Memorandum

Re: Introduction to Chapter 9 and Related Proposals


National Bankruptcy Review Commission

One Columbus Circle N.E., Suite 5-130 ¶ Washington, D.C. 20544 ¶ 202-273-1813 ¶ Fax: 202-273-1048 ¶ e-mail :nbrchq@erols.com

Web Site: www.nbrc.gov

MEMORANDUM

TO:National Bankruptcy Review Commission

Professor Elizabeth Warren

Professor Lawrence P. King

FROM:Stephen H. Case

Elizabeth I. Holland

DATE:March 17, 1997

RE: Introduction to chapter 9 and Related Proposals

____________________________________________________________________________

Introduction

Municipal bankruptcy relief is a relatively recent addition to the federal bankruptcy scheme. For more than one hundred and forty years after the adoption of the Constitution, no municipal bankruptcy legislation existed either on the federal or state level. [ FN: For a complete discussion of the municipal creditors ’ remedies that were available prior to 1933, see Michael W. McConnell & Randal C. Picker, When Cities Go Broke: A Conceptual Introduction to Municipal Bankruptcy , 713 PLI/Comm 35 (March 1995).] Debt restructuring legislation could not exist on the state level, because the states are prohibited from impairing contract obligations under the Contracts Clause of the Constitution. [ FN: Id. at 39-40, citing Hanover Nat ’l Bank v. Moyses , 186 U.S. 181, 188 (1902) ( "[C]ongress ’s power under the Bankruptcy Clause includes the power to discharge the debtor from his contracts and legal liabilities, as well as to distribute his property. The grant to Congress involves the power to impair the obligations of contracts, and this the States were forbidden to do. ")] Federal legislation relating to municipal bankruptcy was similarly hamstrung by Tenth Amendment considerations of state sovereignty.

It was not until the early 20th century that overwhelming economic crises demanded this legislative vacuum be filled. The land development boom of the 1920s followed by the depression of the 1930s sent over 2,019 municipalities, counties and other governmental units into default on their obligations. [ FN: Ashton v. Cameron County Water Improvement District , 298 U.S. 513, 533-34 (1936) (Cardozo, J., dissenting) (citing the "breadth and depth " of the municipal fiscal crises).] In response, Congress enacted temporary emergency legislation to help these municipalities restructure their debt. [ FN: The Bankruptcy Act of 1898, 30 Stat. 544 was amended to include chapter IX, titled "Provisions for the Emergency Temporary Aid of Insolvent Public Debtors and to Preserve the Assets Thereof and for Other Related Purposes ." See 48 Stat. 798 (1934).] This emergency relief was held unconstitutionalby the Supreme Court in Ashton v. Cameron County Water Dist. finding that chapter IX impermissibly interfered with a state’s sovereignty. [ FN: 298 U.S. 513, 532 (holding that chapter IX of the Bankruptcy Act was unconstitutional; Congress ’ enactment of a municipal debt restructuring statute impermissibly abridged a state ’s sovereignty) .] The constitutional faults were remedied [ FN: chapter IX was redesignated as chapter X by the Municipal Corporation Bankruptcy Act, Pub. L. No. 302, 75th Cong., 1st Sess., 50 Stat. 653 (1937). The principal differences between the two were a reduction in the number of consents needed for confirmation of a plan, from 75% to 66.66%, and a small expansion of protection for states ’ sovereign immunity. The Committee Reports succinctly acknowledged the narrow line municipal bankruptcy legislation treads between the states ’ limitation under the Contract Clause and the federal government ’s limitation under principles of state sovereignty. There is no hope for relief through statutes enacted by the States, because the Constitution forbids the passing of State laws impairing the obligations of existing contracts. Therefore relief must come from Congress, if at all. The Committee is not prepared to admit that the situation presents a legislative no man ’s land. ... It is the opinion of the Committee that the present bill removes the objections to the unconstitutional statute, and gives a forum to enable those distressed taxing agencies which desire to adjust their obligations and which are capable of reorganization, to meet their creditors under necessary judicial control and guidance and free from coercion, and to affect such adjustment on a plan determined to be mutually advantageous. H. Rep. No. 517, 75th Cong., 1st. Sess. (1937); S. Rep. No. 911, 75th Cong., 1st. Sess. (1937). Chapter X was redesignated as chapter IX in the 1938 Chandler Act amendments to the Bankruptcy Act, Pub. L. No. 696, 75th Cong., 2d Sess., §3(a), 52 Stat. 840, 939 (1938).] and Congress’ second attempt to provide municipal bankruptcy relief was upheld. [ FN: United States v. Bekins , 304 U.S. 27 (1938) (holding the Municipal Corporation Bankruptcy Act constitutional under both the Fifth and the Tenth Amendments).] Congress extended the sunset provision twice before making chapter IX a permanent part of the Bankruptcy Act in 1946. [ FN: See Pub. L. No. 481, 79th Cong., 2d Sess., §2, 60 Stat. 409, 416 (1946) (amending sections 81, 82, and 83, and repealing section 84 of chapter IX).]

