Chapter 9 Bankruptcy - Municipality Bankruptcy

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).

Purpose of Municipal Bankruptcy

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.  Reorganization of the debts of a municipality is typically accomplished
either by extending debt maturities, reducing the amount of principal or interest,
or refinancing the debt by obtaining a new loan.

Although similar to other Chapters in some respects, Chapter 9 is significantly
different in that there is no provision in the law for liquidation of the assets of the
municipality and distribution of the proceeds to creditors. Such a liquidation or
dissolution would undoubtedly violate the Tenth Amendment to the Constitution
and the reservation to the states of sovereignty over their internal affairs.
Indeed, due to the severe limitations placed upon the power of the bankruptcy
court in Chapter 9 cases (required by the Tenth Amendment and the Supreme
Court's decisions in cases upholding municipal bankruptcy legislation), the
bankruptcy court generally is not as active in managing a municipal bankruptcy
case as it is in corporate reorganizations under Chapter 11. The functions of the
bankruptcy court in Chapter 9 cases are generally limited to approving the
petition (if the debtor is eligible), confirming a plan of debt adjustment, and
ensuring implementation of the plan. As a practical matter, however, the
municipality may consent to have the court exercise jurisdiction in many of the
traditional areas of court oversight in bankruptcy, in order to obtain the
protection of court orders and eliminate the need for multiple forums to decide
issues.

Eligibility

Only a "municipality" may file for relief under Chapter 9. 11 U.S.C. § 109(c). The
term "municipality" is defined in the Bankruptcy Code as a "political subdivision or
public agency or instrumentality of a State." 11 U.S.C. § 101(40). The definition
is broad enough to include cities, counties, townships, school districts, and public
improvement districts. It also includes revenue-producing bodies that provide
services which are paid for by users rather than by general taxes, such as bridge
authorities, highway authorities, and gas authorities.

Section 109(c) of the Bankruptcy Codes sets forth four additional eligibility
requirements for Chapter 9:

1) The municipality must be specifically authorized to be a debtor by State law or
by a governmental officer or organization empowered by State law to authorize
the municipality to be a debtor.

2) The municipality must be insolvent, as defined in 11 U.S.C. § 101(32)(C).

3)  The municipality must desire to effect a plan to adjust its debts.

4) The municipality must either:

A)  Obtain the agreement of creditors holding at least a majority in amount of the
claims of each class that the debtor intends to impair under a plan in a case
under Chapter 9.

B)  Negotiate in good faith with creditors and fail to obtain the agreement of
creditors holding at least a majority in amount of the claims of each class that the
debtor intends to impair under a plan.

C)  Be unable to negotiate with creditors because such negotiation is
impracticable.

D)  Reasonably believe that a creditor may attempt to obtain a preference
commencement of the case.

Municipalities must voluntarily seek protection under the Bankruptcy Code. 11 U.
S.C. §§ 303, 901(a). They may file a petition only under Chapter 9.  A case
under Chapter 9 concerning an unincorporated tax or special assessment district
that does not have its own officials is commenced by the filing of a voluntary
"petition under this chapter by such district's governing authority or the board or
body having authority to levy taxes or assessments to meet the obligations of
such district." 11 U.S.C. § 921(a).

A municipal debtor must file a list of creditors. 11 U.S.C. § 924. Normally, the
debtor files the list of creditors with the petition.  However, the bankruptcy court
has discretion to fix a different time if the debtor is unable to prepare the list of
creditors in the form and with the detail required by the Bankruptcy Rules at the
time of filing.

Assignment of Case to a Bankruptcy Judge

One significant difference between Chapter 9 cases and cases filed under other
Chapters is that the clerk of court does not automatically assign the case to a
particular judge.  "The chief judge of the court of appeals for the circuit
embracing the district in which the case is commenced [designates] the
bankruptcy judge to conduct the case." 11 U.S.C. § 921(b).  This provision was
designed to remove politics from the issue of which judge will preside over the
Chapter 9 case of a major municipality and to ensure that a municipal case will
be handled by a judge who has the time and capability of doing so.

