: to allow the debtor a breathing spell from debt collection efforts and an opportunity to establish a repayment plan with creditors. However, municipal bankruptcy is unlike bankruptcy reorganization for individuals, partnerships, or private corporations. In fact, application of the term "bankruptcy" to chapter 9 is a misnomer.

The primary differences between chapter 9 and chapter 11 of the Code are the result of the constitutional mandate of the Tenth Amendment to the United States Constitution guaranteeing state sovereignty. Congress has the power to establish uniform laws on the subject of bankruptcies throughout the United States. Moreover, the Constitution prohibits the states from passing any law that impairs the obligation of contracts. Accordingly, only federal law can provide the type of relief afforded by chapter 9. Chapter 9 seeks to reconcile the constitutional requirements guaranteeing state sovereignty and prohibiting impairment of contracts by the states by arming the debtor with an arsenal of bankruptcy powers to enable it to achieve financial rehabilitation with almost none of the corresponding restrictions and duties which are imposed on a chapter 11 debtor.

Resort to chapter 9 has been infrequent, and, until recently, public awareness of chapter 9's existence has been limited. For example, the first chapter 9 case in the Central District of California was filed by the Ventura Port District in August 1993. The recent chapter 9 filings by Orange County, California, and the Orange County Investment Pools have undoubtedly heightened awareness of chapter 9. This awareness, however, does not necessarily include an understanding of the differences between chapter 9 and bankruptcy under other chapters of the Code.

Eligibility

Access to protection under chapter 9 is limited. Only entities which meet the specific requirements of the Code may qualify for relief under chapter 9. The first requirement is that only a "municipality" is eligible for chapter 9 relief. The Code defines a municipality as a political subdivision or public agency or instrumentality of a state; however, the terms political subdivision, public agency, and instrumentality of a state are not defined in the Code. Courts have held that a public agency or authority is a municipality if it is subject to control by public authority, state or local.

Second, a municipality's access to chapter 9 protection is conditioned upon specific state authorization. The debtor must be specifically authorized, in its capacity as a municipality or by name, to seek relief under chapter 9, or by a governmental officer or organization empowered by...