by James Spiotto

The state legislatures, in considering how best to assist local governments facing financial challenges or economic distress, may find instructive how other states have addressed these problems and the alternatives and opportunities available in the form of legislation including authorization to file for Chapter 9, municipal bankruptcy, under Federal Bankruptcy Law 11 U.S.C. § 901, et seq.  Dealing with the financial distress of a state or local government requires not merely short-term actions to increase tax revenues and lower costs, but also the long-term reinvestment in the state or local government.  The goal of the long-term reinvestment is to improve and expand governmental services and infrastructure and stimulate business opportunities and growth for creation of new businesses and new jobs resulting in new taxpayers to increase tax revenues that brings about the recovery for the health, safety and welfare of citizens.  Such an approach is likely in the best interests of not only the state or local government but also its citizens and taxpayers, and its creditors, including employees and retirees.  It is only through a robust recovery plan that creditors, including employees and retirees, will be paid to the fullest extent possible.

As will be discussed, the consideration by a state to allow its municipalities to file for Chapter 9 should not preclude the state or its local governments from taking action short of Chapter 9 to assist in times of financial crisis.  Moreover, as will be examined, some states have devised a procedure whereby there is an independent, second look at the wisdom of a municipal bankruptcy filing before it is finalized.  The use of a Local Government Protection Authority as developed by the Civic Federation of Chicago is such an approach as will be discussed below.  As used throughout this presentation, “municipality” is not used as defined in the various state statutes or Constitutions to mean only cities, villages and incorporated towns, but is used in the broader sense contemplated by the Federal Bankruptcy Law to include units of local government, municipal utilities, special tax districts, government health care and transportation entities and school districts generally.[i]

In connection with any analysis of the advisability of a state to permit municipalities to file for Chapter 9, consideration should be given to an unexpected consequence of the availability of such a remedy.  As will be discussed further, Chapter 9 typically is recognized as a last resort, a step to be taken if all else fails in attempts to rescue the financially troubled municipality.  Certainly, given historic costs, expense and disruption resulting from Chapter 9, Chapter 9 is not a step to be undertaken lightly.  However, the very existence of the availability of Chapter 9 may have a salutary effect on efforts to resolve municipal difficulties outside of a Chapter 9 proceeding.  This was recognized in hearings before the United States House of Representatives Committee on the Judiciary as early as 1942.[ii]  The legislative history for hearings on the extension of the Municipal Debt Composition Act reported that the passage of the Municipal Bankruptcy Act in 1934 permitted the City of Detroit to restructure its outstanding municipal debt outside of bankruptcy through a composition of creditors requiring 100% approval of affected creditors.  Since 8% of bondholders were holdouts with 92% approval of creditors, the Mayor and Civic Leaders of Detroit were major supporters of municipal bankruptcy in the passage of 1930’s Chapter IX not because they were clairvoyant that in 2013 they would use it.  Rather, they supported the bankruptcy option realizing that a more drastic alternative would convince the holdouts to accept the plan approved by the 92% given the fear of alternative municipal bankruptcy treatment was perceived to be far worse.  The legislative history also refers to the refunding and refinancing of the significant amount of outstanding indebtedness of the City of Chicago at that time because of the favorable psychology of having the provisions of the Bankruptcy Act available.  Thus, any exploration of the advisability of the passage of authorizing legislation ought not be viewed as necessarily leading to a rush to file Chapter 9.

The Municipal Bankruptcy Experience

As you may be aware, there have been only 662 municipal bankruptcies (see Charts, Appendix 1 and 2) filed in the United States since the adoption of the authorizing legislation in 1937.  Few debtors have been major municipalities.  Orange County, California in 1994, Bridgeport, Connecticut in 1991, Jefferson County, Alabama in 2011, Stockton, California and San Bernardino, California in 2012 and Detroit in 2013 are recent notable exceptions.  For the most part, the 662 Chapter 9 filings have been small municipalities or special tax districts or utilities (about 60%).  In fact, since 1954, less than 20% of all Chapter 9 filings have been cities, towns, villages and counties (63 of 318).  Further, in the municipal bankruptcy, even determining eligibility can take significant time and delay such as in Vallejo, California, which was filed in 2008.  Disputes with municipal unions over pensions and benefits bogged down the proceeding and delayed that City’s emergence from bankruptcy.  The issue of the relative treatment of pension and debt payments took center stage in Chapter 9 cases of Detroit, Stockton and San Bernardino.  The decision on the eligibility of Stockton alone took almost ten months.  After more than a year in bankruptcy, the issue of the eligibility of San Bernardino was finally determined, paving the way for a battle between the competing interests.  The Detroit bankruptcy was long and expensive.  It is safe to say that the availability of a bankruptcy option has not proven to be a “quick or easy fix” to municipalities.[iii]  This is particularly true where there has been contention between the major players in the case.  Historically and practically, Chapter 9 debt adjustments should be the last resort after all other alternatives have been unsuccessful.  Many states have provided assistance, refinancing, oversight and other mechanisms to help local government avoid Chapter 9 if it is at all possible.  The authorization of municipalities to file should not be interpreted as precluding such efforts by a state.

