Government Working Group Proposal #22
Chapter 9: Treatment of Municipal Obligations in
Chapter 9
Background
In 1988, Congress passed "An Act to Amend the Bankruptcy Law
to
Provide for Special Revenue Bonds and for Other Purposes." This legislation, among other
things, added a definition for "special revenues" in 11 U.S.C. § 902(2). The
purpose
of the amendment was to protect the liens on special revenues granted under the revenue bonds.
[FN: 4 Collier on Bankruptcy ô 902.01A,
902-3
(Lawrence P. King et al. eds, 15th ed. 1996).] Five types of
special
revenue obligations qualify as special revenues under the definition:
1. receipts derived from the ownership, operation or disposition of projects or systems of the
debtor that are primarily (or primarily intended) to be used to provide transportation, utility, or
other
services, including the proceeds of borrowings to finance the projects or systems;
2. special excise taxes imposed on particular activities or transactions;
3. incremental tax receipts derived from the benefitted area in the case of tax-increment
financing;
4. other revenues or receipts derived from particular functions of the debtor, whether or not
the
debtor has other functions; or
5. taxes specifically levied to finance one or more projects or systems excluding receipts from
general property, sales, or income taxes (other than tax-increment financing) levied to finance the
general purposes of the debtor[.][ FN: 11
U.S.C.
§ 902(2) (1996).]
Substantive protections in chapter 9 for "special revenues" include section
922(d),
which exempts special revenues from application of the automatic stay. In addition, section 928(a)
exempts special revenues from the lien avoidance provisions on post-petition property in section
552(a). These provisions essentially grant special revenues preferred status because the filing of a
chapter 9 petition does not interrupt the payment of, or post-petition security interest in, pledged
special
revenues.
Proposal
Chapter 9 should be amended to provide comparable protection to all types of tax-exempt
obligations sold in the municipal marketplace. The Proposal will not affect the right of a
municipality to use special revenues for the provision of necessary municipal services.
Reasons for the Change
chapter 9's grant of preferred status to special revenues is contrary to the credit quality
expectations in the municipal marketplace. Many of the municipal obligations currently sold are
not
payable out of special revenues as defined in chapter 9. For example, generalobligation bonds
(secured
by a pledge of the municipality’s power to tax without limitation as to rate or amount at the
level
required to repay the bonds) or tax or revenue anticipation notes (secured by a pledge of the
current
year’s tax receipts or other identified revenues) are viewed as stronger credit investments
than
special revenue obligations, which are only secured by a pledge of repayment from a limited
source.
The above credit-analysis results in lower borrowing costs for municipalities who issue these
types of instruments. Revising the definition of special revenues is designed to ensure that
tax-exempt
funding arrangements and the credit decisions that went into those funding arrangements are
respected
in chapter 9. The Proposal will not prevent a municipality in chapter 9 from using these revenues
for the
provision of necessary municipal services. The Proposal (i) reflects the expectations of the
tax-exempt
bond market; (ii) will improve issuers’ access to the municipal market; and (iii) will result
in
lower borrowing costs to issuers.
Competing Considerations
It has been argued that special revenues should be treated differently under chapter 9
because the
holders of those obligations have a lien against the dedicated revenue stream. As a result, special
revenues should be treated as though they are encumbered by the interest created under the
indenture
and an intervening chapter 9 petition should not interfere with the operation of these rights. It is a
misnomer, however, to classify all other municipal obligations as "unsecured."
Tax-backed
bonds, for example, are secured by the pledge of a local government to pay those bonds from
available
tax-derived sources.
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