Creditors face a challenge at the start of a Chapter 9 municipal restructuring case
for which even repeated experience
in business reorganizations may
not have prepared them. 1
While creditors in Chapter 11 have
multiple opportunities to exert leverage
over a debtor, there is one part of a case
over which they have almost no say: its
commencement. So long as the debtor
is not barred outright from bankruptcy
relief (like a bank or an insurance
company), it need not affirmatively
establish its eligibility to be a debtor;
the filing of its petition constitutes an
“order for relief,” authorizing the case to
proceed. The equitable “bad-faith filing”
doctrine notwithstanding, creditors
are usually well-advised to fight for
their interests on another battlefield.
borrowing; appoint a trustee to replace
the debtor’s governing body; or “prevent
a [C]hapter 9 debtor from spending its
money for any reason, even foolishly
or in a manner that disadvantages other
creditors . . . .” In re City of Stockton,—
B.R.—, 2013 WL 611060, at 4 (Bankr. E.D.
Cal. Feb. 5, 2013) (emphasis added).5
Nor can objecting parties put the brakes
on by appealing eligibility. Once the
court finds a debtor eligible for Chapter
9, it must enter an order for relief (code
§921(d)) and may not stay or otherwise
delay proceedings on account of an
appeal of that order. Code §921(e).
as the power to tax, to condemn property
by eminent domain, and to assert
sovereign immunity; ( 2) the extent of
the state’s, city’s, or county’s operational
control, as opposed to mere regulatory
authority, over the entity; and ( 3) the
state’s own treatment of the entity. Id. at
788-89. Applying these tests, the court
held that the monorail company lacked
the characteristics of a true municipality.
Id. at 795-800 (permitting the company’s
case to continue under Chapter 11).
The reverse is true for creditors of
municipalities seeking relief under
Chapter 9. A would-be Chapter 9 debtor
must satisfy six separate prerequisites
for eligibility. 2 The court must hear
objections to eligibility early in the
case and dismiss the case if the debtor
cannot establish each prerequisite
by a preponderance of the evidence.
So, the first contest creditors and
debtors should be prepared for in
a Chapter 9 case is about whether
there can be a Chapter 9 case at all.
Eligibility disputes can be lengthy and
costly. Objectors may raise multiple
fact-intensive challenges, requiring
extensive discovery. As of this writing,
the California cities of San Bernardino
and Stockton have each spent over half
a year in U.S. Bankruptcy Court, most of
it litigating with creditors over their right
to be there. An examination of Chapter
9’s eligibility requirements shows why
those disputes are so complicated and
what questions a municipality should
be prepared to answer—and creditors to
contest—in the face of a Chapter 9 filing. 6
Other courts apply less detailed tests. A
year after the Las Vegas Monorail case,
a South Carolina court in Connector
2000 Ass’n, Inc., 447 B.R. 752 (Bankr.
D.S.C. 2011), considered a similar type
of hybrid debtor: a nonprofit “public
benefit corporation” that operated a
toll road in the state. The court easily
determined that the debtor was a
municipality, because it was “subject to
control by public authority” (the state
transportation department) and was
“formed to assist the [department] with …
financing, design, construction, and all
other aspects” of the toll road. Id. at 758.
Moreover, disputing eligibility in
Chapter 9 may be a creditor’s single
best opportunity to influence or derail a
distressed municipality’s restructuring.
The 10th Amendment to the U.S.
Constitution3 limits the degree to
which the federal government may
impose its power on a state without
the state’s consent. Chapter 9 takes
federalism seriously: states retain
ultimate control over municipalities,
code §9034, and, without the municipal
debtor’s consent, the court “may not . . .
interfere with . . . the [debtor’s] political
or governmental powers[, its] property
or revenues[, including] income-producing property,” code §904.
What Is a ‘Municipality?’
Relief under Chapter 9 is available
only to a “municipality,” defined as a
“political subdivision or public agency or
instrumentality of a State.” Code §101( 40).
Cities and counties doubtless qualify,
but most Chapter 9 filers are smaller,
discrete entities, such as public utility
districts, school districts, hospitals, and
transportation agencies, for which the
definition leaves room for interpretation.
Similarly, a New York Bankruptcy Court
determined that the New York City
Off-Track Betting Corporation, created
as a “public benefit corporation” to
funnel revenue to the city and state,
qualified as a municipality. In re New
York City Off-Track Betting Corp., 427
B.R. 256, 265-66 (Bankr. S.D.N. Y. 2010).
Particularly vulnerable to challenge
under the code’s definition are debtors
that bear the characteristics of both
public and private entities. The debtor
in In re Las Vegas Monorail Co., 429 B.R.
770 (Bankr. D. Nev. 2010), was one such
hybrid: a private, nonprofit, tax-exempt
corporation formed to provide the public
benefit of expanding and operating
the Las Vegas monorail system.
If a putative debtor is not obviously a
city, county, or other political subdivision
of a state, interested parties should
closely examine the authority under
which it was created, its purposes, its
treatment under state law, and its ability
to avail itself of traditional governmental
powers and any limitations on those
powers. The Chapter 9 petition may
be vulnerable to challenge at this
first step in the eligibility analysis.
Together, these provisions severely
restrict the ability of courts and interested
parties to affect the progress of a
Chapter 9 case. For example, absent
consent, the court may not prevent
or condition the use, sale, or lease of
municipal property; restrict unsecured
From a scholarly survey of statutory and
legislative history, the court distilled
a three-part inquiry for determining
whether an entity is a municipality
under the code: ( 1) the extent to
which the entity possesses traditional
governmental powers or attributes, such
Is a Debtor ‘Specifically
Authorized’ to File Chapter 9?
Similarly, creditors should closely
analyze the source and scope of
the state authorization relied upon
by the debtor. A municipality may
petition for bankruptcy relief only
if its state has voluntarily submitted
to that exercise of federal power.