The Lessons Learned from Constitutional Challenges Municipal Bankruptcy Provisions

The Tenth Amendment to the Constitution explicitly articulates the Constitution’s principle of Federalism by providing that powers not granted to the Federal Government nor prohibited to the States by the Constitution of the United States are reserved to the States respectively or to the people.  Accordingly, while Article I, Section 8 of the Constitution gives Congress the power to “establish uniform laws on the subject of bankruptcies throughout the United States,” that power may not interfere with the power reserved to the States by the Tenth Amendment.  While there may be precedent for the Federal preemption of bankruptcy law for corporations and individuals, there was, at our Nation’s founding, no precedent for a dual sovereign passing a law regulating the bankruptcy of the other.  This remains the case today.  The earliest iterations of statutes providing for municipal debt adjustment (Chapter IX) not unexpectedly resulted in a review of the constitutionality of municipal bankruptcy by the U.S. Supreme Court.

As you know, the current version of Chapter 9 of the Bankruptcy Code attempts to embrace the concept of sovereignty of States and the limitations imposed by the Tenth Amendment.  Section 903 of the Bankruptcy Code specifically reserves a State’s power to control municipalities.[iv]  In addition, § 904 of the Bankruptcy Code specifically limits the jurisdiction and powers of the Court over the municipality.[v]  As a result, the power of a Bankruptcy Court presiding over a Chapter 9 case is limited and cannot interfere with the property, revenue, politics, government and affairs of the municipality.  The jurisdiction of the Bankruptcy Court over the municipality flows from the specific authorization of the State in question to allow the municipality to file.  Most States have chosen not to specifically authorize their municipalities to file.[vi]

Earlier versions of municipal bankruptcy legislation attempted to deal with these concepts as well.  Prior to 1934, Federal bankruptcy legislation did not provide a mechanism for municipal bankruptcy, insolvency, or debt adjustment.[vii]  During the period 1929 through 1937, there were 4,700 defaults by governmental bodies in the payment of their obligations.[viii]  In 1934, the House and Senate Judiciary Committees estimated that there were over 1,000 municipalities in default on their bonds.[ix]  That was obviously a different stage of financial distress than presently exists today with no State in default of any its general obligation bonds.

Until World War II, units of local government were very heavily dependent upon property tax.  During the Depression, there was widespread nonpayment of such taxes.  Bondholders brought suits for accountings, secured judgments and obtained writs of mandamus for levies of further taxes.  The first municipal debt provisions of the Bankruptcy Act of 1898 as amended from time to time (hereinafter the “Bankruptcy Act”) were enacted as emergency legislation for the relief of such municipalities.  The municipal provisions became effective on January 24, 1934.[x]  These provisions were to be operative for a two-year period from that date, but this period was later extended to January 1, 1940.[xi]  This legislation reflected a recognition that municipalities required a mechanism that would stay the annihilating litigation arising from defaults and provide a fresh start through the allowance of municipal debt adjustment to what is sustainable and affordable.  In this way, creditors of the distressed municipality could be paid as much as possible without crowding out essential governmental services.

The municipal debt adjustment provisions of the Bankruptcy Act enacted in 1934 thus reflected an attempt to protect municipalities from debilitating disputes with creditors.[xii]  The 1934 legislation provided a procedure whereby a local governmental unit, if it could obtain acceptances from two-thirds of its creditors, could have a plan of readjustment enforced by the Federal courts.  The 1934 legislation contained language similar to the policy expressed in the current § 904:

The Judge … shall not by any order or decree, in the proceeding or otherwise, interfere with (a) any of the political or governmental powers of the taxing district or (b) any of the property or revenues of the taxing district necessary in the opinion of the Judge for essential governmental purposes or (c) any income producing property, unless the plan of adjustment so provides.

Nevertheless, the Supreme Court determined that, under the 1934 legislation, the court, and to some extent, the creditors through the court, had certain control over the municipality’s revenues and governmental affairs.  In 1936, the Supreme Court of the United States held, in the case of Ashton v. Cameron County Water Improvement Dist., No. 1,[xiii] that the 1934 municipal bankruptcy legislation was unconstitutional because it infringed upon the sovereign powers of the States and potentially permitted too much control by a Federal court and by Federal legislation over municipalities, sub-sovereigns of the sovereign States.

