A TALE OF ONE CITY, BANKRUPT
They were the worst of times.
POSTED: 2013-07-22 19:28:35
RECENT news about the City Detroit's chapter 9 bankruptcy filing puts in the news a seldom used chapter of the U.S. Bankruptcy Code. The chapter of the Bankruptcy Code providing for reorganization of municipalities (which includes cities and towns, as well as villages, counties, taxing districts, municipal utilities, and school districts).
THE first municipal bankruptcy legislation was enacted in 1934, during the Great Depression, when some local governments had large revenue shortfalls and were unable to pay their creditors. .Although Congress took care to draft the legislation so as not to interfere with the sovereign powers of the states guaranteed by the Tenth Amendment by the Constitution, the Supreme Court held the 1934 Act unconstitutional as an improper interference with the sovereignty of the states. Congress enacted a revised Municipal Bankruptcy Act in 1937 which passed constitutional muster. In the past 60 years since Congress established a federal mechanism for the resolution of municipal debts, there have been fewer than 500 municipal bankruptcy petitions filed. Although chapter 9 cases are rare, a filing by a large municipality such as the 1994 filing by Orange County, California, usually involves many millions of dollars of debt.
THE purpose of chapter 9 is to provide a financially-distressed municipality protection from its creditors, while it develops and negotiates a plan for adjusting its debts. Although similar to other chapters in some respects, chapter 9 is really very different. Only a "municipality" may file for relief under chapter 9. The term "municipality" is defined in the Bankruptcy Code as a "political subdivision or public agency or instrumentality of a State."
LIKE its other chapters, the Bankruptcy Code provides an automatic stay chapter 9 cases. The stay operates to stop all collection actions against the debtor and its property upon the filing of the petition. Additional automatic stay provisions are applicable in chapter 9 that prohibit actions against officers and inhabitants of the debtor if the action seeks to enforce a claim against the debtor. Thus, the stay prohibits a creditor from bringing a mandamus action against an officer (mayor, treasurer, et al.) of a municipality on account of a prepetition debt. Fortunately for the residents of the debtor, it also prohibits a creditor from bringing any action against inhabitants of the debtor to enforce any liens.
A bankruptcy court may dismiss a chapter 9 petition, after notice and a hearing, if it concludes the debtor did not file the petition in good faith or if the petition does not meet the requirements of chapter 9. The Bankruptcy Code limits the power of the bankruptcy court to interfere with any of the political or governmental powers of the debtor. The Bankruptcy Code makes it clear that the debtor's day-to-day activities are not subject to court approval and that the debtor may borrow money without court authority.
WHEN cities or counties file for relief under chapter 9, there may be a great deal of interest in the case from entities wanting to appear and be heard, the Bankruptcy Code permits the Securities and Exchange Commission to appear and be heard on any issue and gives parties in interest the right to appear and be heard on any issue in a case. Parties in interest include municipal employees, local residents, non-resident owners of real property, special tax payers, securities firms, and local banks and of course, representatives of the bond holders.
THE municipal debtor has broad powers to use its property, raise taxes, and make expenditures. Most importantly it is also permitted to adjust burdensome non-debt contractual relationships under the power to reject contracts. And a big power municipalities can assert in chapter 9 is rejecting collective bargaining agreements with municipal workers unions and retiree benefit plans.
THE Bankruptcy Code provides that the debtor must file a plan. The plan must be filed with the petition or at such later time as the court fixes. There is no provision in chapter 9 allowing creditors or other parties in interest to file a plan. This limitation is required by the Supreme Court, which interpreted the Tenth Amendment as requiring that a municipality be left in control of its governmental affairs during a chapter 9 case. Neither creditors nor the court may control the affairs of a municipality indirectly through the mechanism of proposing a plan of adjustment of the municipality's debts that would in effect determine the municipality's future tax and spending decisions. A municipality has authority to borrow money during a chapter 9 case as an administrative expense. This ability is important to the survival of a municipality that has exhausted all other resources.
DIFFERENT types of bonds receive different treatment in municipal bankruptcy cases. General obligation bonds, which are usually preferred by municipal bond investors, can take a back seat to revenue bonds in the chapter 9 scenario. General obligation bonds are treated as general debt in the chapter 9 case. The municipality is not required to make payments of either principal or interest on account of such bonds during the case. The obligations created by general obligation bonds are subject to negotiation and possible restructuring under the plan of adjustment. Special revenue bonds, by contrast, will continue to be secured and serviced during the pendency of the chapter 9 case through continuing application and payment of ongoing special revenues. Holders of special revenue bonds can expect to receive payment on such bonds during the chapter 9 case if special revenues are available. The application of pledged special revenues to indebtedness secured by such revenues is not stayed as long as the pledge is consistent with the Bankruptcy Code.
AT any time within 180 days after entry of the confirmation order, the court may, after notice and a hearing, revoke the order of confirmation if the order was procured by fraud.