Municipal Reorganization: Chapter 9 of the U.S. Bankruptcy Code

Municipal Reorganization: Chapter 9 of the U.S. Bankruptcy Code

Order Code RL33924
Municipal Reorganization:
Chapter 9 of the U.S. Bankruptcy Code
March 8, 2007
Robin Jeweler
Legislative Attorney
American Law Division

Municipal Reorganization:
Chapter 9 of the U.S. Bankruptcy Code
Summary
Because municipalities are government entities, their economic problems have
historically been addressed politically through state-based remedies, such as the
creation of a financial control board, not through judicial intervention. Chapter 9 of
the U.S. Bankruptcy Code, 11 U.S.C. § 901 et seq., is entitled “Adjustments of Debts
of a Municipality.” Though rarely used, this chapter of the Code has important
historic antecedents and may be a important tool for insolvent municipal entities.
The term “bankruptcy,” however, is a misnomer when it comes to chapter 9. For
many reasons, chapter 9 differs from chapter 11, which governs the reorganization
of private business. This report provides an overview of chapter 9.
The paramount feature of a municipal reorganization is the requirement that the
municipal debtor and a majority of its creditors reach an agreement on a plan to
readjust the municipality’s debts. The outcome of any reorganization cannot be
predicted with certainty. Several basic principles may provide guidance as one
considers the likely course of a major municipal reorganization. First, the policy
underlying chapter 9 is unlike that of other chapters: municipalities are not subject
to liquidation or strict judicial control. Municipal authorities do not need judicial
permission to exercise governmental functions. Second, development of the
reorganization plan is largely the initiative of municipal authorities.
Even though the U.S. Bankruptcy Code is designed to give the cash-strapped
municipal debtor “breathing room” and an opportunity to marshal its assets, nothing
in the law relieves it from the requirements of applicable nonbankruptcy law. Filing
bankruptcy does not lift from the municipality the burdens imposed upon it by myriad
state and federal laws. Reorganization and, ultimately, repudiation of debt may be
facilitated by a chapter 9. But the manner in which the municipal debtor reaches its
goal for rehabilitation will still be shaped, in large part, by the constraints of the
federal and state laws under which it operates.
On December 6, 1994, Orange County, California, filed under chapter 9, the
largest municipal bankruptcy filing to date. The County reorganized successfully,
and its case was closed in 2000. Though the underlying causes of the County’s
financial problems were arguably unique, chapter 9 proved to be sufficiently flexible
to accommodate the needs of a large municipal debtor and its creditors.

Contents
Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Legislative History . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
How Does Chapter 9 of the U.S. Bankruptcy Code Work? . . . . . . . . . . . . . . . . . . 4
Bankruptcy Court Jurisdiction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Eligibility to File . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Filing the Plan; Appointment of a Trustee . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
The Automatic Stay . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
The Bankruptcy Estate; Control of Property . . . . . . . . . . . . . . . . . . . . . . . . . 7
Rejection of Executory Contracts; Labor Relations . . . . . . . . . . . . . . . . . . . . 8
Confirmation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Orange County . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Municipal Reorganization:
Chapter 9 of the U.S. Bankruptcy Code
Background
State and local governments provide services crucial to the everyday life of most
Americans. These may include education, police protection, public transportation,
water and utilities, to name only a few. When the finances of a municipal entity are
threatened, the notion or threat of a “bankruptcy” causes wide spread consternation.
In 2005, the destruction wrought by Hurricanes Katrina and Rita on the Gulf Coast
led many to speculate on the likelihood of municipal insolvencies and bankruptcy
filings.1 Although states (and the District of Columbia), cannot file for relief under
the U.S. Bankruptcy Code, municipalities may be eligible.2 Chapter 9 of the Code,
11 U.S.C. § 901 et seq., is entitled “Adjustments of Debts of a Municipality.” The
term “bankruptcy,” however, is a misnomer when it comes to chapter 9. For many
reasons, this chapter differs from the other chapters of the Code governing liquidation
and reorganization of consumers and business.
From 1988 to 2005, only 172 chapter 9 reorganizations were filed, the vast
majority by small government agencies like municipal utilities, school districts or
entities established for a single project such as a hospital or convention center.3
1 See, e.g., Jennifer Medina, Local Governments Face Bankruptcy, Layoffs or Both, THE
N.Y. TIMES, Oct. 4, 2005 at A17. As a result of hurricanes, municipal governments in
southern Louisiana are running out of money and seek federal aid “to avoid bankruptcy or
huge layoffs and reductions in city services.” But see Joint Report from the Bureau of
Governmental Research and the Public Affairs Research Council of Louisiana, MUNICIPAL
B A N K R U P T C Y I N P E R S P E C T I V E ( A p r i l 2 0 0 6 ) a va i l a b l e o n l i n e a t
[http://www.la-par.org/Publications/PDF/Municipal%20Bankruptcy.pdf] concluding that
most local governments in Louisiana are not experiencing severe financial distress as a
result of the hurricanes, but many parishes are.
2 11 U.S.C. § 109(c). A municipality is defined as “a political subdivision or public agency
or instrumentality of a State.” 11 U.S.C. § 101(40). A public agency or instrumentality
may include incorporated authorities, commissions, and other entities which are organized
for the purpose of constructing, maintaining and operating revenue producing enterprises.
These include entities whose revenues are derived from taxes or assessments or from income
producing property and public improvement districts, school districts, and revenue
producing bodies that provide services which are paid for by users rather than by general
taxes, such as bridge or highway authorities. 6-900 COLLIER ON BANKRUPTCY ¶
900.02[2][a][ii] (15th ed. rev.)
3 New Generation Research, THE 2006 BANKRUPTCY YEARBOOK & ALMANAC 20 (16th ed.
2006).