In 1937, new legislation was passed attempting to cure the defects outlined by the Court in Ashton and to protect municipalities from the injurious protracted litigation that some were enduring.  The 1937 municipal bankruptcy legislation, enacted in response to the Ashton decision, required:

(l)      no interference with the fiscal or governmental affairs of political subdivisions;

(2)      a restriction on the protection of bankruptcy to the taxing agency itself;

(3)      no involuntary proceedings;

(4)      no judicial control or jurisdiction over property and those revenues of the petitioning agency necessary for essential governmental purposes; and

(5)      no impairment of contractual obligations by the States.

This legislation was upheld by the Supreme Court in United States v. Bekins,[xiv] where the Supreme Court noted that the statute was carefully drawn so as not to impinge upon the sovereignty of the States.  Like the 1934 legislation, language similar to the § 904 concept was included, although references to “the opinion of the Judge” were deleted.

Chapter IX then, while part of the Bankruptcy Act, provided a forum in which a municipality could voluntarily seek an adjustment of indebtedness if authorized by the State to file.  A Chapter IX proceeding was not a proceeding to adjudge the city a bankrupt.  The court’s jurisdiction did not extend to declaring the city bankrupt or to administering its affairs as a bankrupt.  The court was limited to approving as a matter of law or carrying out a proposed plan for reorganization of a municipality’s debt.[xv]

The principles enumerated in Ashton and the 1937 legislation are important in understanding the role of a Bankruptcy Court in a Chapter 9 proceeding today.[xvi]  The Court cannot constitutionally interfere with the revenue, politics, or day-to-day operations of the municipality.  The Bankruptcy Court cannot replace, by its rulings or appointments, the City Council or any other elected or appointed official.  The limited, but vital, role of the Bankruptcy Court is to supervise the effective and appropriate adjustment of municipal debt in accordance with applicable law.  (Obviously, the special limitations on the power of the Bankruptcy Court in a Chapter 9 case would not be applicable if the city consented to the stay or order of the court which affected its political or governmental powers.)[xvii]  Historically, Chapter IX and its successor Chapter 9 were intended to facilitate rather than mandate voluntary municipal debt adjustment, not municipal debt elimination.  States have in their legislation provided mechanisms to assist local governments in distress ranging from needed technical assistance to an emergency manager or receiver who takes charge of governmental operations and financing under state law.

Legislation by the State to Authorize Chapter 9

Only a municipality may be a debtor under Chapter 9 of the Bankruptcy Code.[xviii]  Only a municipality can initiate a Chapter 9 proceeding.  There can be no involuntary Chapter 9 proceeding.  Not only are involuntary proceedings constitutionally prohibited, as set forth in Ashton, but also there is no statutory basis for such an involuntary action.  Only § 301 of the Bankruptcy Code, providing for voluntary cases, is incorporated into Chapter 9.  A municipality is a political subdivision, or public agency, or instrumentality of a state.[xix]  A municipality is not eligible to be a debtor pursuant to any other Chapter of the Bankruptcy Code.[xx]

Moreover, under the 1994 Act, in order to proceed under Chapter 9, state law must have specifically authorized the entity to be a debtor under Chapter 9.[xxi]  As noted, twelve states have specifically authorized a municipality to so proceed.[xxii]  Two states have specifically prohibited municipalities from filing for relief under the Bankruptcy Code.[xxiii]  Another twelve states authorize a filing under certain conditions such as approval of the Governor, Treasurer, some legislative committee or authority or use of an additional review process such as the neutral evaluator in California.  Three states authorize only a specific municipality or type of municipality to file.  (e.g. Illinois currently only authorizes the Illinois Power Authority to file Chapter 9.)  The remaining twenty-one states have no specific authorization so their municipalities cannot file Chapter 9.  See Charts, Appendix 3 and 4.

Prior to 1994, a number of states had been silent on the issue of whether local governmental bodies were authorized to file under Chapter 9.  The power of a municipality “to do all acts necessary, proper or convenient” including the right to sue and be sued had been held sufficient to authorize a municipality to file.[xxiv]  Given the judicial and legislative history surrounding municipal debt adjustments and state authorization to file a Chapter 9, it was important to note there could have been an overlooked problem in this regard.  Commentators cited the reported decisions in North and South Shenango Joint Municipal Authority as a statement of law.[xxv]  This case as reported could stand for the proposition that home rule power granted to a municipality is sufficient authority for it to be eligible to institute a Chapter 9 proceeding even though there is no expressed statutory power to file.  However, such was not the final result in North and South Shenango, in which the Bankruptcy Court was reversed by the district court in an unreported decision.