Notice of Case - Objections - Order for Relief

The Bankruptcy Code requires that notice be given of the commencement of the
case and the order for relief. 11 U.S.C. § 923. The Bankruptcy Rules provide
that the clerk, or such other person as the court may direct, is to give notice.  
The notice must also be published "at least once a week for three successive
weeks in at least one newspaper of general circulation published within the
district in which the case is commenced, and in such other newspaper having a
general circulation among bond dealers and bondholders as the court
designates." 11 U.S.C. § 923. The court typically enters an order designating
who is to give and receive notice by mail and identifying the newspapers in which
the additional notice is to be published.

The Bankruptcy Code permits objections to the petition. 11 U.S.C. § 921(c).
Typically, objections concern issues like whether negotiations have been
conducted in good faith, whether the state has authorized the municipality to file,
and whether the petition was filed in good faith.  If an objection to the petition is
filed, the court must hold a hearing on the objection.  The court may dismiss a
petition if it determines that the debtor did not file the petition in good faith or that
the petition does not meet the requirements of Title 11.

If the petition is not dismissed upon an objection, the Bankruptcy Code requires
the court to order relief, allowing the case to proceed under Chapter 9. 11 U.S.C.
§ 921(d).

Automatic Stay

The automatic stay of section 362 of the Bankruptcy Code is applicable in
Chapter 9 cases. 11 U.S.C. §§ 362(a), 901(a).  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. 11 U.S.C. § 922(a). Thus, the stay
prohibits a creditor from bringing legal action against an officer of a municipality
on account of a pre-petition debt. It also prohibits a creditor from bringing an
action against an inhabitant of the debtor to enforce a lien on or arising out of
taxes or assessments owed to the debtor.

Section 922(d) of Title 11 limits the applicability of the stay. Under that particular
section, a Chapter 9 petition does not operate to stay application of pledged
special revenues to payment of indebtedness secured by such revenues. Thus,
an indenture trustee or other paying agent may apply pledged funds to
payments coming due or distribute the pledged funds to bondholders without
violating the automatic stay.

Proofs of Claim

In a Chapter 9 case, the court fixes the time within which proofs of claim or
interest may be filed.  Many creditors may not be required to file a proof of claim
in a Chapter 9 case.  For example, a proof of claim is deemed filed if it appears
on the list of creditors filed by the debtor, unless the debt is listed as disputed,
contingent, or unliquidated. 11 U.S.C. § 925. Thus, a creditor must file a proof of
claim if the creditor's claim appears on the list of creditors as disputed,
contingent, or unliquidated.

Court's Limited Power

Sections 903 and 904 of the Bankruptcy Code are designed to recognize the
court's limited power over operations of the debtor.

Section 904 limits the power of the bankruptcy court to "interfere with –

(1)  Any of the political or governmental powers of the debtor.

(2)  Any of the property or revenues of the debtor.

(3)  The debtor's use or enjoyment of any income-producing property" unless the
debtor consents or the plan so provides.

The provision 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. In addition, the court cannot appoint a Trustee (except for limited
purposes specified in 11 U.S.C. § 926(a)) and cannot convert the case to a
liquidation proceeding.

The court also cannot interfere with the operations of the debtor or with the
debtor's use of its property and revenues. This is due, at least in part, to the fact
that in a Chapter 9 case, there is no property of the estate and thus no estate to
administer. 11 U.S.C. § 902(1).  Moreover, a Chapter 9 debtor may employ
professionals without court approval, and the only court review of fees is in the
context of plan confirmation, when the court determines the reasonableness of
the fees.

The restrictions imposed by 11 U.S.C. § 904 are necessary to ensure the
constitutionality of Chapter 9 and to avoid the possibility that the court might
substitute its control over the political or governmental affairs or property of the
debtor for that of the state and the elected officials of the municipality.

Similarly, 11 U.S.C. § 903 states 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 the political or governmental powers of the
municipality, including expenditures for such exercise," with two exceptions – a
state law prescribing a method of composition of municipal debt does not bind
any non-consenting creditor, nor does any judgment entered under such state
law bind a nonconsenting creditor.

Role of the US Trustee/Bankruptcy Administrator

In a Chapter 9 case, the role of the US Trustee (or the Bankruptcy Administrator
in North Carolina or Alabama) is typically more limited than in Chapter 11 cases.
Although the US Trustee appoints a creditors' committee, the US Trustee does
not examine the debtor at a meeting of creditors (there is no meeting of
creditors), does not have the authority to move for appointment of a trustee or
examiner or for conversion of the case, and does not supervise the
administration of the case.  Further, the US Trustee does not monitor the
financial operations of the debtor or review the fees of professionals retained in
the case.

