5 Things to Know About: Chapter 9 Bankruptcy

5 Things to Know About: Chapter 9

Spirit of Detroit

Most lawyers have a passing familiarity with bankruptcies filed under Chapters 7 and 13 (individuals) and Chapter 11 (businesses) of the U.S. Bankruptcy Code. And something about Chapter 12 and farmers rings a bell. But what about Chapter 9?

As Detroit begins its long slog through the bankruptcy process, here are five things to know about this unique provision of the federal bankruptcy law.

A little history

Not surprisingly, Chapter 9 was created during the Great Depression, enacted as part of a bankruptcy legislation package in 1934. However, the U.S. Supreme Court found that the federal law constituted an illegal interference with the sovereignty of states and struck it down in 1936’s Ashton v. Cameron County Water Improvement Dist. No. 1.

The next year, Congress took another stab at the concept with the Municipal Bankruptcy Act, which the justices upheld in 1938 (United States v. Bekins). In the 60 years since, Chapter 9 has been used sparingly, with the Administrative Office of the U.S. Courts estimating that less than 500 petitions have been filed.

Recently, the numbers have increased, with 217 petitions filed between 1991 and 2012, and with 20 filed in fiscal year 2012.

 Not for every city

One of the reasons Chapter 9 remains a little-used code provision are the tricky eligibility requirements. Pursuant to 11 U.S.C. § 101(40), “municipality” is defined as a “political subdivision or public agency or instrumentality of a State.”

The language makes for some interesting bedfellows, from cities and towns to school districts and bridge authorities. However, there are four additional requirements including insolvency (as defined by federal law) and a desire to affect a plan to adjust the debts.

A law passed last year by the Michigan Legislature satisfied another of the statute’s mandates, that the municipality must be “specifically authorized” to be a debtor by state law.

Finally, the municipality faces the challenge of obtaining the agreement of creditors holding at least 51 percent of the amount of claims or negotiating in good faith and failing to obtain such agreement.

 What makes it different

Unlike a discharge in Chapter 7 and Chapter 11 bankruptcies, Chapter 9 doesn’t allow for a liquidation of assets and payment to creditors. Instead, to avoid violating the Tenth Amendment, the filing essentially buys a municipality time to negotiate with creditors and lose some debt, typically by refinancing, obtaining new loans, extending the life of debt maturities or reducing interest or principal owed.

Because of federalism concerns, the bankruptcy court itself takes a more hands-off approach, typically limiting itself to approval of the petition filing, confirming the plan and some oversight of plan implementation.

Charles J. Tabb, a professor at the University of Illinois Law School, who literally wrote the book on bankruptcy (with textbooks like The Law of Bankruptcy and Bankruptcy Law: Principles, Policies & Practice, among other publications), explained that the focus is different in a Chapter 9 case. When a municipality files for bankruptcy, “there is an emphasis on reaching consensus, collaboration and negotiation,” he said.

 We’re #1!

With an estimated $20 billion in liabilities and 100,000 creditors, Detroit is now the largest entity to ever file for Chapter 9 protection, bumping Jefferson County, Ala., which filed in 2011 with roughly $4.2 billion in debt, to the number two spot. Two California locations are next on the list: Orange County, which listed $1.9 billion in debt when it filed in 1994 and the city of Stockton, which filed last year with a mere $1 billion in liabilities.

 Is it over yet?  

Another trademark of Chapter 9 petitions: length. Detroit residents should not hold their breath that the city will pass out of bankruptcy any time soon. As a reference point, it took the city of Stockton nine months just to be declared eligible to file its petition.

Tabb declined to hazard a guess as to the length of the Detroit bankruptcy process.

“The complexity boggles the mind,” he said. “The problem is that the city has to achieve a restructuring agreement amongst all the parties and in the meantime, go about business as usual.”

Unlike even a huge company, which can shut down, a city has to keep going, Tabb explained. “The city needs a fire department and a police department and somehow they have to find a fair amount of money to pay people in the interim while restructuring the debt.”

Other possible impediments to a speedy resolution: legal challenges from creditors (likely) and pushback from state bodies, which already occurred when a state court ruled last week that the state constitution prohibits the bankruptcy filing because it would affect public employee pensions.

Tuesday, July 23, 2013
BY: Correy E. Stephenson 

If you would like to comment on this story, email Correy E. Stephenson at correy.stephenson@thedolancompany.com.

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