In a decision arising out of the filing by a Colorado special purpose district before the 1994 legislation, the bankruptcy court revisited the same issue.  The special purpose district had, under applicable statute, the ability to be a party to suits, actions and proceedings, to borrow money, incur indebtedness and issue bonds, to refund any bond indebtedness, to manage, control and supervise all of the business and affairs of the district and to exercise all rights and powers necessary or incidental to or implied from the special powers granted by the statute.  The statute further provided that the specific powers granted should not be considered as limitations upon any power necessary or appropriate to carry out the purposes and intent of the statute.  The court found that the express and specific authorization to file a Chapter 9 is not required by 11 U.S.C. § 109(c)(2) and the aforementioned general powers were sufficient to constitute a general authorization for a Chapter 9 filing.  The court held that the ability to file a Chapter 9 was necessary or incidental to the power to refund bond indebtedness and the District’s ability to manage, control or supervise its business and affairs.[xxvi]  However, a Philadelphia bankruptcy court decision,[xxvii] citing the North and South Shenango case, held that the right to sue and be sued did not constitute the requisite affirmative action required by the Bankruptcy Code.  In the bankruptcy of the City of Bridgeport, the court also concluded that specific authorization to file a Chapter 9 petition was not required.[xxviii]  The legislative history behind the 1994 Act specifically noted the controversy and the purpose of the amendment to clarify the matter.  The state law must specifically authorize the filing.[xxix]  The court in the Orange County bankruptcy ruled that the Orange County Investment Pool was not specifically authorized to file a Chapter 9 petition by a statute which referenced a laundry list of public entities that are authorized to file but which did not refer to an investment fund.[xxx]

Given the requirement that the state specifically authorize its municipalities to be debtors under Chapter 9, the issue is whether it is advisable to give municipalities this ultimate remedy or give municipalities the sole power to decide to file Chapter 9.  A further question is whether the ability to file should be part of a procedure whereby there is a second look by knowledgeable parties before the remedy is exercised.  This consideration may be informed by the tradition of states providing assistance or oversight to their municipalities where appropriate.

The Traditional Role of States in Assisting Financially Troubled Municipalities

States typically play an important role in assisting municipalities in times of financial distress.  It is unusual that the largest city in the State of Michigan, Detroit, has chosen bankruptcy as its best option.  States traditionally have enacted legislation designed to protect their cities from financial distress or to aid cities should financial distress befall them.

Traditionally, states have attempted to supervise local government financing and limit volatility through the enactment of debt limitations and laws that permit the refunding of municipal obligations.  Over time, states have developed more sophisticated mechanisms of assisting and providing oversight to their municipalities through the use of receivers, financial managers, and oversight and refinance authorities.  Each state has its own, unique approach to these mechanisms.  Various states have adopted different vehicles to provide supervision, oversight, and assistance to their municipalities on an ongoing basis and especially in times of financial distress.  At their most basic, these methods, which may be found in legislation or constitutional provisions, include limitations on debt and taxes and on the authority to refinance outstanding debt.  More hands’on involvement by the states arises in the event of financial distress.  Procedures devised for such situations generally start with the requirement to balance the budget and progress to review, assistance and oversight by the states of municipal budgets and financial issues.

In addition, states have developed unique approaches to the oversight, supervision, and assistance of local governments in times of emergency.  These include advisory commissions that review the financials, the budgeting and financing done by municipalities, receiverships, financial managers, financial control boards, refinance authorities, oversight commissions, and others.  These mechanisms will be briefly reviewed in this material and are discussed in more detail in Municipalities in Distress? referenced in endnote 3.

Financial Cycles Require That State and Local Governments Prepare for Economic Downturns

The impact of economic cycles has been demonstrated throughout the history of state and local government debt financing.[xxxi]  Unfortunately, we all recognize an adverse effect of downturns, namely, lower state and local government revenues.  Nevertheless, economic downturns provide no holiday from the threat of higher state and local government expenses, which are highlighted by the ever-increasing need for improvement in infrastructure, education, health care, and public safety.  Over time, various new mechanisms have been introduced to provide supervision and assistance to those local governments that are experiencing financial distress.  There does not appear to be a reason any local government should have to endure, without supervision or assistance, the devastating effects of a financial meltdown and possibly to resort to the filing of municipal bankruptcy under Chapter 9 of the U.S. Bankruptcy Code.  Traditionally, States have worked with their local governments to avoid financial meltdowns and bankruptcy, and there is no reason to believe that tradition will not continue.