Role of Creditors

The role of creditors is more limited in Chapter 9 than in other cases. There is no
first meeting of creditors, and creditors may not propose competing plans. If
certain requirements are met, the debtor's plan is binding on dissenting
creditors. The Chapter 9 debtor has more freedom to operate without court-
imposed restrictions.

In each Chapter 9 case, however, there is a creditors' committee that has powers
and duties that are very similar to those of a committee in a Chapter 11 case.
These powers and duties include selecting and authorizing the employment of
one or more attorneys, accountants, or other agents to represent the committee;
consulting with the debtor concerning administration of the case; investigating
the acts, conduct, assets, liabilities, and financial condition of the debtor;
participating in the formulation of a plan; and performing such other services as
are in the interest of those represented. 11 U.S.C. §§ 901(a), 1103.

Intervention/Right of Others to be Heard

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 Rules provide that "the Secretary of the Treasury of the United
States may, or if requested by the court shall, intervene in a Chapter 9 case."  
Further, "Representatives of the state in which the debtor is located may
intervene in a Chapter 9 case."  In addition, 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.
11 U.S.C. §§ 901(a), 1109.  Parties in interest include municipal employees, local
residents, non-resident owners of real property, special tax payers, securities
firms, and local banks.

Powers of the Debtor

Due to statutory limitations placed upon the power of the court in a municipal
debt adjustment proceeding, the court is far less involved in the conduct of a
municipal bankruptcy case (and in the operation of the municipal entity) while the
debtor's financial affairs are undergoing reorganization. The municipal debtor
has broad powers to use its property, raise taxes, and make expenditures as it
sees fit. It is also permitted to adjust burdensome non-debt contractual
relationships under the power to reject executory contracts and unexpired
leases, subject to court approval, and it has the same avoiding powers as other
debtors. Municipalities may also reject collective bargaining agreements and
retiree benefit plans without going through the usual procedures required in
Chapter 11 cases.

A municipality has authority to borrow money during a Chapter 9 case as an
administrative expense. 11 U.S.C. §§ 364, 901(a).  This ability is important to the
survival of a municipality that has exhausted all other resources. A Chapter 9
municipality has the same power to obtain credit as it does outside of
bankruptcy. The court does not have supervisory authority over the amount of
debt the municipality incurs in its operation. The municipality may employ
professionals without court approval, and the professional fees incurred are
reviewed only within the context of plan confirmation.

Dismissal

As previously noted, the 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. 11 U.S.C. § 921(c). The
court may also dismiss the petition for cause, such as for lack of prosecution,
unreasonable delay by the debtor that is prejudicial to creditors, failure to
propose or confirm a plan within the time fixed by the court, material default by
the debtor under a confirmed plan, or termination of a confirmed plan by reason
of the occurrence of a condition specified in the plan. 11 U.S.C. § 930.

Treatment of Bondholders and Other Lenders

Different types of bonds receive different treatment in municipal bankruptcy
cases. 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. 11 U.S.C. § 928. 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 11 U.S.C. § 928 [§ 922(d) erroneously
refers to § 927 rather than § 928], which insures that a lien of special revenues
is subordinate to the operating expenses of the project or system from which the
revenues are derived. 11 U.S.C. § 922(d).

Bondholders generally do not have to worry about the threat of preference
liability with respect to any prepetition payments on account of bonds or notes,
whether special revenue or general obligations.  Any transfer of the municipal
debtor's property to a noteholder or bondholder on account of a note or bond
cannot be avoided as a preference, i.e., as an unauthorized payment to a
creditor made while the debtor was insolvent. 11 U.S.C. § 926(b).

Plan for Adjustment of Debts

The Bankruptcy Code provides that the debtor must file a plan. 11 U.S.C. § 941.
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's pronouncements
in Ashton, 298 U.S. at 528, and Bekins, 304 U.S. at 51, 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.

Confirmation Standards

The standards for plan confirmation in Chapter 9 cases are a combination of the
statutory requirements of 11 U.S.C. § 943(b) and those portions of 11 U.S.C. §
1129 (the Chapter 11 confirmation standards) made applicable by 11 U.S.C. §
901(a). Section 943(b) lists seven general conditions required for confirmation of
a plan. The court must confirm a plan if the following conditions are met:

1.  The plan complies with the provisions of Title 11 made applicable by sections
103(e) and 901.

2.  The plan complies with the provisions of Chapter 9.

3.  All amounts to be paid by the debtor or by any person for services or
expenses in the case or incident to the plan have been fully disclosed and are
reasonable.