I. Statutory Background

A. 1976 Amendments to chapter IX

chapter IX remained virtually "unchanged and virtually unused for thirty years." [ FN: 4 Collier on Bankruptcy ¶ 900.01[4], at 900-7 (Lawrence P. King et al. eds., 15th ed. 1996) (citing H.R. Rep. No. 94-686, 94th Cong., 1st Sess. 4 (1975)).] In response to New York City’s fiscal crisis in the 1970s, chapter IX was revised in 1976 to permit a large municipality to restructure its debt without having to comply with certain requirements, which would have made a large municipal debtor’s filing under chapter IX all but impossible. Amendments included an automatic stay upon the filing of a chapter IX petition [ FN: Bankruptcy Act of 1898, §85(e)(1) (repealed 1978).] as well as a provision permitting a debtor to file if prepetition negotiation with each class of its creditors wasimpractical. [ FN: Id. at §84(3) (repealed 1978).] The 1976 amendments to chapter IX were part of the process of bankruptcy law reform that culminated in the 1978 Bankruptcy Code. "Thus, the 1976 revision was incorporated into the Bankruptcy Code in almost identical form and substance." [ FN: Collier , ¶ 900.01[4], at 900-9.]

B. Current Provisions of chapter 9

1. Eligibility for Relief

Only municipalities, defined as a "political subdivision or public agency or instrumentality of a state", are eligible for chapter 9. [ FN: 11 U.S.C. §101(40) (1996).] A municipality must satisfy four threshold requirements in order to obtain chapter 9 relief: [ FN: Id. at §109(c).]

1. Have specific state authorization to be a debtor under chapter 9; [ FN: The 1994 Amendments to chapter 9 changed the pre-approval requirement from "general " to "specific " state authorization of the municipality "in its capacity as a municipality or by name ." 11 U.S.C. §109(c)(2) (1994). Twelve states have specifically authorized their municipalities to file for chapter 9 relief: Alabama (Ala. Code §11-81-3); Arizona (Ariz. Rev. Stat. Ann. §35-603); Arkansas (Ark. Code Ann. §14-74-103); California (Cal. Gov ’t Code §43739); Colorado (Colo. Rev. Stat. §32-1-140); Florida (Fla. Stat §218.01); Idaho (Idaho Code §67-3903); Kentucky (Ky. Rev. Stat. Ann. §66.400); Montana (Mont. Code Ann. §7-7-4111); Oklahoma (Okla. Stat. tit. 62, §283); South Carolina (SC Code Ann. §6-1-10); and, Texas (Tex. Local Gov ’t Code Ann. §140.001). Only Georgia has specifically barred its municipalities from chapter 9 relief. Ga. Code Ann. §36-80-5.]

2. Be insolvent; [ FN: Municipal insolvency is defined as "financial condition such that the municipality is-- (i) generally not paying its debts as they become due unless such debts are the subject of a bona fide dispute; or (ii) unable to pay its debts as they become due " 11 U.S.C. §101(32)(C) (1996).]

3. Desire to effect a plan to adjust its debts; [ FN: 11 U.S.C. §109(c)(4) (1996).] and

4. Must satisfy one of four alternatives:

a. Has obtained the consent of at least a majority in amount of impaired claimholders under the proposed plan; or

b. Has negotiated in good faith but has failed to reach any agreement with a majority of the impaired claimholders under the proposed plan; or

c. Negotiation with such claimholders is impractical; or

d. Has a reasonable belief that a creditor may attempt to obtain a preference. [ FN: Id. at §109(c)(5).]