How States Have Attempted to Supervise State and Local Government Financing and Volatility in Times of Economic Distress

Historically, States have adopted various mechanisms to provide supervision, oversight, and assistance to their municipalities on an ongoing basis and especially in times of financial distress.  In the past, these mechanisms primarily have started with basic limitations on debt and taxes and authorization to issue refunding bonds.

At the front lines of protecting the financial status of local government are constitutional and statutory limitations on the debt municipalities may have outstanding at any time.  In addition to debt limitations, all States include provisions in their statutory law for the issuance of refunding bonds.

Debt Limitations

One of the most important protections for municipalities and their creditors is the limitation that the various States have imposed on the amount of debt a municipality may issue and hold at any one time-in fact, all States with the exceptions of Alaska, Florida, and Tennessee impose some sort of limit.[xxxii]  Municipalities in 28 States are restricted by limits imposed by their respective constitutions.  Twenty-one States that impose debt limitations on their municipalities do so via statutory provisions.  These municipal debt limits range from a percentage of a valuation of assessed property in the local unit of government to a set monetary amount.[xxxiii]  Some states provide that home rule units have no debt limits, tax caps or referendum for debt imposed by the state.  Instead, these states rely on a home rule unit to deal with financial and governmental matters as responsible home rule units.

Refunding Bonds

The most common way that municipalities restructure their debt is through the issuance of refunding bonds.  Refunding bonds, as the name implies, are bonds that are issued to redeem the principal of outstanding bonds.  Every state provides some sort of refunding bond provision for its municipalities.  By issuing refunding bonds, a municipality may be able to refinance its debt at a more favorable interest rate or restructure its outstanding obligations to mature at a time when the municipality believes it will be more flush with money.  Refunding bonds also may help a municipality to push off its debt troubles for another day.  In most cases, the issuance of refunding bonds does not result in an increase in outstanding debt, because the refunded bonds no longer count toward the legal limits.  By setting debt limits and taxing limits and allowing for the issuance of refunding bonds some states have attempted to curb the number of municipal financial crises and defaults.  In addition to these provisions, some steps have gone a step further to help beleaguered municipalities resolve their financial issues at the initial signs of a problem.

The Use of Various Mechanisms by States to Provide Financial Oversight and Assistance to Municipalities in Distress to Avoid the Use of Chapter 9

The limitation on indebtedness and authorization to issue refunding bonds are the basic tools in the States’ arsenal to assist municipalities.  However, in times of financial distress, these basic approaches have been enhanced by additional mechanisms.  These methods have started with reaffirming statutory requirements to balance budgets and progressed to greater state assistance and oversight of municipal budgets and finances in times of financial emergency as well as the use of refinance authorities, receivers, financial managers and financial oversight authorities.  States have approached the task of supervising and assisting their municipalities in a variety of ways.  Although these mechanisms vary by type and degree of supervision and assistance, the widespread development of these mechanisms indicates the growing trend of more active oversight and supervision of municipalities by States in order to build better credibility with citizens and creditors, including the municipal bond market.

There appears to be statistical and practical support for the proposition that states that authorize their municipalities to file Chapter 9 bankruptcy but also have mechanisms for assistance, oversight or at least a “second look” before being able to file for Chapter 9 have reduced the use of Chapter 9 by their municipalities and have provided for the most effective relief to bridge the financial crisis.  As you know, only 12 states[xxxiv] allow a municipality solely on its own decision to file a Chapter 9 bankruptcy without a “second look,” either the approval of the governor, treasurer, some state agency or authority or a last effort at negotiation like the neutral evaluator in California (adopted in 2011) and 12 more require a second look.

Since 1980, those municipalities with no second look are more than six times more likely to file Chapter 9 than in the state where a second look is required (200 versus 32).  Accordingly, a review of mechanism and procedure for a second look or oversight and assistance used by states in connection with consideration of the authorization of use of Chapter 9 municipalities seems prudent.

In the next installment of this series, we will examine various state-implemented programs to assist municipalities in times of fiscal crisis.

James Spiotto is Managing Director of Chapman Strategic Advisors, LLC and Co-Publisher of MuniNet Guide.

[i]           Section 101(40) of the U.S. Bankruptcy Code defines municipality as “a political subdivision or public agency or instrumentality of a state.”

[ii]          Municipal Bankruptcy Composition Law: Hearing on H.R. 6912 Before the Special Subcommittee on Bankruptcy and Reorganization of the Committee on Judiciary, 77th Cong., 2d Sess. (1942).

