When cities file for bankruptcy
COMPTON—The city of Compton has until Sept. 1 to decide whether it should file for bankruptcy under Chapter 9, Title 11 of the United States Bankruptcy Code.
California is among at least 27 states that allow municipalities to file for Chapter 9 bankruptcy protection.
Chapter 9 is available only to municipalities or public service agencies to assist them in the restructuring of debts.
It is similar to other forms of bankruptcy but has some unique characteristics because cities are entities of state governments, and the power of Congress in municipal matters is limited by the 10th and 11th Amendments.
An important difference between Chapter 11 and Chapter 9 is that it increases the city’s ability to re-write collective bargaining agreements. It specifically allows cities to renegotiate unsustainable pension benefit packages.
The purpose of Chapter 9 is to provide a financially-distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts by extending debt maturities, reducing the amount of principal or interest or refinancing the debt with a new loan.
Cities and towns across the U.S. have been struggling under soaring costs for labor including pensions and retiree health benefits, while sales- and property tax revenue plunged after the longest recession since the 1930s.
High pension costs have been cited as a part of the reason for a flurry of bankruptcy filings that have occurred recently. Some economic experts think the upsurge in municipal bankruptcy filings could be due in part to a lessening of the stigma attached to the action.
“It’s still no honor to be a Chapter 9 debtor, but if it’s your only alternative, that’s what you do,” said Marc Levinson, the bankruptcy attorney for Stockton and for Vallejo, a city of 120,000 in the San Francisco Bay area that filed for court supervision in 2008.
San Bernardino, a community of 209,000, Stockton and Mammoth Lakes have all recently agreed to seek court protection from their creditors, the first such filings since 2008.
Stockton, a community of 292,000 east of San Francisco, entered bankruptcy on June 28. Mammoth Lakes, a mountain resort of 8,200, sought protection July 3, saying it can’t afford the $43 million it owes on a legal judgment, more than twice the size of its annual general-fund spending.
A bankruptcy filing can increase the cost of borrowing or make it more difficult to access the capital markets in the future.
The bankruptcy court in Chapter 9 filings is not as active in managing a municipal bankruptcy case as it is in corporate reorganizations under chapter 11.
The functions of the bankruptcy court in Chapter 9 cases are generally limited to approving the petition if the debtor is eligible, confirming a plan of debt adjustment and ensuring implementation of the plan. As a practical matter, however, the municipality may consent to have the court exercise jurisdiction in many of the traditional areas of court oversight in bankruptcy, in order to obtain the protection of court orders and eliminate the need for multiple forums to decide issues.
In order to be eligible for Chapter 9 protection a municipality must be specifically authorized to be a debtor by state law or by a governmental officer or organization empowered by state law to make such an authorization. It must be insolvent, it must desire to effect a plan to adjust its debts, and it must negotiate in good faith with creditors and fail to obtain the agreement of creditors holding at least a majority or the debt.
The role of creditors is also more limited in Chapter 9 than in other cases. There is no first meeting of creditors, and creditors may not propose competing plans. If certain requirements are met, the debtor's plan is binding on dissenting creditors. A Chapter 9 debtor has more freedom to operate without court-imposed restrictions.
A municipal debtor has broad powers to use its property, raise taxes and make expenditures as it sees fit. It is also permitted to adjust burdensome nondebt contractual relationships under the power to reject executory contracts and unexpired leases, subject to court approval. Municipalities may also reject collective bargaining agreements and retiree benefit plans without going through the usual procedures required in Chapter 11 cases.
A municipality has authority to borrow money during a Chapter 9 case as an administrative expense. This ability is important to the survival of a municipality that has exhausted all other resources. A Chapter 9 municipality has the same power to obtain credit as it does outside of bankruptcy. The court does not have supervisory authority over the amount of debt the municipality incurs in its operation. The municipality may employ professionals without court approval, and the professional fees incurred are reviewed only within the context of plan confirmation.
The first municipal bankruptcy legislation was enacted in 1934 during the Great Depression. Although Congress took care to draft the legislation so as not to interfere with the sovereign powers of the states guaranteed by the 10th Amendment to the Constitution, the Supreme Court held the 1934 Act unconstitutional as an improper interference with the sovereignty of the states.
Congress enacted a revised Municipal Bankruptcy Act in 1937. The law has been amended several times since 1937. In the more than 60 years since Congress established a federal mechanism for the resolution of municipal debts, there have been fewer than 500 municipal bankruptcy petitions filed. Such filings by a large municipality can— like the 1994 filing by Orange County—involve many millions of dollars in municipal debt.