Throughout the United States, many municipalities are facing severe financial distress and being forced to examine Chapter 9  -- the section of the Bankruptcy Code governing municipality eligibility -- as a means of eliminating debt and restructuring their obligations. 

While the causes of financial distress vary among municipalities, municipal creditors are often composed of the same groups, a mix of “ordinary people” such as pensioners and civil servants, combined with sophisticated financial institutions and bondholders. 

Add these diverse constituencies to the current political environment, mix in the fact that municipalities must often raise taxes to raise revenue, and the result is often a prolonged political battle that provides little progress towards a real solution.

It is often overlooked that the Bankruptcy Code itself attempts to alleviate the potential for stalemate and assuage fears that if bankruptcy is “too easy” there will be a rash of unnecessary municipal filings. The Bankruptcy Code does this by generally requiring municipalities to work with their creditors as a prerequisite to filing for protection under Chapter 9.

Chapter 9 requires the municipality to demonstrate that prior to filing for bankruptcy, it:

  • Obtained the agreement of certain creditors to the restructuring plan; or
  • Negotiated with creditors but was unable to reach a resolution; or
  • Show that although it did not negotiate with its creditors, engaging in the process would have been impractical. 

Additionally, some states, such as California, require a municipality to attend mediation with its creditors before filing for Chapter 9 protection (unless a state of emergency exists.)  Failure to adhere to these requirements can result in dismissal of the bankruptcy petition. 

This pre-filing negotiation process is intended to expedite the Chapter 9 process and maximize its efficiency. Creditors should use this process wisely and recognize that, no matter what the cause of a municipality’s financial woes, all parties will need to compromise their claims for a prompt and efficient resolution. 

Fundamentally, all restructurings are simply a matter of math:  the assets of the debtor must be valued, measured against the claims asserted, and then distributed accordingly.  The more quickly major constituencies (including the taxpayers) accept the inevitable, the faster municipalities can move forward with reorganization, emerge from Chapter 9 protection and establish a new sense of normalcy.

Goodwin Procter LLP is one of the nation’s leading law firms, with a team of 700 attorneys and offices in Boston, Los Angeles, New York, San Diego, San Francisco and Washington, D.C. The firm combines in-depth legal knowledge with practical business experience to deliver innovative solutions to complex legal problems. We provide litigation, corporate law and real estate services to clients ranging from start-up companies to Fortune 500 multinationals, with a focus on matters involving private equity, technology companies, real estate capital markets, financial services, intellectual property and products liability.

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