[iii]        In fact, not all fifty States permit their municipalities to file for Chapter 9.  Only twelve States specifically authorize municipal bankruptcies.  For more detail, see the book entitled Municipalities in Distress? published by Chapman and Cutler LLP, which is a 50 state survey of State laws dealing with financial emergencies of local governments, rights and remedies provided by States and State authorization of municipalities to file for Chapter 9 bankruptcy.

[iv]         “This Chapter 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 such municipality, including expenditures for such exercise …” 11 U.S.C. § 903.

[v]          “Notwithstanding any power of the court, unless the debtor consents or the plan so provides, the court may not, by any stay, order, or decree, in the case or otherwise, interfere with – (1) any of the political or governmental powers of the debtor; (2) any of the property or revenues of the debtor; or (3) the debtor’s use or enjoyment of any income producing property.” 11 U.S.C. § 904.

[vi]         See States listed in Note 22 for those that currently authorize municipalities to file.

[vii]        See The Bankruptcy Act of 1800, 2 Stat. 19 (1800); The Bankruptcy Act of 1841, 5 Stat. 440 (1841); The Bankruptcy Act of 1867, 14 Stat. 517 (1867); The Bankruptcy Act of 1898, 30 Stat. 544 (1898).  That is not to say that there were no defaults in government obligations in the nineteenth century.  Indeed, the 1842 default by the State of Pennsylvania on its bonded debt inspired William Wordsworth to pen the sonnet “To the Pennsylvanians” in which he spoke of “won confidence, now ruthlessly betrayed.”  It was the defaults of local utility districts and municipalities in the 1800s that tarnished the integrity of the “new frontier’s” obligations.  George Peabody, an eminent financier, sought to be admitted to polite English Society only to be rebuffed, not due to his lack of social grace, but because his countrymen did not pay their debts.  It was the defaults by State governments in the early nineteenth century and municipalities in the late nineteenth century that brought about the procedures which are now taken for granted, including debt limitations on municipal issues, bond counsel, and clearly defined bondholders’ rights and State statutory provisions relating thereto.

[viii]      See A Commission Report, City Financial Emergencies: The Intergovernmental Dimension (Advisory Commission on Intergovernmental Relations, Washington, D.C., July 1973) (“ACIR Report”).

[ix]         S. Rep. No. 407, 73rd Cong., 2d Sess. (1934).

[x]          48 Stat. 798 (1934).

[xi]         49 Stat. 1198 (1936).

[xii]        See generally H.R. Rep. No. 207, 73rd Cong., 1st Sess. 103 (1933); H.R. Rep No. 517, 75th Cong., 1st Sess. 3-4 (1937); H.R. Rep. No. 686, 94th Cong., 1st Sess. 541, 542 (1975); H.R. Rep. No. 595, 95th Cong., 1st Sess. 397-398 (1977); S. Rep. No. 95-989, 95th Cong., 2nd Sess. 110 (1978), reprinted in 1978 U.S.C.C.A.N. 5787.

[xiii]      Ashton v. Cameron County Water Improvement Dist. No. 1, 298 U.S. 513, 80 L. Ed. 1309, 56 S. Ct. 892 (1936), reh’g denied 299 U.S. 619, 81 L. Ed. 457, 57 S. Ct. 5 (1936).

[xiv]       United States v. Bekins, 304 U.S. 27, 82 L. Ed. 1137, 58 S. Ct. 811 (1938), reh’g denied 304 U.S. 589, 82 L. Ed. 1549, 8 S. Ct. 1043 (1938).

[xv]        Leco Properties, Inc. v. R.E. Crummer & Co., 128 F.2d 110 (5th Cir. 1942).  Further, the court had no jurisdiction to determine the existence the city or boundary disputes in the nature of quo warrantoGreen v. City of Stuart, 135 F.2d 33 (5th Cir. 1943), cert. denied 320 U.S. 769, reh’g denied 320 U.S. 813, 88 L. Ed. 491, 64 S. Ct. 157 (1943).

[xvi]       Upon the adoption of the Bankruptcy Reform Act of 1978, the roman numerals which had previously been used to identify chapters of the Bankruptcy Act were abandoned in favor of Arabic numbers.  Hence, since the effective date of the Bankruptcy Code, “Chapter IX” has become Chapter 9.

[xvii]      See, In re Richmond Unified School District, 133 B.R. 221 (Bankr. N.D. Cal. 1991), (a Chapter 9 debtor may voluntarily divest itself by consent of its autonomy rights under § 904 of the Bankruptcy Code.