2. Scope of Relief Granted

Statutory confusion exists over whether a chapter 9 petition constitutes an order for relief. Despite the incorporation of section 301, which states that the filing of a voluntary petition constitutes an order for relief, [ FN: 11 U.S.C. §301 (1996).] section 921(d) states that if the judge does not dismiss the municipal petition on good faith grounds or for failure to meet the other requirements of chapter 9, an order for relief will be entered. [ FN: Id. at §921(d) ( "If the petition is not dismissed under subsection (c) of this section, the court shall order relief under this chapter. ")] Commentators agree that "[t]here should be no need for the court to actually enter an order for relief. Requiring the actual entry of an order for relief could result in unnecessary delay and could impair the administration of the case." [ FN: David S. Kupetz, Municipal Debt Adjustment Under the Bankruptcy Code , 27 Urb. law. 531, 557 (Summer 1995) (citing 4 Collier on Bankruptcy ¶ 921.04, 921-6 (15th ed. 1994) "That language [set forth in Section 301] should make it unnecessary for the court to enter an ‘order for relief ’ under section 921(d). The only issue upon an objection should be whether the court dismisses the petition or overrules the objection. ")]

The use of the language "after the order for relief" in other parts of the Bankruptcy Code exacerbates this confusion. A creditor is defined as "an entity that has a claim against the debtor that arose at the time of or before the order for relief". [ FN: 11 U.S.C. §101(10)(A) (1996).] A number of time periods applicable in chapter 9 begin to run upon the entry of an order for relief. For example, the debtor’s time to commence certain avoidance actions is limited to the later of (among other things) two "years after the entry of the order for relief." [ FN: Id. §546(a)(1)(A).] In addition, creditors’ committee formation by the US trustee can not begin until after the entry of the order for relief. [ FN: Id. §1102(a)(1).] The court in Colorado Centre Metro. Dist., held that the creditors’ committee did not have standing to object to the chapter 9 petition because the committee could not be formed until after an order for relief was entered. [ FN: 113 B.R. 25, 26-27 (Bankr. D. Colo. 1990) (ruling that a chapter 9 petition does not constitute an order for relief and that the creditors ’ committee could not be formed until the order for relief was entered; section 1102(a)(1) provides that a committee shall be appointed "as soon as practicable after the order for relief ").]

Automatic stay protection under section 362 is expanded for municipal debtors under section 922 by (i) protecting the debtor’s officers and inhabitants, and (ii) preventing the enforcement of a lien arising out of taxes or assessments owed to the debtor. [ FN: 11 U.S.C. §922 (1996).] Section 922 further preserves the application of pledged special revenues as nonrecourse secured claims undersection 927. [ FN: Section 927 prevents section 1111(b) from transforming a nonrecourse pledged special revenue claim into a full recourse general municipal obligation. 11 U.S.C. §927 (1996).]

3. Scope of the Bankruptcy Court’s Involvement in a chapter 9 Case

The scope of the bankruptcy court’s involvement in a chapter 9 case is severely limited by the Tenth Amendment’s preservation of state sovereignty. Section 903 preserves the political and governmental power over a municipality to the respective state, including decisions related to expenditures. [ FN: Id. at §903. Section 903 reiterates a state ’s inability to bind a nonconsenting creditor to a municipal debt restructuring.] Section 904 prohibits the court (unless the debtor consents or the plan so provides) from interfering with (i) the political or governmental powers of the debtor; (ii) the debtor’s revenues; or (iii) the debtor’s use of any income-producing property. [ FN: Id. at §904.]