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Many observers characterize chapter 9 filings as “rare.”4 Because municipalities are
government entities, their economic problems have historically been addressed
politically through state-based remedies, such as the creation of a financial control
board, not through judicial intervention. Although the financial problems of cities
like New York, N.Y. or Camden, N.J., received widespread publicity, they did not
file under the U.S. Bankruptcy Code.
History, however, may not always be an accurate predictor of the future. In
addition to regional disaster-related problems in the Gulf Coast, observers speculate
that future chapter 9 filings may be driven by municipal pension and health care
liabilities. Press accounts indicate that these liabilities may reach crisis levels for
many municipalities.5 The city of San Diego, Ca., for example, has struggled with
onerous pension liabilities, compounded by alleged fiscal mismanagement. Although
it has not filed under chapter 9, there has been public debate on the wisdom of such
a remedial course.6
Legislative History
The first municipal debt provisions under federal bankruptcy law were enacted
in 1934 as emergency legislation for the relief of distressed minor subdivisions of the
states.7 Although Congress has express power to establish “uniform Laws on the
subject of Bankruptcies throughout the United States,”8 the U.S. Supreme Court
found the original provisions to be an unconstitutional infringement of state
sovereignty, violating the Tenth Amendment9 in Ashton v. Cameron Co. Water
Improvement Dist.10 The Court articulated its concern over the possibility of
usurpation of state sovereignty by the federal government:
4 In re City of Desert Hot Springs, 327 F.3d 930, 937 (9th Cir. 2003), cert. den. 540 U.S.
1110 (2004)
5 See, e.g., Gary Kaplan and Joel Moss, Distressed Cities See No Clear Path: Health,
Pension Obligations Threaten Fiscal Crisis, THE NATIONAL LAW JOURNAL, March 6, 2006,
at S1; Mary Williams Walsh, Once Safe, Public Pensions Are Now Facing Cuts, THE NEW
YORK TIMES, Nov. 6, 2006 at A1; Paying Health Care From Pensions Proves Costly, THE
NEW YORK TIMES, Dec. 19, 2006 at A1; Bob Porterfield, Retiree Health Care
Overwhelming Governments, Sept. 25, 2006 at [http://abcnews.go.com/Health/wireStory
?id=2485444&CMP=OTC-RSSFeeds0312].
6 Compare Mike Allen, Analysts Say Bankruptcy No Option for City, 25 SAN DIEGO
BUSINESS J. 1 (Sept. 27, 2004) with Patrick Shea, San Diego’s Pension Crisis: The case for
municipal bankruptcy, SIGNONSANDIEGO.COM, THE SAN DIEGO UNION TRIBUNE (February
18, 2005) at [http://www.signonsandiego.com/news/metro/pension/20050218-704-thecasef.
html].
7 48 Stat. 798 (May 24, 1934).
8 Article I, section 8, cl. 4 of the United States Constitution.
9 The Tenth Amendment provides:
The powers not delegated to the United States by the Constitution, nor prohibited
by it to the States, are reserved to the States respectively, or to the people.
10 298 U.S. 513 (1936).

