Over the past several years, Chapter 9 of the United States Bankruptcy Code — the chapter under which municipalities may seek to reorganize and adjust their debts — has been the subject of unprecedented attention, both within the bankruptcy bar and among the public at large. This surge in interest is attributable to a number of high-profile Chapter 9 cases filed recently by cities, counties, and towns throughout the country, including the City of Detroit; Jefferson County, AL; the City of Central Falls, RI; the Cities of Vallejo, Stockton, and San Bernardino in California; and the Town of Mammoth Lakes, CA.
Chapter 9 Debtors
While Chapter 9 cases involving cities, counties, and towns get most of the attention, most of the municipalities that file for Chapter 9 are other types of governmental units. In fact, of the 14 Chapter 9 cases commenced since Detroit filed in July 2013, only one of those debtors — the City of San Bernardino — was a city, county, or town.
Who are these other types of municipal entities seeking relief under Chapter 9? Many are special purpose municipal entities whose mission is to provide a specific public service often performed by cities, counties, or towns and for which there generally are no private sector providers of such services. Like cities, counties, and towns, these entities are generally not susceptible to liquidation, either inside or outside of bankruptcy court, because of the central public functions they perform and the lack of any market for their assets. Examples of these types of entities include irrigation districts, water authorities, and sanitary or solid waste districts.
Other Chapter 9 debtors are municipal entities that provide services commonly provided by entities in the private sector and whose assets and operations may be saleable. These "public-private" debtors include community hospitals, health care districts and authorities, housing authorities, special purpose economic development authorities, and property owner improvement districts. Of the 14 cases filed since Detroit, six have been filed by municipally owned health care providers, such as community hospitals and health care authorities.
These "public-private" cases differ markedly from the typical city, county or town debtor Chapter 9, not only in terms of the amount and nature of the debt involved, but also in the types of issues that routinely arise in them. In city-county-and-town cases, the debts range from the millions to the billions of dollars, and generally consist of long-term bonded debt and pension obligations. The debt involved in most "public-private" Chapter 9s, on the other hand, generally consists of secured project-financing debt, capital leases, equipment loans, and trade debt, with the total amount of debt typically in the tens of millions or less.
Trade debt generally does not create significant issues in city-county-and-town cases, where the primary focus is usually on defaulted bond liabilities or underfunded employee obligations. To avoid disputes and interruption of necessary goods and services, debtors in city-county-and-town cases may simply pay pre-petition trade claims in the ordinary course even after they have filed for Chapter 9 pursuant to their rights under section 904 of the Bankruptcy Code. In a "public-private" Chapter 9 case, however, trade debt concerns are often very significant, as the debtor seeks to conserve its cash to facilitate its ongoing operations. In this respect, a "public-private" Chapter 9 more closely resembles an operating Chapter 11 case than a city-county-or-town Chapter 9. Perhaps because of the greater role trade creditors assume in public-private Chapter 9 cases, unsecured creditors committees are a more common fixture in those cases than in city-county-and-town cases.
Issues concerning the sale of assets arise more frequently in Chapter 9 cases involving "public-private" debtors than in city-county-and-town cases, as "public-private" debtors often use Chapter 9 as a means of selling their assets on a going concern basis. Again, in this respect, "public-private" Chapter 9 cases often look much like a Chapter 11 case, but with a notable exception. Although many if not most Chapter 11 sales are made by motion filed under section 363 of the Bankruptcy Code, that option is not available in municipal bankruptcy cases because section 363 is not incorporated into Chapter 9.
Without section 363 available, a Chapter 9 debtor is left to sell its assets in one of two ways. First, it can sell its assets in accordance with its general powers under applicable state law. A Chapter 9 debtor need not obtain bankruptcy court approval of a sale made within its state law rights, as section 904 of the Bankruptcy Code precludes a bankruptcy court, absent the debtor's consent or a Chapter 9 plan so providing, from interfering with a Chapter 9 debtor's political and governmental powers, its property and revenues, or its use and enjoyment of any income-producing property. This non-judicial sale option, however, will not allow a debtor to sell property free and clear of liens unless all the lien holders are paid in full or consent to the release of their liens, or unless state law allows for such a free-and-clear sale.