The US trustee is similarly constrained from extensive involvement in chapter 9. The only explicit role the US trustee has in chapter 9 is committee appointments under section 1102. [ FN: See Kupetz, supra, note 21 at 566 ( "The one limited area where the United States trustee has been granted an explicit role in chapter 9 cases involves the requirement that the United States trustee appoint creditors ’ committees. It does not appear to have been contemplated that the United States trustee would have any role in chapter 9 cases beyond the limited role of appointing a committee or committees of creditors. ")] This limited role is consistent with chapter 9's explicit avoidance of interference with state sovereignty. [ FN: Id. at 555-56 ( "The omission of chapter 9 cases from the general administrative and supervisional authority of the United States trustee is consistent with other limitations in the chapter 9 context designed to avoid interference with state sovereignty. Giving the United States trustee any general supervisory authority in a chapter 9 case could be deemed to be improper interference with the political and financial affairs of the municipal debtor. ")] Sections 327, 328 and 330 related to the retention and compensation of professionals do not apply in chapter 9, rendering the US trustee’s traditional involvement in this area moot.

4. Substantive Bankruptcy Code Provisions Applicable in chapter 9

chapter 9 debtors do not have access to all of the substantive provisions of the Bankruptcy Code. Section 901 lists the Code sections and subsections that are applicable in chapter 9, including, in relevant part:

·Adequate protection (11 U.S.C. § 361)

·Automatic stay (11 U.S.C. § 362 as supplemented by section 922);

·Obtaining post-petition credit on a super-priority or priming lien basis (11 U.S.C. § 364(c) & (d));

·Executory contracts (11 U.S.C. § 365);

·Allowance of claims or interests and administrative expenses (11 U.S.C. §§ 502 & 503)

·Administrative expense priorities (11 U.S.C. § 507(a)(1));

·Avoidance powers (11 U.S.C. §§ 544-548);

·Creation and powers of creditors’ committees (11 U.S.C. §§ 1102 & 1103)

·Classification of claims and interests (11 U.S.C. § 1122);

·Relevant provisions relating to the contents of a municipal debtor’s plan (11 U.S.C. § 1123(a)(1) -(b));

·Impairment of claims or interests (11 U.S.C. § 1124);

·Postpetition disclosure and solicitation (11 U.S.C. § 1125);

·Provisions regarding acceptances of a plan (except those governing acceptances of interestholders of the debtor) (11 U.S.C. § 1126 (a),(b),(c),(e), (f), and (g));

·Deemed acceptance or rejection of plan as modified unless notification of change within time set by the court (11 U.S.C. § 1127(d));

·Confirmation requirements for municipalities are as follows:

·The proponent must comply with the applicable provisions of title 11 (11 U.S.C. § 1129(a)(2));

·The plan has been proposed in good faith and not by any means forbidden by law (11 U.S.C. § 1129(a)(3));

·Governmental regulatory commission with jurisdiction over the rates of the debtor has approved any rate change in the plan or such rate change is conditioned on such approval (11 U.S.C. § 1129(a)(6));

·Each class of claims and interests has either accepted the plan or is not impaired under the plan (11 U.S.C. § 1129(a)(8));

·If any classes are impaired under the plan, at least one impaired class has accepted the plan (11 U.S.C. § 1129(a)(10));

·Cramdown of secured and unsecured claims (11 U.S.C. § 1129(b)(1)(a), (b)(2)(A) & (b)(2)(B)).

While chapter 9 debtors do not enjoy the full range of relief and powers offered by the Bankruptcy Code, the above list indicates a careful application of only those provisions that are necessary to complete a municipal restructuring while balancing the state sovereignty concerns.

5. Bankruptcy Code Provisions Noticeably Absent from chapter 9

Certain provisions of the Bankruptcy Code are noticeably absent from the laundry list contained in section 901(a).

Property of the Debtor. Section 541 governing property of the estate is absent because no estate is created upon the filing of a chapter 9 petition; the phrase "property of the estate" when used elsewhere in the Code is translated "property of the debtor" in chapter 9. [ FN: 11 U.S.C. §902(1) (1996) ( " ‘property of the estate ’, when used in a section that is made applicable in a case under this chapter by section 103(e) or 901 of this title, means property of the debtor ").]