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If federal bankruptcy laws can be extended to respondent, why not to the State?
If voluntary proceedings may be permitted, so may involuntary ones, subject of
course to any inhibition of the Eleventh Amendment. If the State were
proceeding under a statute like the present one, with terms broad enough to
include her, apparently the problem would not be materially different. Our
special concern is with the existence of the power claimed — not merely the
immediate outcome of what has already been attempted. And it is of the first
importance that due attention be given to the results which might be brought
about by the exercise of such a power in the future.11
Congress revised the bankruptcy law’s municipal reorganization provisions in
1937.12 The Court reconsidered its objections in Ashton and held the Act
constitutional in United States v. Bekins.13 The Court acknowledged that the federal
measure was necessary because the Constitution’s contract clause14 prohibits the
states, but not the federal government, from enacting any law that alters contractual
obligations and therefore severely limits the ability of the states to afford adequate
relief to an insolvent municipality. The Court also recited those factors, retained and
incorporated into present chapter 9, which it deemed vital to protect state autonomy:
state consent to the municipal filing for reorganization; judicial restraint from
interference with the fiscal or governmental affairs of the political subdivision; and,
prohibition of involuntary proceedings.15

Chapter 9’s modern genesis is in legislation enacted in the wake of New York
City’s financial crisis in 1975. Although New York City did not file in bankruptcy,
the procedural mechanisms of old chapter IX were generally believed to be totally
inadequate to govern the reorganization of a major municipality like New York.
Among the procedural obstacles was the requirement that the petitioning
municipality obtain the prior consent of owners of fifty-one percent of its outstanding
securities before the bankruptcy court could approve the petition as properly filed.
The petitioning municipality was thus required to locate its creditors, draw up a plan,
and negotiate and obtain the required consents before it could even file its
reorganization. Until the case was filed, the municipality could not even ask the
court to issue a stay of all pending litigation — the usual first, critical rehabilitative
procedure in bankruptcy. Hence, in 1976, Congress enacted major substantive
revisions pursuant to P.L. 94-260 to chapter IX of the Bankruptcy Act of 1898. The
procedures effected by P.L. 94-260 were incorporated as chapter 9 of the current law,
the Bankruptcy Reform Act of 1978, P.L. 95-598, as amended.
11 Id. at 530 (citations omitted).
12 50 Stat. 653 (August 16, 1937).
13 304 U.S. 27 (1938).
14 Article I, section 10, clause 1 includes the prohibition against the passage, by any state,
of a “Law impairing the Obligation of Contacts”.
15 Bekins, 304 U.S. 27 at 51.

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Although financial crises have threatened more than one city — New York in
1975, Cleveland, Ohio in 1979, and Bridgeport, Conn. in 1991,16 to name only a few
— only one major county, Orange County, Ca., has reorganized under chapter 9
since its enactment in 1978. Even so, this chapter of the Code has been amended
twice since enactment. In 1988, Congress passed amendments generally concerned
with the definition of municipal “insolvency”; the rights of creditors as general
obligation bondholders and special revenue bondholders; and, the status of municipal
financing leases.17
Chapter 9 was again amended by § 402 of the Bankruptcy Reform Act of 1994,
P.L. 103-394. These amendments require that a municipality be specifically
authorized by the state to file in bankruptcy and is discussed below. The Reform Act
of 1994 also created a National Bankruptcy Review Commission to study the
Bankruptcy Code and make recommendations for change. Its report made only
passing reference to chapter 9.18 Likewise, the Bankruptcy Abuse Prevention and
Consumer Protection Act of 2005, P.L. 109-8, which made major changes to
consumer and business bankruptcy practice, does not significantly alter chapter 9
procedure.
How Does Chapter 9 of the
U.S. Bankruptcy Code Work?
Bankruptcy Court Jurisdiction
A major business reorganization under chapter 11 of the Code is a fluid process.
The debtor is expected to negotiate a business plan for rehabilitation with its creditors
who ultimately vote to accept or reject it. The process is designed to facilitate
consensus. The Code, and judicial oversight, establish parameters designed to
promote debtor rehabilitation, maximize the bankruptcy estate for distribution among
creditors, and ensure fair dealing.
Chapter 9 differs from all other operative bankruptcy chapters (that is, 7, 11, 12,
and 13) in several fundamental ways. First, general bankruptcy procedures do not
apply in chapter 9 unless they are expressly adopted. 11 U.S.C. § 901. Second,
chapter 9 does not preclude state legislation addressing reorganization, sometimes
referred to as “composition” of indebtedness, although state legislation may not bind
16 Bridgeport, Conn. filed under chapter 9 in 1991. The bankruptcy court found it to be
eligible to file, but sustained the State of Connecticut’s objection to the filing on the ground
that it was not “insolvent”, i.e., incapable of paying its debts as they became due. In re City
of Bridgeport, 129 B.R. 332 (Bankr.D. Conn. 1991). The court interpreted insolvency as
being dependent upon a cash flow analysis, i.e., an inability to pay debts as they become
due, not a projected budget deficit.
17 P.L. 100-597.
18 REPORT OF THE NATIONAL BANKRUPTCY REVIEW COMMISSION, Chapter 4: Other
Recommendations and Issues, 981-1007 (Oct. 20, 1997).