4. The debtor is not prohibited by law from taking any action necessary to carry
out the plan.

5.  Except to the extent that the holder of a particular claim has agreed to a
different treatment of such claim, the plan provides that on the effective date of
the plan, each holder of a claim of a kind specified in section 507(a)(1) will
receive on account of such claim cash equal to the allowed amount of such claim.

6.  Any regulatory or electoral approval necessary under applicable non-
bankruptcy law in order to carry out any provision of the plan has been obtained,
or such provision is expressly conditioned on such approval

7.  The plan is in the best interests of creditors and is feasible.
11 U.S.C. § 943(b).

Section 943(b)(1) requires as a condition for confirmation that the plan comply
with the provisions of the Bankruptcy Code made applicable by sections 103(e)
and 901(a) of the Bankruptcy Code. The most important of these for purposes of
confirming a plan are those provisions of 11 U.S.C. § 1129 (i.e., § 1129(a)(2), (a)
(3), (a)(6), (a)(8), (a)(10)) that are made applicable by 11 U.S.C. § 901(a).
Section 1129(a)(8) requires, as a condition to confirmation, that the plan has
been accepted by each class of claims or interests impaired under the plan.
Therefore, if the plan proposes treatment for a class of creditors such that the
class is impaired (i.e., the creditor's legal, equitable, or contractual rights are
altered), then that class's acceptance is required. If the class is not impaired,
then acceptance by that class is not required as a condition to confirmation.
Under 11 U.S.C. § 1129(a)(10), the court may confirm the plan only if, should
any class of claims be impaired under the plan, at least one impaired class has
accepted the plan. If only one impaired class of creditors consents to the plan,
plan confirmation is still possible under the "cram down" provisions of 11 U.S.C. §
1129(b). Under "cram down," if all other requirements are met except the § 1129
(a)(8) requirement that all classes either be unimpaired or have accepted the
plan, then the plan is confirmable if it does not discriminate unfairly and is fair
and equitable.

The requirement that the plan be in the "best interests of creditors" means
something different under Chapter 9 than under chapter 11. Under Chapter 11,
a plan is said to be in the "best interest of creditors" if creditors would receive as
much under the plan as they would if the debtor were liquidated. 11 U.S.C. §
1129(a)(7)(A)(ii).  Obviously, a different interpretation is needed in Chapter 9
cases because a municipality's assets cannot be liquidated to pay creditors. In
the Chapter 9 context, the "best interests of creditors" test has generally been
interpreted to mean that the plan must be better than other alternatives available
to the creditors.  Generally speaking, the alternative to Chapter 9 is dismissal of
the case, permitting every creditor to fend for itself.  An interpretation of the "
best interests of creditors" test to require that the municipality devote all
resources available to the repayment of creditors would appear to exceed the
standard. The courts generally apply the test to require a reasonable effort by
the municipal debtor that is a better alternative for its creditors than dismissal of
the case.

Parties in interest may object to confirmation, including creditors whose claims
are affected by the plan, an organization of employees of the debtor, and other
tax payers, as well as the Securities and Exchange Commission. 11 U.S.C. §§ 901
(a), 943, 1109, 1128(b).

Discharge

A municipal debtor receives a discharge in a Chapter 9 case after:

(1) confirmation of the plan.

(2) deposit by the debtor of any consideration to be distributed under the plan
with the disbursing agent appointed by the court.

(3) a determination by the court that securities deposited with the disbursing
agent will constitute valid legal obligations of the debtor and that any provision
made to pay or secure payment of such obligations is valid. 11 U.S.C. § 944(b).

Thus, the discharge is conditioned not only upon confirmation, but also upon
deposit of the consideration to be distributed under the plan and a court
determination of the validity of securities to be issued.

There are two exceptions to the discharge in Chapter 9 cases. The first is for any
debt excepted from discharge by the plan or order confirming the plan. The
second is for a debt owed to an entity that, before confirmation of the plan, had
neither notice nor actual knowledge of the case. 11 U.S.C. § 944(c).

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. 11 U.S.C. §§ 901(a), 1144.


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