Rejection of Collective Bargaining Agreements. Section 1113 listing the terms under which a debtor can reject a collective bargaining agreement in a chapter 11 case are not applicable in chapter 9. Consequently, the rules under the Supreme Court’s opinion in National LaborRelations Board v. Bildisco and Bildisco apply, permitting a chapter 9 debtor to treat a collective bargaining agreement as an executory contract under section 365. [ FN: 465 U.S. 513 (1984) (permitting debtor in possession to reject collective bargaining agreement under section 365).] The result under Bildisco and section 365 is precisely the result that section 1113 was enacted to overrule. The provisions under section 1114 governing the payment of retirees’ insurance benefits similarly do not apply in chapter 9.

Retention and Compensation of Professionals. None of the usual provisions governing the retention and compensation of professionals (11 U.S.C. §§ 327-331) apply in chapter 9. Section 1103, however, governing the retention of committee professionals does apply in chapter 9, and under section 1103(b) the court may determine whether the attorney or accountant sought to be retained by the committee has an adverse interest connected to the case. The only provision that the court can use to review the fees of a chapter 9 debtor’s professionals is section 943(b)(3) requiring that "all amounts to be paid by the debtor or by any person for services or expenses in the case or incident to the plan have been fully disclosed and are reasonable." [ FN: 11 U.S.C. §943(b)(3) (1996). The language of this section arguably permits the court to review all fees in the case whether paid by the debtor or not.] Similarly, the only provision the court can use to require a chapter 9 debtor to pay its professional fees is section 943(b)(5) which requires payment of all administrative expenses on the effective date of the plan, unless the professional consents to different treatment. [ FN: Id. at §943(b)(5) ( "except to the extent that the holder of a particular claim has agreed to a different treatment of such claim, the plan provides that on the effective date of the plan each holder of a claim of a kind specified in section 507(a)(1) of this title will receive on account of such claim cash equal to the allowed amount of such claim ").] While the bankruptcy court cannot order payment of interim fees to the professionals, the chapter 9 debtor does not need permission to pay professionals during the pendency of the case.

II. Proposals for chapter 9 Reform

Starting with the Great Depression, then New York City’s fiscal crisis, and now the fallout from Orange County, municipal bankruptcy legislation has always been reactive. In keeping with this tradition, the Government Working Group has proposed a number of minor changes to address certain anomalies in the Bankruptcy Code brought to light after the Orange County filing. These proposals are attached. The Government Working Group will continue to address some of the bigger (and more hotly contested) chapter 9 issues raised in Orange County at its next meeting in Seattle, WA.

Government Working Group Proposal #18

Chapter 9: Incorporation of the Securities Contract Liquidation Provisions

11 U.S.C. §§ 555, 556, 559 & 560

Background

After the enactment of the Bankruptcy Code in 1978, certain securities contract liquidation provisions were added by subsequent legislation in sections 555, 556, 559 and 560. [ FN: Sections 555 and 556 were added in the "Technical and Substantive Change in Bankruptcy with Respect to Securities and Commodities " Pub. L No. 97-222 (1982). Section 559 was added as part of the Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub. L. No. 98-353 (1984). Section 560 was added in 1990 by "An Act To Amend Title 11 of the United States Code Regarding Swap Agreements and Forward Contracts ", Pub. L. No. 101-311 (1990).] Each of these provisions permits the liquidation and/or termination of securities contracts, commodity or forward contracts, repurchase agreements and swap agreements, notwithstanding certain provisions of the Bankruptcy Code, including the automatic stay. [ FN: Where provided, however, the right to terminate certain securities ’ contracts under these provisions are still subject to the limitations under the Securities Investor Protection Act of 1970.] These provisions protect both the debtor as well as the nondebtor parties to these securities contracts by minimizing losses due to market fluctuations. By encouraging the mitigation of damages immediately, these provisions prevent a chain reaction of defaults due to a single insolvency.

Proposal

The securities contract liquidation provisions in 11 U.S.C. §§ 555, 556, 559 & 560 should be applicable under chapter 9 and should be added to the list contained in section 901(a).