[xviii]    11 U.S.C. § 109(c).  Claims by holders of industrial revenue bonds are not governed by Chapter 9, and amounts owed by private companies to the holders of industrial development bonds are not to be included among the assets of the municipality.  S Rep No 95989, 95th Cong, 2d Sess. 109 (1978).  The determination of whether or not an entity is a “municipality” can be difficult.  Although originally Chapter 11 relief was sought and denied because of the debtor’s status as a municipality, the Court in In re Jersey City Medical Center, 817 F.2d 1055 (CA3, 1987), ruled that a public municipal hospital was a proper debtor under Chapter 9.  Conversely, the cases American Milling Research and Development, Inc., No. 7400129 and Fort Cobb Irrigation District, No. 7600679, were initially filed under Chapter 9 but were converted to Chapter 11 bankruptcies.

[xix]       11 U.S.C. § 101(29).

[xx]        Only a “person” is eligible for relief under Chapters 7 and 11 of the Code.  “Governmental unit” is excluded from the definition of “person.” 11 U.S.C. § 101(33).

[xxi]       11 U.S.C. § 109(c)(2).

[xxii]      See:

Ala. Code § 11-81-3

Ariz. Rev. Stat. Ann. § 35-603

Ark. Code Ann. § 14-74-103

Idaho Code Ann. § 67-3903

Minn. Stat. Ann. § 471.831

Mo. Ann. Stat. § 427.100

Mont. Code Ann. § 7-7-132

Neb. Rev. St. § 13-402

Okla. Stat. Ann. Tit. 62 §§ 281, 283

S.C. Code Ann. § 6-1-10

Tex. Loc. Gov’t Code § 140.001

Wash. Rev. Code § 39.64.040

Colorado has enacted legislation specifically authorizing its beleaguered special taxing districts to file a petition under Chapter 9.  Section 32’1’1402 of the Colorado revised statutes states that “any insolvent taxing district is hereby authorized to file a petition authorized by federal bankruptcy law and to take any and all action necessary or proper to carry out the plan filed with said petition ….”

[xxiii]    See, e.g., Ga. Code Ann §§ 36’80’5.

[xxiv]     In re Pleasant View Utility Dist. of Cheatham County, Tenn., 24 BR 632 (BR MD Tenn., 1982).  The court concluded that the term “generally authorized” as used in § 109(c) mans only that the state should give some indication that the municipality has the necessary power to seek relief under the federal bankruptcy law.  The court so held despite legislative history of the section which indicated that the Senate rejected the House’s proposal that a municipality would be eligible to file a Chapter 9 petition unless such filing was prohibited by state law.  See HR Rep No 595, 95th Cong, 1st Sess. 263264, 318319, reprinted in [1978] US Code Cong & Admin News 5963, 62206222.  The Senate’s position was a departure from the earlier notion that a municipality’s authority to file a municipal bankruptcy was an inherent element of existence.  See In re South Beardstown Drainage & Levee Dist., 125 F.2d 13 (CA7, 1941).  See also In re City of Wellston, 43 BR 348 (BR ED Mo, 9184), in which the court held that a grant of powers to act for the preservation of peace and good order and for the benefit of trade and commerce was sufficient to authorize the filing of a Chapter 9 petition.

But see In re North & South Shenango Joint Municipal Authority, No. 8100408 in the United States Bankruptcy Court for the Western District of Pennsylvania.  There, the bankruptcy court found that a joint municipal authority which had been created under Pennsylvania law to construct and operate sewer systems, had been “generally authorized” to file a petition under Chapter 9.  The court relied on the distinction in Pennsylvania law between municipal authorities like the debtor authorized to do all acts “necessary or convenient for the promotion of their business,” and political subdivisions, which were required to obtain the approval of the state Department of Community Affairs before they could file a petition for relief under the federal bankruptcy law.  The court found that the decision to restrict political subdivisions’ resort to bankruptcy evidenced a contrary intent regarding municipal authorities.  14 BR 414 (BR WD Pa, 1981).  The Third Circuit declined to exercise jurisdiction over the appeal.  Pennbank v. Washbaugh, 673 F.2d 1301 (CA3, 1981).  However, the District Court, to which an appeal was also taken, reversed the Bankruptcy Court and held that there was no sufficient showing of state authorization.  80 BR 57 (BR WD Pa, 1982).  The case was then handled in a state court proceeding.  (Letter of Kirkpatrick, Lockhart, Johnson & Hutchinson, Pittsburgh, Pennsylvania to author dated August 8, 1984).

[xxv]      See e.g., 4 Collier on Bankruptcy, § 900.03 n 12.

[xxvi]     Villages at Castle Rock Metropolitan District No. 4, No. 89 B 16240 (D Colo., May 11, 1990).

[xxvii]    In re Carroll Township Authority, 119 BR 61 (BR WD Pa, 1990).

[xxviii]  In re City of Bridgeport, 128 BR 688 (D Conn 1991).

