Magazine article The CPA Journal

Navigating Municipal Bankruptcy

Magazine article The CPA Journal

Navigating Municipal Bankruptcy

Article excerpt

Historically, bankruptcy of governmental units has been rare, but in recent years large municipal units such as Detroit, Mich., Jefferson County, Ala., San Bernardino, Calif., and Stockton, Calif., have all filed and successfully exited from Chapter 9 bankruptcy. As with private sector bankruptcies, municipal bankruptcies have important implications for creditors and constituents of financially distressed units. For instance, many Detroit union workers, retirees, suppliers, and employees faced consequences such as the cancellation of existing city contracts and reduction of benefits paid to employees.

CPAs can benefit from having a good understanding of the Chapter 9 process in order to help clients doing business with bankrupt municipal units. This article seeks to shed light on some of the basic peculiarities and challenges of the Chapter 9 process, with an emphasis on Detroit's experience. The article also addresses auditors' associations with municipal units and important timelines involving municipal bankruptcy.

Chapter 9 Filings

Chapter 9 of the United States Bankruptcy Code grants financially distressed municipal units a temporary stay against creditors while the unit develops and negotiates a plan for adjusting its debts to make a fresh start. Even though Chapter 9 is similar to other chapters of the Bankruptcy Code, there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors, because doing so would violate the Tenth Amendment's reservation to the states of sovereignty over their internal affairs (Thomas Moers Mayer, "State Sovereignty, State Bankruptcy, and a Reconsideration of Chapter 9," American Bankruptcy Law Journal, vol. 85, no. 4, http://bit.ly/2mBhsOR). In view of this reservation, bankruptcy courts are generally not as active in managing a municipal bankruptcy as they are in corporate reorganizations under Chapter 11.

Unlike Chapters 7 and 11, Chapter 9 must be voluntarily initiated by the municipal unit, as is the case with Chapter 13 bankruptcy (11 USC 301 and 303). Chapter 9 also differs from Chapter 7 in that Chapter 9 filings, like Chapter 11 filings, involve reorganizations and not a liquidation of assets. Consistent with 11 USC 109(c), only municipalities or their political subdivisions or agencies may file for bankruptcy under Chapter 9; federal governmental units are not eligible.

Once the petition for bankruptcy is filed, creditors are enjoined from pursuing the municipal unit [11 USC 362(a) and 901(a)]. During the period of bankruptcy protection, municipalities are allowed to continue to borrow from creditors; release bonds; raise, collect, and levy taxes; and provide services to constituents. Trustees are rarely appointed in Chapter 9 situations because the municipal unit retains its assets, governance, and right to drafta plan of rehabilitation.

Unlike cases filed under the other chapters of the Bankruptcy Code, the clerk of the bankruptcy court does not automatically assign a case to a particular judge. Instead, the chief judge for the Circuit Court of Appeals for the federal district in which the case is commenced appoints a judge to review the bankrupt unit's petition and plan of adjustment [11 USC 921(a)]. This provision is intended to remove politics from the issue of which judge presides over the Chapter 9 case while assuring the assigned judge has the time and capability to handle the matter.

The role of creditors is limited under Chapter 9. For example, unlike filings under Chapters 7, 11, and 13, there is no first meeting of creditors under Chapter 9 (11 USC 341). In addition, creditors are not allowed to propose competing plans of rehabilitation (11 USC 941). The role of courts is also limited, as the unit's day-to-day activities are not subject to approval by the court, and the unit may continue to borrow money without the court's approval (11 USC 904). The unit may also employ certain professionals to assist without the court's approval, and the fees paid to these professionals are reviewed by the court only within the context of the plan's confirmation [11 USC 901(a)]. …

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