Reasons for the Change

The Orange County crisis was triggered by risky investments in precisely the types of securities covered by these provisions. [ FN: The Orange County investment pool leveraged its investments through the use of reverse repurchase agreements. In a "reverse repo " the County borrowed money from a broker by lending the broker U.S. government securities owned by the County and then reinvested the cash it received in derivative securities. As long as the cost of borrowing the money from the broker is less than the return obtained on the derivative instrument, the transaction is profitable. See County of Orange , 183 B.R. 594, 598 n.4 (Bankr. C.D. Cal. 1995).] After it filed its chapter 9 petition, Orange County contested the liquidation of certain repurchase agreements on the ground that section 559 did not apply under chapter 9 of the Bankruptcy Code. [ FN: See County of Orange v. Nomura Securities Int ’l Inc. , Adv. No. 94-02480 (Bankr. S.D. Cal.) (complaint dismissed) (challenging close-out of repurchase agreements under section 559).] This assertion caused a short-lived disruption inthe U.S. government securities market. [ FN: See , e.g. , Peter Heap, Court Ruling on Collateral Could Hinder Repurchase Trading , The Bond Buyer , December 14, 1994, at 4 (stating that an adverse ruling on the liquidation of Orange County ’s reverse repo positions could have adverse impact on market; "The market has been premised on the fact that there ’s an exemption (for collateral) from bankruptcy. "); Orange County Suit Scars Markets , Charleston Gazette , Dec. 17, 1994, at 5 (stating that Orange County ’s suit against certain broker/dealers for liquidation of reverse repo positions would affect the entire yield curve).]

To the extent that municipalities invest in these types of securities, there is no reason why the Code provisions relating to them are not applicable in chapter 9. Orange County demonstrates that municipal finance and investment strategies are taking advantage of these sophisticated yield-enhancing instruments. The liquidation provisions protect both parties to the transaction by mitigating any possible damages due to market shifts and preserve the efficiency and operation of the market for everyone else. The chain reaction potential for disruption and defaults caused by another "Orange County" type filing necessitates inclusion of these provisions in chapter 9. The omission of these sections from chapter 9 was a legislative oversight and should be corrected.

Competing Considerations

There do not appear to be any competing considerations to this proposal.

Government Working Group Proposal #19

Chapter 9: Petition as Order for Relief

Background

Section 301 of title 11, applicable in chapter 9 under section 901(a), provides that the "commencement of a voluntary case under a chapter of this title constitutes an order for relief under such chapter." 11 U.S.C. § 301 (1996). In contradistinction, section 921(d) provides that the court shall order relief if a chapter 9 petition is not dismissed for lack of good faith or failure to comply with the requirements of title 11. 11 U.S.C. § 921(d).

Proposal

Section 921(d) should be deleted. Section 921(c) already authorizes the court to dismiss a chapter 9 petition for (i) lack of good faith; or (ii) failure to meet the requirements of title 11. Deletion of section 921(d) will eliminate the statutory conflict between section 301 providing that a voluntary petition constitutes an order for relief and section 921(d) authorizing the court to order relief only if the petition is not dismissed under section 921(c).

Reasons for the Change

Statutory confusion exists over whether a chapter 9 petition constitutes an order for relief. Despite the incorporation of section 301, which states that the filing of a voluntary petition constitutes an order for relief, [ FN: 11 U.S.C. §301 (1996).] section 921(d) states that if the judge does not dismiss the municipal petition on good faith grounds or for failure to meet the other requirements of chapter 9, an order for relief will be entered. [ FN: Id. at §921(d) ( "If the petition is not dismissed under subsection (c) of this section, the court shall order relief under this chapter. ")] Commentators agree that "[t]here should be no need for the court to actually enter an order for relief. Requiring the actual entry of an order for relief could result in unnecessary delay and could impair the administration of the case." [ FN: David S. Kupetz, Municipal Debt Adjustment Under the Bankruptcy Code , 27 Urb. law. 531, 557 (Summer 1995) (citing 4 Collier on Bankruptcy ¶ 921.04, 921-6 (15th ed. 1994) "That language [set forth in Section 301] should make it unnecessary for the court to enter an ‘order for relief ’ under section 921(d). The only issue upon an objection should be whether the court dismisses the petition or overrules the objection. ")]