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an impaired, nonconsenting creditor.19 11 U.S.C. § 903. Third, in deference to the
Tenth Amendment and principles of federalism, court jurisdiction is greatly
circumscribed. The court may not interfere with the debtor’s political or
governmental powers, property or revenues, or use or enjoyment of income-
producing property. 11 U.S.C. § 904. The focus of chapter 9 is not necessarily to
attempt to balance the rights of the debtor and its creditors but to meet the needs of
a municipal debtor.
Eligibility to File
In order to be eligible to file, the debtor municipality must be “specifically”
authorized to file under state law in its capacity as a municipality, or by name; it must
be insolvent;20 and it must either (a) have obtained agreement to a reorganization plan
by a majority of creditors whose claims it intends to impair; or (b) demonstrate that
it has negotiated in good faith with creditors and failed to obtain agreement;21 or (c)
prove that negotiation is impracticable.22
Prior to the 1994 amendment, municipalities were required to be “generally
authorized” to file under state law. The few courts that had considered eligibility had
split over the question what constitutes “general authorization” to file. In In re
Pleasant View Utility District,23 the court concluded that general authorization to file
did not require express authorization. Several courts followed the Pleasant View
analysis,24 while others interpreted the “general authorization” requirement as
19 Only once has the alteration of a municipal bond contract been sustained by the Supreme
Court. In Faitoute Co. v. Asbury Park, 316 U.S. 502 (1942), the Court sustained a New
Jersey statute authorizing state control over insolvent municipalities. The plan involved an
exchange of securities for new bonds with extended maturity and a lower interest rate. In
response to this decision, however, Congress, amended the bankruptcy law to proscribe state
laws addressing composition of indebtedness from becoming binding on non-consenting
creditors. See, 11 U.S.C. § 903. To allow each state to enact its own version of Chapter 9
of the Bankruptcy Code would frustrate the constitutional mandate of uniform bankruptcy
laws. See, H.Rept. 686, 94th Cong., 2d Sess. 19, reprinted in 1976 U.S. CODE CONG. &
ADM. NEWS 539, 557.
20 See, In re Hamilton Creek Metropolitan Dist., 143 F.3d 1381 (10th Cir. 1998).
21 See, In re Sullivan County Regional Refuse Disposal District, 165 B.R. 60 (Bankr.D.N.H.
1994). The court dismissed the chapter 9 filings of the county solid waste disposal districts
which failed to establish prepetition good faith negotiations. The debtor districts s did not
seriously attempt until four or five weeks prepetition to develop feasible repayment plan in
response to creditor’s repeated demands; the districts never exercised assessment powers;
and districts never set out for creditors comprehensive workout plan.
22 11 U.S.C. § 109(c).
23 24 B.R. 632 (Bankr.M.D.Tenn. 1982).
24 See, In re City of Bridgeport, 128 B.R. 688 (Bankr.D.Conn. 1991); In re Greene County
Hospital, 59 B.R. 388 (Bankr.S.D.Miss. 1986); In re City of Wellston, 43 B.R. 348
(Bankr.E.D.Mo. 1984).