[xxix]     See Bankruptcy Reform Act of 1994 Section by Section Description appearing at 140 Cong. Rec. H 10771 (daily ed 10/4/94).

[xxx]      In re County of Orange, 183 BR 594 (BC CD Cal. 1995).  See also In re AlleghanyHighlands Economic Development Authority, 720 BR. 647 (BC WD Va. 2001).

[xxxi]     Since 1949, there have been 11 economic downturns in the United States, and the states and their local governments not only have weathered those financial storms but have provided substantial support to the eventual economic recovery by expenditures for infrastructure and other purposes that have increased employment and GDP growth. In each of these economic downturns, increased government debt financing for needed essential infrastructure and improvements was what helped provide the stimulus for recovery. These bond-funded projects have stimulated the economy by providing increased employment for construction, purchase of goods, and the ripple effect that such increases in salaries and purchases have on tax revenues, employment, and GDP. See “The Role of the State in Supervising and Assisting Municipalities, Especially in Times of Financial Distress,” by James E. Spiotto in the Municipal Finance Journal, Winter/Spring 2013.

[xxxii]    Even Alaska and Florida have some indirect control on debt. Alaska has a limitation on taxes and a municipality may not levy ad valorem taxes for any purpose in excess of 3% assessed value of the property in the municipality. However, these limitations do not apply to taxes levied for payment of principal and interest on bonds. Alaska Stat. §§ 29.45.090, 29.45.100 and 29.47.200 (2012). Florida has a limitation on ad valorem taxes to finance or refund capital projects only if approved by the voters.

[xxxiii]  Compare Alabama-Ala. Const. Art. XII, § 225 and Ark. Const. § 342 (2012) (debt may not exceed a particular percentage of valuation) with Washington, DC-D.C. Code § 47’102 (setting debt limit at 1878 levels). Alabama is somewhat unique in providing that any tax to be levied must be levied by the state legislature and does not grant the local government the power to levy taxes on its own.

[xxxiv]   The number was thirteen states before 2011 and California’s adoption of the neutral evaluator process before municipalities are able to file a Chapter 9.

NEW_SECTIONNew York Fed’s Chapter 9 and Alternatives for Distressed Municipalities in States WorkshopEND_SUPP_HDR

On December 14, 2014, the Federal Reserve Bank of New York, the Volcker Alliance and George Mason University sponsored a workshop on Chapter 9 and alternatives for distressed municipalities and states.  It featured Paul Volcker, former Chairman of the Federal Reserve, Dick Ravitch, former Lieutenant Governor of New York who was involved with helping to solve the New York City financial crisis in 1975, the three bankruptcy judges from the largest recent Chapter 9s, Judge Rhodes who presided over Detroit, Judge Klein who presided over Stockton, and Judge Bennett who presided over the Jefferson County Chapter 9.  Representatives of state and local government also attended the workshop, including Chuck Reed, former Mayor of San Jose, California, the current Mayor of Atlantic City, Don Guardian and the current Mayor of Syracuse, New York Stephanie Miner as well as representatives of the municipal finance industry, including our co-publisher James Spiotto.  The following is a paper that our co-publisher presented as resource materials for the discussion.  It presents an overview of the municipal bankruptcy experience since the Depression, the lessons learned from constitutional challenges to municipal bankruptcy provisions, the role of states in authorizing their municipalities to file a Chapter 9 and also the benefit of providing a second look by state officials as to whether Chapter 9 is necessary and appropriate as the last resort.  It examines the traditional role of states in assisting financially troubled municipalities and it discusses the reality that financial cycles require state and local governments to prepare for economic downturns.  It reviews how states have attempted to supervise state and local government financing and volatility, especially in times of economic distress.  It also reviews debt limits, refunding bonds and various other mechanisms by states to provide financial oversight and assistance to municipalities in distress to avoid Chapter 9.  It discusses model state implemented programs to assist in the time of financial crisis, and explores the past use of municipal receivers, emergency managers, financial control boards and other mechanisms to deal with local government distress.  It also provides a summary of the priorities for the payment of creditors and the intended protection of special revenue pledges and statutory liens for bondholders as well as an explanation of the basic treatment of bonds and notes and the historical support for state constitutional and statutory mandated priorities, appropriations and set asides.

This will be presented in a three part series, the first, the history and experience of Chapter 9s and how states have attempted to control state and local government debt financing, the second, state implemented programs to assist local governments at the time of financial crisis, including emergency managers, receivers, financial control boards and new alternative proposals, and finally, third, the summary of basic treatment of creditors in Chapter 9, including priorities and special protections for creditors as well as the pitfalls of litigation on competing rights of creditors.