The use of the language "after the order for relief" in other parts of the Bankruptcy Code exacerbates this confusion. A creditor is defined as "an entity that has a claim against the debtor that arose at the time of or before the order for relief". [ FN: 11 U.S.C. §101(10)(A) (1996).] A number of time periods applicable in chapter 9 begin to run upon the entry of an order for relief. For example, the debtor’s time to commence certain avoidance actions is limited to the later of (among otherthings) two "years after the entry of the order for relief." [ FN: Id. §546(a)(1)(A).] In addition, creditors’ committee formation by the US trustee can not begin until after the entry of the order for relief. [ FN: Id. §1102(a)(1).] The court in Colorado Centre Metro. Dist., held that the creditors’ committee did not have standing to object to the chapter 9 petition because the committee could not be formed until after an order for relief was entered. [ FN: 113 B.R. 25, 26-27 (Bankr. D. Colo. 1990) (ruling that a chapter 9 petition does not constitute an order for relief and that the creditors ’ committee could not be formed until the order for relief was entered; section 1102(a)(1) provides that a committee shall be appointed "as soon as practicable after the order for relief ").]

Only involuntary petitions do not constitute an order for relief under the Bankruptcy Code. 11 U.S.C. § 303 (1996). Involuntary bankruptcy petitions can not be filed against municipalities. 11 U.S.C. § 901(a) (1996). All voluntary petitions under the Bankruptcy Code constitute an order for relief under section 301 and municipalities should not be an exception. The authority of the court to dismiss a chapter 9 petition under section 921(c) adequately safeguards the policy of preserving chapter 9 as the avenue of last resort for municipal entities.

Competing Considerations

A municipality has to satisfy more prerequisites in order to file a chapter 9 petition than any other person or entity under the Bankruptcy Code. See, e.g., 11 U.S.C. § 109(c) (1996). Strong policy considerations against municipal filings led to these hurdles that a municipality must comply with prior to being eligible for chapter 9 relief. It may be argued that these strong policy considerations against municipal filings warrants the denial of an order for relief prior to a court determination that these prerequisites have been satisfied. If this is the prevailing view, section 301 should not be applicable under chapter 9 and section 921 should be clarified to provide the circumstances under which an order for relief should be entered in a chapter 9 case.

Government Working Group Proposal #20

Chapter 9: Eligibility of Municipalities to Serve on Creditors’ Committees

Background

Section 1102(b)(1) provides that a creditors’ committee "shall ordinarily consist of the persons, willing to serve, that hold the seven largest claims against the debtor...". Section 101(41) defines "person" as including an "individual, partnership, and corporation, but does not include governmental unit, except that a governmental unit that --

(A) acquires an asset from a person --

(i) as a result of the operation of a loan guarantee agreement; or

(ii) as receiver or liquidating agent of a person;

(B) is a guarantor of a pension benefit payable by or on behalf of the debtor or an affiliate of the debtor; or

(C) is the legal or beneficial owner of an asset of --

(i) an employee pension benefit plan that is a governmental plan, as defined in section 414(d) of the Internal Revenue Code of 1986; or

(ii) an eligible deferred compensation plan, as defined in section 457(b) of the Internal Revenue Code of 1986;

shall be considered, for purposes of section 1102 of this title, to be a person with respect to such asset or such benefit". Section 101(41) thus carves out certain circumstances under which a municipality shall be considered a person for purposes of service on a creditors’ committee.

Proposal

11 U.S.C. § 101(41) should be amended to permit municipalities to serve on creditors’ committees in chapter 9 cases under the provisions of 11 U.S.C. § 1102.

Reasons for the Change

When Orange County filed its chapter 9 petition some of its biggest creditors were other municipal entities located both in and outside the County. The anomaly in the statute excluding municipalities from creditors’ committees was discovered when the US trustee was forming the Orange County committees. In an effort to come to a reasonable solution that would permit the municipalities to represent their interests in the case, the US trustee formed a committee composed entirely of the largest municipal creditors. No parties in interest objected to the formation of this committee despite the statutory prohibition against governmental units serving on a creditors’ committee. The result in Orange County was equitable, but the statutory glitch should be corrected.

Competing Considerations

It may be argued that the current statutory exceptions to governmental units serving on creditors’ committees are narrowly drawn to permit service when the municipality is acting in certain capacities, equally applicable in chapter 9. As a consequence, there may be no reason to expand this exception in chapter 9. Orange County may have been an unusual circumstance that was properly addressed by the US trustee.