Why (Not) Chapter 9 Bankruptcy?

This post is authored by Benjamin Chapple.

On September 6, 2012, Institute Professor Juliet Moringiello gave a CLE presentation titled “Why (Not) Chapter 9?“.  Professor Moringiello explained that in the past two years there have been a number of notable Chapter 9 bankruptcies, involving municipalities such as: Central Falls, Rhode Island, Harrisburg, Pennsylvania, Jefferson County, Alabama, and Mammoth Lakes, California.

The professor explained that Chapter 9 bankruptcies are rarely filed in large part for two reasons: (1) a paucity in case law creates uncertainty regarding how the bankruptcy will result; and (2) the statutory eligibility requirements of 11 U.S.C. § 109(c). One eligibility requirement to note is that the municipality must be specifically authorized by state law, or by a competent state government official or organization before it can file for bankruptcy.  While twenty four states have no authorizing legislation, and one state—Georgia—has legislation prohibiting Chapter 9 bankruptcies, the level at which the remaining twenty five states are authorized varies. It was explained that this authorization requirement is in place to address Tenth Amendment concerns, because a municipality is a creature of its states and entering bankruptcy places the municipality under the jurisdiction of the federal government.

Professor Moringiello’s presentation also identified and explained the delicate constitutional balance that exists between the federal and state government—specifically as a result of the Tenth Amendment, Contracts Clause, and Bankruptcy Clause. After addressing the constitutional implications of Chapter 9 bankruptcies, non-bankruptcy debt collection alternatives were discussed.

Professor Moringiello explained throughout her presentation that most interested parties advocate for either state or federal control; thus, finding that there cannot be state and federal cooperation. Professor Moringiello discussed the deficiencies of relying on Chapter 9 alone, and concluded that currently Chapter 9 is an incomplete rehabilitation tool.  Chapter 9 is incomplete because (1) Code sections outside of Chapter 9 apply in Chapter 9 only if included under § 901, and therefore Chapter 9 does not incorporate all of the provisions of Chapters 1, 3 and 5; (2) in Chapter 9 bankruptcies the municipality (debtor) maintains exclusive control over its filing, plan, and use of its assets; and (3) unlike other types of bankruptcy, there is no possibility that a trustee or examiner will be appointed.

Professor Moringiello concluded that the optimal approach is for state and federal cooperation because state involvement, she argues, can ameliorate some of the Chapter 9 deficiencies noted above. Specifically, the professor advocates that states could, and should serve as a check on its municipality’s behavior since a trustee cannot be appointed.

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