Journal of
Corporate
Renewal
Nov/Dec
2013
barring the city from impairing pension
rights of its retirees, pursuant to the
Michigan constitution. Additionally,
many creditors argued that the city could
have negotiated in good faith with them
but chose not to, in violation of Section
109(c)( 5). The Bankruptcy Court was
expected to be working through these
legal and factual objections to eligibility
at the time of this article’s publication.
A Chapter 9 municipal debtor faces far
fewer changes and restrictions than does
a Chapter 11 debtor in possession. While
many of the provisions of the Bankruptcy
Code are expressly incorporated into
Chapter 9 by Section 901(a) of the
code, which contains a laundry list of
applicable code sections, notably absent
is the concept of a “bankruptcy estate”
or “property of the estate,” as set forth in
Section 541 of the Bankruptcy Code.
The concept of property of the estate
and Bankruptcy Court supervision
over such property generally do not
exist in Chapter 9, due to the 10th
Amendment to the U.S. Constitution
and principles of federalism, which
reserved to the states and, by extension,
to municipalities, sovereignty over
their internal affairs. 5 Accordingly, a
Bankruptcy Court cannot interfere with
the political or governmental powers,
property, or revenues of a municipality. 6
As a result of this limited court oversight,
a municipality is free to use its cash
to pay both pre- and post-petition
creditors, both in and outside of the
ordinary course of its business, and
a Bankruptcy Court is not permitted
to interfere with such payments. In
another major departure from Chapter
11, a municipality in Chapter 9 is not
required to seek court permission to use
cash collateral or obtain financing. 7 A
municipality may borrow money and
incur debt with priority over any or all
administrative expenses or secured by
a lien on the municipality’s property;
however, some state laws restrict the
ability of a municipality to borrow
money to fund operating expenses.
Similarly, because Sections 327-331
are not applicable in Chapter 9,
a municipality does not need court
approval to retain professionals.
Scope of the Automatic Stay
Section 362 of the Bankruptcy Code,
which sets forth the automatic stay
concept, is expressly incorporated
into Chapter 9. In addition to the
protections provided in Section 362,
Section 922(a) of the Bankruptcy
Code expands the automatic stay in
Chapter 9 cases to prohibit: (i) the
commencement or continuation of
legal and other proceedings against
officers and inhabitants of the
municipality that seek to enforce a
claim against the municipality; 8 and
(ii) the enforcement of a lien on or
arising out of taxes or assessments
owed to the municipality. By statute,
the exceptions to the automatic stay
in Section 362(b) do not apply to the
Section 922(a) automatic stay. 9
It is notable, however, that the automatic
stay expressly does not apply to
pledged special revenues for payment
of indebtedness secured by such
revenues. 10 Thus, generally speaking and
subject to certain statutory safeguards,
an indenture trustee or other agent for
such bonds may apply pledged funds to
payments coming due or distribute the
pledged funds to bondholders during
the Chapter 9 case without violating
the automatic stay or an order of the
Bankruptcy Court. This is a significant
departure from Chapter 11, under
which cash generated by a secured
creditor’s collateral can be freely used
by the debtor as long as the debtor
can provide “adequate protection.”
While the Chapter 9 stay may appear
straightforward, court action may be
necessary to tailor the stay to meet
the needs of a specific municipal
debtor. For example, on the first day
of Detroit’s bankruptcy case, the city
filed two motions seeking to clarify
the scope of the automatic stay, both
of which were ultimately granted.
The first motion sought to confirm the
stay with respect to the city’s officers,
including its emergency manager,
and inhabitants. The second motion
sought to extend the stay to: (i) state
entities, including the governor, state
treasurer, and the oversight board that
appointed the emergency manager;
(ii) non-officer employees; and (iii)
other agents of the city. Consequently,
litigation against the state entities and
the emergency manager, and all other
litigation that could have the “direct
or practical effect of denying the
[c]ity the protections of the automatic
stay in [C]hapter 9,” were automatically
stayed by the bankruptcy filing.
Assumption, Rejection
of Contracts
Like a Chapter 11 debtor, a municipality is
permitted to assume or reject executory
contracts and unexpired leases as
part of the exercise of its business
judgment. Also like a Chapter 11 debtor, a
municipality must cure any defaults and
provide adequate assurance of future
performance if it seeks to assume an
executory contract or unexpired lease.
Conversely, a contract that is rejected is
treated as a prebankruptcy breach, giving
rise to an unsecured claim for damages.
A municipality is not required to
follow the steps for rejecting collective
bargaining agreements set forth in
Section 1113 of the Bankruptcy Code,
which requires, among other things,
specific negotiations with the union.
Section 1113 is not incorporated in
Section 901(a) of the code and, thus,
is not applicable in Chapter 9. 11
Rather, to reject a collective bargaining
agreement, courts and commentators
generally agree, a municipality only
needs to satisfy the test set forth in
the U.S. Supreme Court’s landmark
Bildisco decision, specifically: (i) that
the collective bargaining agreement
burdens the estate, (ii) that after
careful scrutiny the equities balance
in favor of contract rejection, and
(iii) that reasonable efforts to negotiate
a voluntary modification have been
made and are not likely to produce a
prompt and satisfactory solution. 12
Exit Strategy
The purpose of a Chapter 9 is to provide
a means to restructure and adjust
debt through a “plan of adjustment.” 13
Liquidation is not an alternative for
a municipality in Chapter 9. Unlike a
debtor in Chapter 11, a municipality in
Chapter 9 retains the exclusive right
to file a plan of adjustment through
the case, and creditors may not file a
competing plan. Once again, this is
due to 10th Amendment concerns.
Generally speaking, confirmation
of a plan of adjustment resembles
confirmation of a plan of reorganization
under Chapter 11 with respect to contents
of a plan, impairment, disclosure and
solicitation, acceptance, confirmation,
feasibility, compliance with the
Bankruptcy Code, and cram down
(i.e., the plan is in the “best interests of
creditors,” 14 is “fair and equitable,” and
does not “discriminate unfairly”).
Chapter 9 also imposes additional
requirements, including: (i) the plan
must comply with the provisions of
Chapter 9; (ii) any amounts to be paid by
the municipality or any third party under
the plan for services or expenses in the
case must be reasonable; and (iii) any
continued from page 17
