Important Differences Between Chapter 9 and Chapter 11 Proceedings

With the economy still lagging and an apparent end to federal assistance for state and local governments, some experts are predicting an increase in chapter 9 bankruptcy filings. Chapter 9 of the Bankruptcy Code provides a rarely used avenue for municipalities and other political subdivisions to obtain relief from creditors. Since its adoption in 1937, there have only been an estimated 620 filings, [1] but 2011 filings are already outpacing those of 2010, [2] with one analyst predicting 100 significant municipal defaults this year. [3] There are even discussions of amending the Code to allow financially troubled states to reorganize their finances under bankruptcy court supervision. [4]

If the predicted increase in municipal filings materializes, more bankruptcy attorneys will find themselves involved in chapter 9 proceedings. Should such an occasion arise, it is important to be aware of several key differences between chapter 9 and chapter 11 practice. Of primary importance is the realization that chapter 9 selectively imports other Code sections. The specific sections applicable to chapter 9 are set forth in § 901. Furthermore, definitions applicable only in chapter 9 cases are set forth in § 902.

The first critical distinction is that a chapter 9 debtor must qualify for relief. The necessary qualifications are set forth in § 109(c). First, the state in which the municipality is located must have specifically granted the specific municipality, or municipalities in general, the ability to avail itself of chapter 9 relief. Roughly half of the states have provided such authorization. [5] A chapter 9 debtor must also be insolvent, desire to adjust its debts and either have reached an agreement with a majority of its creditors, have negotiated in good faith and failed to obtain an agreement, be unable to negotiate because of the number of creditors or reasonably believe that a creditor will attempt to obtain an avoidable transfer if negotiations are attempted.

Once a petition is filed, it is not subject to the normal assignment procedure utilized by the bankruptcy court. Rather, § 921(b) of the Code provides that the chief judge of the court of appeals for the circuit within which the case is commenced must appoint a bankruptcy judge to hear the case. Involuntary chapter 9 cases are not permitted. The automatic stay is made applicable in chapter 9 cases pursuant to § 922(a), and is expanded to prohibit actions against any officer or inhabitant of the debtor if the action seeks to enforce a claim against the debtor or actions to enforce a lien arising from taxes or assessments owed to the debtor.

Pursuant to § 921(c), interested parties may object and the petition may be dismissed if it is found to have been filed in bad faith or if the petition does not meet the requirements established by the Bankruptcy Code. The court must hold a hearing if an objection is filed. [6] Unlike other voluntary cases, § 921(d) provides that an order of relief is not entered upon the filing of the petition, but only upon the court’s determination that the petition will not be dismissed under § 921(c).

Rather than a plan of reorganization, § 941 requires a chapter 9 debtor to file an adjustment plan. There is no statutory deadline for filing and if not filed with the petition, the plan is to be filed at such time as fixed by the court. There is no provision in chapter 9 to allow creditors to move to end exclusivity or to propose a competing plan.

In order to be confirmed, a plan of adjustment must meet seven standards set forth in § 943. Chapter 9, via § 901, also borrows a number of confirmation criteria from chapter 11 cases. As in proceedings governed by chapter 11, a chapter 9 plan must be accepted by all classes of impaired creditors, or if not all classes accept the plan, confirmation is possible if at least one impaired class accepts the plan and the plan is deemed to not discriminate unfairly and to be fair and equitable.

Discharge procedure under chapter 9 also differs from that found in other chapters of the Bankruptcy Code. Section 944(b) provides that discharge is granted only after the plan has been confirmed, the consideration to be distributed under the plan has been deposited with a disbursing agent appointed by the court and the court has determined that any securities deposited with the disbursing agent constitute a valid legal obligation of the debtor and that the provisions made to pay such obligations are valid. The requirement of a judicial determination of the validity of any new bonds issued to retire municipal debt is intended to promote confidence in the bonds, much as an opinion of counsel might be offered to purchasers of corporate or municipal bonds in a public underwriting. [7]

As provided by § 944(a), the discharge is effective against all creditors, regardless of whether they filed a proof of claim and or they voted to accept the plan. Because the Bankruptcy Code is not explicit, there is some dispute as to whether the discharge affects only such debts as existed at the time of filing or if debts incurred through the date of confirmation are included in the discharge. [8] Other characteristics that differentiate chapter 9 practice from other more commonly-used chapters include the following:

• In recognition of the sovereignty of the states and the limitations of the 10th Amendment, a bankruptcy court is prohibited under § 904 from interfering with the debtor’s political or governmental powers, any of the debtor’s property or revenue or the debtor’s use or enjoyment of any income-producing property. The only exceptions are for actions to which the debtor consents or actions that are provided for in the plan of adjustment.
• In the event that the debtor refuses to bring an avoidance action, § 926 allows a creditor to request that the court appoint a trustee to pursue such a cause of action.
• Whereas in a chapter 11 case, security interests in post-petition revenue are terminated pursuant to § 552, § 928(a) provides that in a chapter 9 case, “special revenues” acquired by a debtor after the commencement of a case remain subject to pre-petition security agreements. “Special Revenue,” as defined by § 902(2), includes receipts derived from the operation of utility or transportation systems, excise taxes imposed on particular activities or transactions, tax-increment financing payments and taxes specifically levied to support a particular project or system. However,
  § 928(b) provides that a security interest on special revenues derived from a project or system is subordinate to its necessary operating expenses.
• Section 365 is incorporated into chapter 9, providing a municipal debtor with the authority to assume or reject executory contracts. This authority is not tempered by
  § 1113, which is not incorporated into chapter 9. Section 1113, which places restrictions on a debtor’s rejection of collective-bargaining agreements, was passed in reaction to the Supreme Court’s ruling in NLRB v. Bildisco & Bildisco, [9] which held that rejection of a labor contract in bankruptcy was not a violation of federal law. There is considerable controversy as to the extent a debtor’s ability to reject a collective bargaining agreement is constrained by state law. [10]

It is likely that chapter 9 bankruptcy filings will continue to increase and municipalities will seek advice from commercial bankruptcy attorneys. Practitioners, therefore, should keep in mind these key differences between chapter 9 and chapter 11 practices.