THINGS YOU MAY HAVE FORGOTTEN ABOUT CHAPTER 9 MUNICIPAL RESTRUCTURINGS
Many of us in the restructuring industry worked on Chapter 9 matters in the late 80’s and early to mid-90’s. Some were involved in large, exotic matters like Orange County, California. Most of us earned our stripes in repairing the state of affairs for numerous, smaller municipal improvement districts, levy improvement districts, road districts, and the like, both in and out of court. Recently, the City of Detroit caught a lot of attention in what appears to have been a successful restructuring. (As with most of these matters, the real proof will be in the performance over the next decade or two.) But in the interval between the mid-90’s and now, despite the City of Detroit case, many hard learned lessons might have become obscured. Just to refresh memories for old-timers and to highlight for newcomers some (but by no means all) of the key considerations in most municipal restructurings, consider the following:
- Many types of entities created as sub-units of the various States, Counties or Cities may fall within the definition of “municipality” (see §§ 101(27), (32)(C), and (40) of the Bankruptcy Code). The array of eligible candidates might surprise you, but an entity eligible for Chapter 9 is, by definition, ineligible for restructuring under Chapter 11 and can never (or almost never, giving room for the human capacity to defy boundaries) be liquidated under Chapter 7; (The Commonwealth of Puerto Rico, by example, is not presently eligible for either Chapter 9 or 11.)
- Some provisions of Chapter 11 are expressly adopted by and into Chapter 9 by reference. Others are not. Knowing which are omitted and the resulting nuances are critical to success in the advanced planning for and the outcome of a Chapter 9 case.
- Many of these municipal units are created specifically to issue public debt – often tax exempt bonds – to accomplish specific projects of public works, utility improvements, road and highway construction, etc. Others may be designed for public or public/private developments such as urban development districts, hotel districts, museum districts or public hospital districts.
- In the next few years, increased focus might be on municipal units that are healthcare oriented. They are just like for-profit healthcare restructurings, except when they’re not. Insert smiley face emoticon if you are so inclined. The differences may be critical.
- If conventional wisdom wants to dictate that a Chapter 11 corporate reorganization in Court should be pre-packaged or pre-arranged, or that out of court arrangements should be tied up in a nice consensual bow as early as possible, this same wisdom applies doubly in the case of a financially troubled municipal unit. There are usually only two exits from a Chapter 9 filing – confirmation of a plan of adjustment or dismissal. To reach the happy ending of plan confirmation, key creditors and creditor classes must agree, just as in Chapter 11.
- To underscore the prior point, asset sales are most often simply not possible in the municipal context. True, the City of Detroit sold or considered selling sundry non-governmental assets that had been accumulated over the years of its storied history. But a levy improvement district cannot sell its levy. In some instances, a hospital district might be able to sell, lease or farm out its hospital or healthcare operations, but in some jurisdiction this could be impeded by State law.
- Many governmental units have taxing powers, although this power may be limited by law. In a default context, State law may dictate that a taxing authority must then levy the maximum tax legally permitted until the defaults are cured or the defaulted debt is paid. This is one of the factors that may motivate an actual Chapter 9 filing as opposed to an out of court restructuring.
- In some instances, levying the maximum permitted tax may put the municipal unit in a “death spiral,” where taxpayers flee the jurisdiction. Avoid this if you can. The specter of the death spiral can in some cases, though, motivate creditors to accept a compromise.
- Creating separate classes of creditors in a proposed Chapter 9 plan in an attempt to invoke or threaten the invocation of cramdown confirmation can be more difficult in a Chapter 9 case than in Chapter 11. Some States do not permit or welcome public bonds that are subordinate or different in priority to other bond issues or to ordinary unsecured debt. A bankruptcy practitioner trying to plan through these issues will need a qualified public bond lawyer either in the same firm or associated as co-counsel. The inverse is also true. As they say, “Fools rush in where Angels fear to tread.”
- Yes, cramdown, debt reduction and discharge, contract rejection, and several other magic powers of bankruptcy can be statutorily available in Chapter 9. Successfully using those powers might be a different question.
- In Chapter 9, you may encounter big obstacles in trying to amend, restate, payoff, “refund” or even tweak the terms of pre-petition bond issuances. Some Bankruptcy Code provisions can, like scissors, cut contractual or State law paper, but some State law requirements in the area of public finance can, like rocks, break scissors. In most instances, the restructured debt coming out of your Chapter 9 case or out of court workout will need to still be tax exempt. The Bankruptcy Court will likely have no power to order the Attorney General or other officer of the State to sign off on the tax exempt status. Once again, obtaining and following sound guidance from your public bond co-counsel on this score is critical to any success.
- In lieu of Chapter 9, Cities and Counties can, in theory, assume the debts of a troubled municipal unit, with that unit dissolving into the City or County. Just don’t ever really count on that happening in your lifetime or mine.
- And last but not least, look before you leap. To file and maintain a Chapter 9 case, the municipal unit must be “insolvent” within the Bankruptcy Code’s definition. No insolvency, no case. If the issue is a close call, an out of court resolution, even with warts, may be preferable. Or, before jumping in the Chapter 9 pool, consider a prepackaged vote of creditors as a means for potentially avoiding a filing that draws fierce, unexpected opposition on this or other points.
For questions about Chapter 9 municipal restructurings, please contact Mike Sutherland or Lisa Lucas.