United States: Sixth Circuit Finds Bankruptcy Court Cannot Force City To Provide Services In Chapter 9

Last Updated: December 12 2016
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On November 14, 2016, the United States Court of Appeals for the Sixth Circuit held that courts in chapter 9 cases lack authority to order a municipal debtor to provide services to its constituents. Affirming the bankruptcy court's dismissal of customers' claims arising from the termination of their water service by the Detroit Water and Sewerage Department, the Sixth Circuit held that section 904 of the Bankruptcy Code prohibits a chapter 9 court from entering orders that "interfere" with a municipality's "political [and] governmental powers."In re City of Detroit, Mich., No. 15-2236, 2016 WL 6677715 (6th Cir. Nov. 14, 2016).

Key Takeaways

  1. Section 904 of the Bankruptcy Code prohibits a chapter 9 court from entering orders that "interfere" with a municipality's political and governmental powers.
  2. While municipalities indisputably do not have the power to violate citizens' constitutional rights, chapter 9 courts do not have the judicial power to enjoin such violations.
  3. There is no cognizable property right to affordable water service.

Overview

The City of Detroit filed for chapter 9 relief in July of 2013. A year later, the plaintiffs, 10 Detroit residents and four organizations claiming to represent residential customers of the Detroit Water and Sewerage Department, filed an adversary proceeding seeking declaratory and injunctive relief (including a temporary restraining order) to stop the DWSD from shutting off water service and to force it to restore water service to all customers. Among other things, the plaintiffs asserted that the denial of water services violated their due process and equal protection rights. Defendants filed a motion to dismiss the complaint.

The bankruptcy court denied the motion for a temporary restraining order and granted the motion to dismiss, ruling that, under section 904, "except as to the plaintiffs' constitutional claims, this Court lacks authority to grant the injunctive relief requested . . . ." The bankruptcy court then found that the due process and equal protection claims were not adequately pled and dismissed all claims. After the district court affirmed, the plaintiffs appealed to the Court of Appeals.

Analysis

The Sixth Circuit focused its analysis on the limits placed on a chapter 9 court's powers by section 904, which provides that absent the debtor's consent, a chapter 9 court cannot interfere with (i) any of the political or governmental powers of the municipality debtor; (ii) any of the debtor's property or revenues; and (iii) the debtor's use or enjoyment of income-producing property. The Court concluded that the statute clearly prohibits courts from interfering with the decisions a municipality makes with respect to the services and benefits it will provide. Section 903, a companion provision, explains that chapter 9 "does not limit or impair the power of a State to control, by legislation or otherwise, a municipality . . . in the exercise of the political or governmental powers of such municipality . . . ."

The Court of Appeals concluded that section 904 "makes clear that the court may not interfere with the choices a municipality makes as to what services and benefits it will provide." It continued by describing section 904 as the "keystone in the constitutional arch between federal bankruptcy power and state sovereignty" and stating that the Tenth Amendment to the U.S. Constitution reserves to the states all powers not expressly delegated to the federal government. "One of those powers is the power to create and govern municipalities." This power "cannot be taken away by any form of legislation." Thus, the Court agreed with the bankruptcy court's observation that Congress drafted chapter 9 to provide federal courts "only enough jurisdiction to provide meaningful assistance to municipalities that required it, not to address the policy matters that such municipalities control."

With this policy background, the Court applied section 904 to the facts at hand, holding that the injunctive and declaratory relief sought by the plaintiffs would "necessarily interfere with the city's 'governmental powers,' its 'property [and] revenues,' as well as its 'use [and] enjoyment of . . . income-producing property.'" In light of those conclusions, the Circuit Court held that section 904 stripped the bankruptcy court of the power to order "anything of the sort."

The Court of Appeals addressed the plaintiffs' constitutional claims even though it found that section 904 explicitly prohibited the requested relief. The Court explained that while municipalities indisputably do not have the power to violate citizens' constitutional rights, "it does not follow that the bankruptcy court has judicial power to enjoin such violations." Why? Because "[s]ection 904 says it does not." And "'[w]hen the statute's language is plain, the sole function of the courts . . . is to enforce it according to its terms'—all of its terms." While the Court of Appeals echoed the bankruptcy court's empathy for the plaintiffs' circumstances, it held that there is no fundamental right to water service, and that due process requires only that the City's water rates reasonably reflect the cost of providing the service, not that the rate structure reflect the customers' ability to pay.

The Court's application of section 904 reflected the significant differences between chapter 9 and chapter 11. Unlike in a chapter 11 case, there is no bankruptcy estate in a chapter 9 case, and therefore the Bankruptcy Code's restrictions on use, sale or lease of property do not apply in chapter 9. And chapter 9 does not permit the appointment of a trustee or examiner; nor is there any provision for an involuntary chapter 9 case. The Sixth Circuit concluded that:

the city alone files its chapter 9 petition with the consent of the state. And the city alone files and amends its plan of adjustment. . . . Neither the court nor creditors can directly force a liquidation of a municipality's assets in bankruptcy. Reading § 904 to preclude recovery on common-law and constitutional claims alike complements this structure.

The Court of Appeals vacated the district court's order with respect to the plaintiffs' procedural due process claims, finding such claims to be moot because less than a month after the plaintiffs filed their amended complaint, changes to the disputed procedures were enacted. The Court of Appeals found that the procedure at issue was "sufficiently altered so as to present a substantially different controversy," and the claim was thus moot.

Because plaintiffs could not recover on their state law or constitutional claims, the Court of Appeals affirmed the order of the district court affirming the bankruptcy court's order of dismissal.

Insights & Implications

The overarching theme of the opinion is the Circuit Court's recognition of the need to preserve the delicate balance of state-federal sovereignty. At the time of its bankruptcy, Detroit was burdened with over $18 billion in escalating debt, more than 100,000 creditors, hundreds of millions of dollars of negative cash flow, failing infrastructure and a crumbling water and sewer system. The Court of Appeals acknowledged the heavy lifting the bankruptcy court did when deliberating on and approving a plan of adjustment aimed to remedy the debilitating conditions the City faced when it filed for chapter 9 relief. The Sixth Circuit appreciated that a federal court's power should be more constrained in the chapter 9 context and that section 904 ensures that bankruptcy power cannot be used to indirectly dictate how a debtor city should be governed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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