A second sale option is for a Chapter 9 debtor to sell its property pursuant to a confirmed Chapter 9 plan of adjustment of debts, a method which allows for the sale of a debtor's property free and clear of liens and interests. Although Chapter 9 does not incorporate section 363, it does incorporate section 1123(a)(5)(D) of the Bankruptcy Code, which provides that a bankruptcy plan may provide for the sale of all or any part of a debtor's property, either subject to or free of any lien on such property. Utilizing section 1123(a)(5)(D), a number of Chapter 9 debtors have liquidated their assets pursuant to a confirmed Chapter 9 plan. For example, in the Natchez Regional Medical Center case filed in 2014, the debtor-community hospital sold substantially all of its assets on a going concern basis to a publicly-traded, for-profit company pursuant to a confirmed Chapter 9 plan. Similarly, in 2012, the West Jefferson Amusement and Public Park Authority similarly sold the amusement park property it owned and operated in Bessemer, AL, to a privately owned purchaser as part of its Chapter 9 plan.
Chapter 9 does not relieve a municipal debtor from complying with applicable state law regarding the sale or disposition of a debtor's assets. If regulatory or electoral approval of the sale is required under state law, the debtor will need to get it. Similarly, if state law requires a municipality to follow a certain procedure as a predicate to selling its property, the municipality must follow those procedures when in Chapter 9. Accordingly, in the Natchez Regional case, the debtor was required to, and did, fully comply with all applicable state law requirements pertaining to the sale of a community hospital's assets in order to ensure confirmation of its "liquidating" Chapter 9 plan.
The deference that a bankruptcy court should give to the decisions of a "public-private" Chapter 9 debtor's leadership is an issue that has not garnered much attention. Under section 904 of the Bankruptcy Code, a bankruptcy court may not interfere with any of the municipal debtor's political or governmental powers, any of its property or revenues, or its use or enjoyment of any income-producing property. Accordingly, if a Chapter 9 debtor were to propose to sell its assets under its state law authority without seeking bankruptcy court authority to do so, section 904 would preclude the bankruptcy court from interfering with the sale. However, if a Chapter 9 debtor were to propose to sell its assets free and clear of liens pursuant to a Chapter 9 plan, then the debtor's proposed plan sale would be subject to the bankruptcy court's review as to whether the plan satisfied Chapter 9's confirmation requirements. Those requirements include, by reference, section 1129(a)(3)'s requirement that a plan be "proposed in good faith." In assessing "good faith" and the confirmability of a Chapter 9 plan, is it appropriate for a court to consider whether the debtor in question is a city, county, town, or other "true" municipality that provides a uniquely public service not available through the private sector with leadership generally elected by the public, or is instead a "public-private" municipal entity that provides services — such as the operation of a hospital or an amusement park — that are offered by private entities as well and whose assets are subject to liquidation?
The Bankruptcy Code does not distinguish between these two types of Chapter 9 debtors. To the contrary, section 903 of the Bankruptcy Code, which reserves to the states the power to control its municipalities and the exercise of their political and governmental powers, coupled with section 904's admonition against bankruptcy court interference in a municipality's governance and use of its property, strongly indicates that state law alone should set the standards for evaluating a Chapter 9 debtor's actions — whether that debtor is a city run by elected officials with millions of residents, or a municipal authority run by appointed officials whose only asset is a struggling hospital or a mothballed amusement park.
Jay R. Bender is chair of the Bankruptcy, Restructuring, and Distressed Investing Practice Group at Bradley Arant Boult Cummings LLP. He represents debtors, banks, secured creditors, indenture trustees, and purchasers of distressed assets in complex Chapter 11 and Chapter 9 bankruptcy cases in state and federal court receivership proceedings, and in out-of-court workouts, reorganizations, restructurings, and liquidations. Mr. Bender can be reached at firstname.lastname@example.org.
Republished with permission. This article first appeared in The Bankruptcy Strategist in June 2015.