Restructuring a Municipality in Chapter 9

Report
Beyond City Limits:
Restructuring a Municipality
in Chapter 9
Laura Day DelCotto, Esq.
DelCotto Law Group PLLC
[email protected]
859-231-5800
www.dlgfirm.com
Lexington I Somerset I Frankfort I Danville
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Today’s Economic Climate
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Why?
 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
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Why? (cont.)
 Demographics
 Kentucky Fried Pensions
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Why? (cont.)
 Show me the MONEY
http://www.timeplots.com/
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Why? (cont.)
 Denial/Fear
 Extend and Pretend
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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
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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?
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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
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Cost/Benefit Analysis:
More Assessment Factors

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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”
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Recently Filed Cases
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Detroit
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 “Zone of Insolvency” Duties
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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
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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)
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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; and
5) 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.
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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.
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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
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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
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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
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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
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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
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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
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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?
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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.
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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
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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?
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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
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Retention of Professionals
In 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
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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
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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.”
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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
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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 nonbankruptcy law
 Confirmation Requirements of§943(b)
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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
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 EMBRACE REALITY
 EXHIBIT LEADERSHIP
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“Out of clutter, find simplicity.
From discord, find harmony. In
the middle of difficulty, lies
opportunity.” – Albert Einstein
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“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
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