beyond city limits: restructuring a municipality in chapter 9

Lexington I Somerset I Frankfort I Danville www.dlgfirm.com

Beyond City Limits: Restructuring a Municipality in Chapter 9

Laura Day DelCotto, Esq.DelCotto Law Group PLLC

[email protected]

www.dlgfirm.com


Today’s Economic Climate


Despite media reports, it’s not over yet; slow economic recovery and weak job growth expected even as the recession ends

Protracted weakness of real estate projected—slow recovery expected along with “structural” changes

Housing market still in recovery; residential values will take many years to return to 2006 levels, with great geographic disparity

Changing consumer behavior—lower retail spending will significantly affect numerous businesses/industries

Why?


Why? (cont.) Demographics Kentucky Fried Pensions


Why? (cont.)

Show me the MONEYhttp://www.timeplots.com/


Why? (cont.)

Denial/Fear Extend and Pretend


Effects on Municipalities

Squeezed between costs of providing basic services and flat or declining revenues

Squeezed by budgeted revenues not meeting budgeted expenditures, and insufficient reserves to cover shortfall

Payroll costs and employee benefits are often a key component of a municipality's fiscal stress

“Exotic” financial instruments behaving unpredictably, causing borrowing costs to increase

Municipal credit suffering an eroding tax base as a result of the stalled housing market and consumer distress

Unfunded Mandates


Cost/Benefit Analysis:Why Would a Municipality File a Chapter 9?

Burdensome contracts - labor, supplies, etc.

Pension and OPEB renegotiation

Health insurance costs for current workers

Restructuring debt

Other factors that apply in Chapter 11 (vs. Chapter 9)

Creates forum for all parties

Who will exhibit Leadership?


Cost/Benefit Analysis:Why Would a Municipality Avoid Chapter 9? Stigma/Fear

Future access to debt markets

Unpredictability of court proceedings• Compounded by lack of Chapter 9 case law

Public nature of court proceedings

Greater scrutiny and influence of outside parties• Independent federal court judge• Creates forum for all parties


Cost/Benefit Analysis:More Assessment Factors Better to resolve problems outside of bankruptcy if

at all possible – yes and no Transparency ID in clear terms specific factors that are driving

revenues down and/or expenses up Communicate scope and nature of challenges to all

potentially impacted stakeholders May be necessary for the municipality's

management to engage in extensive labor negotiations with assistance of labor attorneys

Restructure creditors’ long term debt - consensual vs. cram down

Make the hard decisions about ongoing programs and projects-- postponing, scaling back & cancelling to free up cash

Press/”Public Relations”


Recently Filed Cases


Detroit


“Zone of Insolvency” Duties


Preparing for Chapter 9 “Good faith negotiations” with creditors and

stakeholders legal prerequisite to filing a Chapter 9 case

Continued negotiations with key constituencies

Analyze all possible options: short term fixes and long term exit strategies


Eligibility – Who can File? An entity that is eligible for chapter 11 is generally not eligible for chapter

9, and vice versa Knox County Hospital Adair County Hospital District Seven Counties

Only a “municipality” may file for chapter 9, whereas only a “person” may file for chapter 11

Absent certain narrow exceptions, 11 U.S.C. section 101(41) defining “person” excludes “governmental units”

Section 303 expressly limits chapter 9 to voluntary proceedings (no risk of involuntary filing)


Eligibility – Who can File?To be eligible, must satisfy all of the following [11 U.S.C.§109(c)]:

1) Must be a “municipality”: Means “political subdivision or public agency or instrumentality of a State” [11 U.S.C.§101(40)];

2) Must be “specifically authorized” under state law to be a debtor under federal bankruptcy law;

3) Must be insolvent – unable to or not paying debts as they come due (cash flow test);

4) Must desire to “effect a plan to adjust” its debts; and5) Must (A) have obtained the agreement of majority of each impaired class

of creditors, or (B) have negotiated in good faith with its creditors and failed to obtain agreement of majority within each class, or (C) be unable to negotiate with creditors because such negotiation is impracticable, or (D) must ”reasonably believe” that a creditor may attempt to obtain an avoidable preferential transfer.


Eligibility – What is a Municipality?A “municipality” is a “political subdivision or public

agency or instrumentality of a State.”Courts determine whether a petitioner is a

municipality by evaluating whether the petitioner:• Was created with the sovereign powers of the state,

such as the power to sue and be sued, issue bonds, levy and collect;

• Is subject to control by a state or municipal authority; or

• Would have fallen within the jurisdiction of the bankruptcy courts under prior bankruptcy statutes.


Eligibility – Is the Municipality Specifically Authorized? Pursuant to section 109(c)(2), a municipality may only file

a chapter 9 case if it has been specifically authorized to do so under state law

KRS Chapter 66

A state may specifically authorize a municipality “in its capacity as a municipality or by name.”

A state statute authorizing its subdivisions to commence bankruptcy adequately satisfies requirement of specific authorization


Eligibility – Is the Municipality Insolvent? Pursuant to sections 109(c) and 101(32)(C), a

municipality must show, as of the date of filing, that it is either:• Generally not paying its debts as they become due

unless such debts are the subject of a bona fide dispute; or

• Unable to pay its debts as they become due


Eligibility – Is the Municipality Insolvent? (cont.) Insolvency Test #1: generally not paying its debts as

they become due Courts view this as a flexible standard, requiring:

Consideration of the totality of the circumstances; and

A balancing of the interests of the debtor and its creditors/stakeholders


Eligibility – Is the Municipality Insolvent? (cont.) Insolvency Test #2: unable to pay its debts as they become

due.

