Chapter 9 of the Bankruptcy Code and its Implications for Financially
Burdened Municipalities in Michigan
By James S. Harrington
As a new governor and legislature prepare to tackle continuing budget challenges for the
State of Michigan, the financial woes facing Michigan municipalities continue to mount.
Media coverage of this issue has increased as the City of Hamtramck publicly raised the
possibility of seeking relief from creditors under Chapter 9 of the Bankruptcy Code. But
what does Chapter 9 entail, and is it a realistic option for Michigan municipalities?
What is Chapter 9?
Chapter 9 of the Bankruptcy Code allows “municipalities” – including cities and towns,
villages, counties, taxing districts, municipal utilities and school districts, among other
entities – to reorganize and refinance their debts. Similar to Chapter 11 bankruptcy, a
municipality seeking relief under Chapter 9 receives protection from its creditors while in
bankruptcy.
Chapter 9 differs from Chapter 11 in certain major respects, however. Significantly, The
Tenth Amendment of the United States Constitution – which limits federal powers and
preserves state sovereignty – curtails the bankruptcy court’s involvement in managing a
Chapter 9 case, as opposed to its major oversight role in a Chapter 11. The bankruptcy
court’s role in a Chapter 9 case generally involves: (i) approving a petition (i.e.,
determining if a municipal debtor is eligible for Chapter 9), (ii) confirming a
reorganization plan, and (iii) overseeing implementation of the plan.
Sections 903 and 904 of the Bankruptcy Code set forth the limitations of the court’s
power over the operations of the municipal debtor. Broadly speaking, a bankruptcy court
cannot take actions that interfere with, among other things, the political or governmental
powers of the debtor, the property or revenues of the debtor, or the debtor’s use or
enjoyment of income-producing property. Unlike in Chapter 11, a municipal debtor may
employ professionals without court approval.
Is a Municipality Eligible for Chapter 9?
A Chapter 9 petition must be filed voluntarily (as opposed to Chapter 11 which allows for
involuntary filings), and municipalities are not permitted to file under any other chapter
of the Bankruptcy Code. The bankruptcy court must determine whether a municipality is
eligible to be a debtor. Section 109(c) contains the eligibility requirements and provides
that the debtor must be:
a municipality (as defined in the Bankruptcy Code’s definitions under
section 101(40);
“specifically” authorized to be a debtor under state law; and
insolvent.
Specific Authorization to File
Pursuant to section 109(c), a municipality must be specifically authorized to file for
Chapter 9 protection by state law or by a governmental officer or organization
empowered by state law to authorize a filing. While a number of states have enacted laws
that permit municipalities to file for Chapter 9 on their own accord, Michigan is not one
of them. Therefore, municipalities such as Hamtramck must first seek permission from
state government. As press coverage has made clear, such permission has not been
forthcoming from the state. Given the number of financially troubled municipalities in
Michigan, it is possible that state officials are concerned that authorizing one
municipality to file for Chapter 9 will open the floodgates for others who are similarly
situated.
Role of Creditors
Creditors have a more limited role in Chapter 9 than in Chapter 11. For example,
creditors in a Chapter 9 caseare not entitled to propose competing reorganization plans.
However, as in Chapter 11 cases, a creditors’ committee is appointed to oversee the case
on behalf of all creditors and to investigate the actions of the municipal debtor, among
other responsibilities.
Contracts and Leases
Chapter 9 debtors, like Chapter 11 debtors, have the right to assume (affirm) executory
contracts and leases, and reject burdensome contracts and leases. Therefore, part of a
municipal debtor’s power is to restructure its contractual and lease obligations as part of
its overall financial restructuring.
The Plan
Ultimately, the purpose of a Chapter 9 case is for the municipal debtor to reorganize its
finances pursuant to a “plan of adjustment” pursuant to Section 941 of the Bankruptcy
Code. Like a Chapter 11 plan of reorganization, a Chapter 9 plan of adjustment must be
accompanied by a disclosure statement that contains “adequate information.” Creditors
may not propose a competing plan. The Bankruptcy Code sets forth a number of
standards for confirmation of a plan of adjustment in Section 943(b). In addition, as in
Chapter 11 cases, under Bankruptcy Code Section 1126 a Chapter 9 plan must be
approved by two-thirds of the amount of claims in each voting class and more than half
of the members of each voting class.
A plan must also be proposed in “good faith” and be in the “best interest of creditors.” In
the Chapter 11 context, the “best interest of creditors” test is met if creditors will receive
as much in value under the proposed plan as they would receive in a liquidation of the
debtor’s assets. In the Chapter 9 context, because a municipality’s assets cannot be
liquidated to pay creditors, the proposed Chapter 9 plan must be better for creditors than
the “alternative.” The alternative to a plan is dismissal, which leaves creditors fending for
themselves. Accordingly, the bankruptcy court must determine if dismissal is a better
alternative for creditors than the treatment the debtor proposed.
Conclusion
While not exhaustive, the intent of this article is to provide a general overview of Chapter
9, as well as similarities and differences with Chapter 11. Given the financial difficulties
faced by a number of Michigan municipalities burdened with underfunded pension
obligations and reduced tax revenue, it is likely that discussion of Michigan
municipalities filing for Chapter 9 bankruptcy will increase throughout 2011. Contact us
to learn more about the Chapter 9 process.