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requiring express authorization.25 Municipal debtors filing under chapter 9 after
October 4, 1994 must be expressly authorized under state law to do so.26
Filing the Plan; Appointment of a Trustee
Only the municipal debtor may file a reorganization plan, and, unlike chapter
11, there is no statutory time frame for doing so, although a court may impose one.27
A trustee is not appointed in chapter 9. If the debtor fails to propose a plan on a
timely basis, or if the debtor proposes one that cannot be legally confirmed or that
creditors do not accept, the court’s sole remedy is dismissal.28 Dismissal operates to
restore the debtor and creditors to their procedural and substantive rights under
applicable nonbankruptcy law.
The Automatic Stay
Among the greatest advantages to the chapter 9 municipal debtor are the
automatic stay and the opportunity to acquire post-petition financing. A petition filed
in bankruptcy operates as an automatic stay of all actions, including judicial and
administrative ones, intended to enforce a claim against the debtor, including its
officers and inhabitants.29 The stay does not operate to delay or waive application of
non-commercial or nonbankruptcy-related laws.
Ordinarily, the automatic stay operates to protect a debtor’s property which may
be held by a third party, subject to certain express exceptions. Hence, a third party
holding property of the debtor would be prohibited by the stay from disposing of it,
even under a colorable legal claim to it. One important area of exceptions to the
automatic stay is for actions for the set-off of a wide variety of financial instruments
and agreements, such as forward contracts and repurchase agreements.30
Amendments to the Code added in 1984, 1990, and 2005 apply to municipalities and
are designed to protect the smooth functioning of investment markets.
25 See, In re North and South Shenango Joint Municipal Authority, 80 B.R. 57 (W.D.Pa.
1982); In re Carroll Township Authority, 119 B.R. 61 (Bankr.W.D.Pa. 1990).
26 See, In re Slocum Lake Drainage District, 336 B.R. 387 (Bankr.N.D.Ill. 2006)(holding that
the debtor drainage district was not specifically authorized to file a chapter 9 under Illinois
law); In re County of Orange, 183 B.R. 1995 (Bankr.C.D.Ca. 1995). Orange County and a
consolidated investment fund, the “Orange County Investment Pool” or OCIP, filed separate
chapter 9 petitions. Although the County was permitted to file, the bankruptcy court held
that the OCIP was not specifically authorized to file chapter 9.
27 11 U.S.C. § 941.
28 11 U.S.C. §§ 930, 941, 942.
29 11 U.S.C. §§ 362, 922.
30 11 U.S.C. § 362(b)(6) & (7).

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The Bankruptcy Estate; Control of Property
A municipal debtor, unlike one under chapter 11, does not need bankruptcy
court approval to borrow and spend money. Indeed, there is not a separate
bankruptcy “estate” in a chapter 9 case, so the debtor is free to control property
without regard to restrictions generally applicable to estate property.
Although a municipal debtor retains autonomy, the Code does impose some
affirmative obligation on it to act to reorganize its debt. An initial requirement is that
the debtor file its petition in “good faith.”31 While a finding of “good faith” reposes
a great deal of discretion in the court, it is a protective criterion for the creditors.
In addition to the automatic stay, a chapter 9 debtor may avail itself of a wide
array of bankruptcy powers, including the right to avoid preferences,32 to set aside
fraudulent conveyances,33 to borrow money on the security of liens senior to existing
liens of record,34 to reject executory contracts,35 and to bind all creditors by a
confirmed plan.36
The fundamental character of chapter 9 is defined by the jurisdictional
constraints imposed upon the court, discussed supra. Narrower provisions tailored
to municipal reorganization, most of which were added by the 1988 amendments,
include special protections for leases to the municipality,37 and requirements for the
segregation, separation, and protection from avoidance actions of municipal revenues
dedicated to general bondholders versus special revenue bondholders.38 These
provisions clarify that payments to bondholders cannot be “recaptured” as avoidable
31 11 U.S.C. § 921(c). See, In re City of Desert Hot Springs, supra note 4. The City was a
defendant in a lawsuit in which the plaintiff was awarded a judgment of 3 million dollars,
and thereafter attempted to freeze city funds. After somewhat complicated judicial
proceedings, including a retrial and appeals, the City filed under chapter 9. Plaintiff/creditor
moved to have the case dismissed as being filed in bad faith. The bankruptcy court denied
the motion, which the Ninth Circuit Court of Appeals declined to review.
32 11 U.S.C. § 547. An “avoidable preference” allows the debtor to nullify or “avoid”
prepetition transfers from the debtor to others. A creditor who may have lawfully received
money from the debtor within a specified time prior to the filing may be compelled by the
court to disgorge and return it to the debtor for the benefit of the bankruptcy estate. The
purpose of requiring creditors in specified situations to disgorge monies received from the
debtor legally prior to bankruptcy is to maximize the estate to permit equitable distribution
among all creditors.
33 11 U.S.C. § 548.
34 11 U.S.C. § 364(c).
35 11 U.S.C. § 365.
36 11 U.S.C. § 944.
37 11 U.S.C. § 929. This section provides that a lease to a municipality is not to be treated
as an executory contract or unexpired lease solely because it is subject to termination in the
event the debtor fails to appropriate rent.
38 11 U.S.C. §§ 922(d), 927, 928.