Courts consider a cash-flow basis; i.e., the municipality must show that debt payments would cause a negative cash balance

This test further requires certainty that debts will not be met – a mere possibility that the municipality is cash-flow negative will not satisfy this test


Eligibility – The Intent Based Requirements

Chapter 9 eligibility also requires a municipality: Act in good faith; and Evidence a desire to effect a plan to adjust its debts

These intent based requirements generally impose a duty on a municipality to negotiate with creditors and propose a settlement if feasible both before and after its chapter 9 petition


Eligibility – The Intent Based Requirements (Cont.)

There are four independent statutory tests for good faith under section 109(c)(5).

A court will conclude a municipality filed in good faith if it: Has obtained the agreement of creditors holding at least a majority in

amount of the claims of each class that such entity intends to impair under a plan;

Has negotiated in good faith with creditors and has failed to obtain the agreement of creditors holding at least a majority in amount of claims of each class that such entity intends to impair under a plan;

Is unable to negotiate with creditors because such negotiation is impracticable; or

Reasonably believes that a creditor may attempt to obtain a transfer that is avoidable under 11 U.S.C.§547


Eligibility – The Intent Based Requirements (Cont.) There is no statutory language to determine whether

a municipality desires to effect a plan to adjust its debts. Courts interpreting this requirement have considered the following questions: Does the municipality have debts that could be adjusted in

a plan? Has the municipality proposed a reasonable settlement

with its creditors? Has the municipality administered its case in a reasonably

timely manner?


Role of Bankruptcy Court

Role of a Chapter 11 Court A debtor’s business in a chapter 11 case is

generally subject to review of the bankruptcy court under a business judgment standard.

Additionally, a chapter 11 debtor must obtain the approval of the court to, among other things, use cash collateral outside of the ordinary course of business.


Role of Bankruptcy Court

Role of a Chapter 9 Court Bankruptcy Code provides that the Chief Judge of the

Circuit in which the case is filed shall assign a judge to each Chapter 9 case

Sections 903 and 904 work in tandem to curtail a court’s ability to control a municipality’s governance and spending/constitutional –state sovereignty issues

Bankruptcy court has the discretion to approve or reject a plan, or dismiss the case for cause on its own initiative, after notice and a hearing under sections 930 and 943


Commencement of a Chapter 9 Case

In addition to filing the petition itself, the municipality must file a number of pleadings in order to initiate the bankruptcy case

Creditors list List of Creditors Holding the 20 largest

unsecured claims (“Top 20” List) Pleadings establishing eligibility Notice by publication – 11 U.S.C.§923 11 U.S.C. § 103(f) and 11 U.S.C. 901 – what

else within the Bankruptcy Code applies?


Automatic Stay in Ch. 9

In all chapter cases, once a petition is filed there is an automatic stay on all actions to collect against the debtor under 11 U.S.C.§362.

In a chapter 9 case, Section 922: Incorporates all of the protections of the automatic stay of

§362; and Stays actions against an officer or inhabitant of the debtor and

actions to enforce liens or assessments owed to the debtor. Note: The §922 stay does not operate to stay the

application of pledged special revenues to indebtedness secured by such revenues


Retention of ProfessionalsIn a chapter 11 case:

Applications for employment of professionals must be filed and require approval of the bankruptcy court

Interim and final payments to professionals during the course of a chapter 11 process require notice and court approval

In a chapter 9 case: No required approval process for employment or

fees


Official Committees

The United States Trustee for the relevant district may appoint a committee or committees to represent the interests of creditors holding similar classes of claims. Section 901(a) and Section 1102


Preparing the Chapter 9 Plan of Adjustment Plan Process

Exclusivity in Filing/Modifying a Plan In a chapter 11 case: The debtor has the exclusive

right, for a statutorily prescribed period, to file a plan; and after this period has expired, or a trustee has been appointed, any party in interest may file a plan.

In a chapter 9 case: only the debtor may file or modify a plan at any time.

Despite exclusivity, a chapter 9 debtor does operate under time constraints in filing a plan “as the court fixes.”


Plan of Adjustment Plan of Adjustment

Classifies claims according to their legal priority under state and federal law

As to each class of similar claims, the plan provides a “treatment” for how that class of claims is to be satisfied

Must be confirmed by vote of creditors and Court order

The Disclosure Statement Issued with the proposed Plan of Adjustment Includes an overview of the plan, treatment of claims, financial

projections Ballots

Each class must vote in favor: requires ½ in number and 2/3 in $ value of each class

Cramdown


Plan Confirmation As in chapter 11, plan confirmation in a chapter 9

case requires a proposed plan to be feasible and in the best interests of creditors per §943 Feasible “Best Interest of Creditors” – best of all reasonably

possible alternatives. Chapter 9 test differs from “better than liquidation” test for chapter 11 debtors

Regulatory or electoral approval under non-bankruptcy law

Confirmation Requirements of§943(b)


Discharge Under §944, upon confirmation, a chapter 9 plan is binding on all

creditors who had actual notice or knowledge of the chapter 9 case, and the debtor is discharged from all debts except those debts that are excepted from discharge by the plan.

Chapter 9 creditors must have notice or actual knowledge of the case. Ensure that all entities get notice of chapter 9 case.

Emergence: the municipality emerges from chapter 9 with all of the rights and powers established under state law and under the terms of the plan

Perform confirmed plan – often years in to future


EMBRACE REALITY EXHIBIT LEADERSHIP


“Out of clutter, find simplicity. From discord, find harmony. In

the middle of difficulty, lies opportunity.” – Albert Einstein


“The beauty of the soul shines out when a man bears with composure one heavy mischance after another, not because he does not feel them, but because he is a man of high and

heroic temper.” – Aristotle

beyond city limits: restructuring a municipality in chapter 9

Documents