issuance of a 10-year warrant, payable
in annual installments with interest.
Bond insurance thus serves to allay
concerns over timely payment despite
state-by-state variations in the ability
to enforce municipal obligations.
Bond insurance is also sometimes used
as a backstop for liquidity providers
who commit to remarket variable
interest rate bonds. This liquidity
support is often provided to ensure
that holders of adjustable debt will,
from time to time, be able to sell their
bonds if an unexpected or undesirable
interest rate change occurs. In that
event, the liquidity provider must
either remarket the bonds to a new
holder or acquire the bonds itself.
Hence, a liquidity provider often requires
credit support for its own protection
following a repurchase of the bonds.
If a liquidity provider is compelled to
purchase the bonds, it may be entitled
to an accelerated repayment from the
insurer, as opposed to repayment over
the original amortization schedule of the
bond, which usually is the only remedy
available to the original bondholder.
Chapter 9 Concepts
The legislative history of Chapter 9
suggests that it was not necessarily
intended to result in the repudiation
of municipal debt. See H.R. Rep. NO.
95-595, at 263 (1977) (“[T]he term
‘bankruptcy’ in its strict sense is really
a misnomer for a [C]hapter 9 case. …
Therefore, the primary purpose of
[C]hapter 9 is to allow the municipal
unit to continue operating while
it adjusts or refinances creditor
claims with minimum (and in many
cases, no) loss to its creditors.”).
Nevertheless, spiraling claims for
unfunded pension and retiree benefits
have limited the ability of distressed
municipalities to maneuver, forcing
them to examine all options to reduce
budgets and maintain essential services.
Although bond debt historically was
typically left unscathed in Chapter
9, recent cases suggest that this
trend is unlikely to continue.
Other unique provisions of Chapter 9
may affect the treatment of bond debt
and, by extension, the likelihood of
insurance claims. Bankruptcy Code
Section 904 prohibits a Bankruptcy
Court from interfering “unless the
debtor consents or the plan so provides”
with any of the debtor’s political or
governmental powers, property or
revenues, or use or enjoyment of
income-producing property. In addition,
Section 363, concerning the use or sale
of property, is omitted from Chapter 9.
Thus, a Chapter 9 debtor enjoys wide
latitude to pay prepetition claims on
a current basis or to defer payment
until the effective date of a plan.
affect a bond insurer’s risks and
participation in a particular case.
Further, a Bankruptcy Court cannot
appoint a trustee to manage or
control the debtor, except in very
limited circumstances to pursue
avoidance actions, or compel a
liquidation of municipal assets.
Moreover, only the municipality
can propose a plan of adjustment;
creditor plans are not permitted. The
sole effective remedy for disgruntled
creditors is dismissal of the case.
At one end of the spectrum, insurance
for unsecured GO bonds might have
the highest likelihood of being invoked,
especially if the municipal debtor faces
a true fiscal emergency in which it
must choose between the delivery of
essential public services and payment
of prepetition claims. At the other end,
insurance for revenue bonds might
not necessarily be triggered upon
commencement of a Chapter 9 case.
Therefore, a Chapter 9 debtor has
almost complete discretion (a) to
determine whether and when to file
a bankruptcy case, (b) to manage
its affairs and property during the
pendency of the case, and (c) to
file a plan of adjustment during a
virtually perpetual exclusive period.
Unlike GO bonds, a revenue bond is
secured solely by income generated by
the project financed with the proceeds
of the bond. Although holders of
revenue bonds face the risk of project
failure and lack recourse to municipal
receipts other than the specific revenue
stream pledged, their rights in Chapter
9 are comparatively more favorable
than the rights of a GO bondholder.
Varieties of Municipal Debt
Municipal bond insurance is not
confined to traditional general obligation
(GO) bonds backed by a pledge of
the full faith and credit and taxing
power of the issuer. Rather, insurance
may accompany numerous types of
municipal financing instruments,
including public enterprise revenue
bonds, tax increment and redevelopment
bonds, and financing leases/certificates
of participation, among many others.
The particular rights of a bond
insurer following a default under
any of these instruments may vary
by the type of insured obligation.
Specifically, if a revenue bond qualifies
as a “special revenue” obligation under
Section 902( 2) of the Bankruptcy Code,
the indebtedness will continue to be
serviced, notwithstanding the automatic
stay under Section 362. Five categories
of special revenues are listed in Section
902( 2): (a) receipts from the operation
of water, sewage, waste, or electric
systems, (b) highway or bridge tolls,
(c) user fees, (d) special excise taxes, and
(e) proceeds from project financing.
Chapter 9 affords differing treatment
to various types of municipal bond
debt. This, in turn, may affect the
likelihood that the bond insurer will
be called upon to honor its policy. In
some cases, a municipality’s ability to
impair municipal bond obligations is
significantly limited. In other situations,
the need for continued access to the
capital markets, either to finance a plan
of adjustment or for general operating
purposes following confirmation of
a plan, may counsel a more practical
approach to the adjustment of bond
debt. In any event, the unique features
of municipal debt instruments and the
corresponding provisions of Chapter 9
Bonds secured by statutory liens on tax
revenues might also remain unaffected
in a Chapter 9 case. Generally, a secured
party may obtain a security interest
(i.e., a lien created by agreement) in
after-acquired property of the borrower.
Section 552 of the Bankruptcy Code,
however, terminates the reach of
a security interest in post-petition
property unless the property constitutes
proceeds of the prepetition collateral.
Although Section 552 of the Bankruptcy
Code is applicable under Chapter 9, it
only truncates a lien created under a
security agreement, not one that arises
by operation of law. In many cases,
liens securing bonds issued pursuant
to municipal financing schemes are
created automatically by state law rather
than by contract. As a result, post-petition tax receipts should continue to
serve as collateral for the bondholders.
Last, financing arrangements based
on lease transactions enjoy certain
protections under Chapter 9. Like