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preferences, and that monies from special projects which are financed by and
dedicated to special bondholders are not converted to general obligation funds by
virtue of bankruptcy.
Rejection of Executory Contracts; Labor Relations
In 1984, the United States Supreme Court, in National Labor Relations Board
v. Bildisco,39 allowed a chapter 11 debtor to unilaterally abrogate a collective
bargaining agreement (CBA), finding the labor contract to be an “executory contract”
under 11 U.S.C. § 365 subject to rejection by the debtor, upon presentation of
evidence that the agreement burdens the estate and that the equities favor rejection.
In 1984, Congress overturned the Bildisco holding by enactment of a new § 1113 of
the Code which requires a chapter 11 debtor to negotiate proposed modifications of
a CBA with the authorized representative of the employees covered by such
agreement. Many steps are required of the debtor, and ultimately, court approval is
necessary for debtor rejection or modification of a CBA.
This provision of the Code, applicable to chapter 11 debtors, however, is not
expressly applicable to a chapter 9 debtor. Section 1113 was enacted to reconcile the
conflict between the National Labor Relations Act and the Bankruptcy Code. Labor
relations for state and local public employees are covered exclusively by state law.40
Hence, a chapter 9 municipal debtor does not have to comply with § 1113 and may
enjoy greater latitude than a private debtor under chapter 11 with respect to
modification or rejection of labor agreements in bankruptcy. Collective bargaining
agreements may be subject to rejection under chapter 9, like other executory
contracts, with damages treated as prepetition debt. However, Bildisco has been held
to apply to municipal debtors. The bankruptcy court overseeing the Orange County
reorganization found that the County had not satisfied standards established by the
Bildisco decision and state case law to establish the necessity for unilateral
abrogation of its employee CBAs:
The [Labor] Coalition further argues that before impairing its contractual rights
on the basis of an emergency, the County must satisfy the following four-part test
...: (1) a declared emergency must be based on an adequate factual foundation;
(2) the agency’s action must be designed to protect a basic social interest and not
benefit a particular individual; (3) the law must be appropriate for the emergency
and obligation; and (4) the agency decision must be temporary, limited to the
immediate exigency that caused the action. ... In my view, any unilateral action
by a municipality to impair a contract with its employees must satisfy these
factors if not as a legal matter, certainly from an equitable standpoint.41
The ability and standards by which a chapter 9 debtor may modify or abrogate CBAs
with public employees are likely to vary from state to state.
39 465 U.S. 513 (1984).
40 The NLRA excludes “any State or political subdivision thereof” from the definition of
“employer.” 29 U.S.C. § 152(2).
41 In re County of Orange, 179 B.R. 177, 184 (Bankr.C.D.Ca.1995)(citations and footnotes
omitted).

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Confirmation
Reduced to its bare essential, debt adjustment under chapter 9 simply requires
the debtor and its creditors to reach some agreement on an acceptable reorganization
plan. The municipality need not actually negotiate the plan with its creditors; it may
file a debt adjustment plan or modifications to the plan unilaterally. But the plan
must ultimately be approved by creditors in order to become effective. If consensus
is reached, the court reviews the plan to determine that it “does not discriminate
unfairly, and is fair and equitable, with respect to each class of claims or interests that
is impaired under, and has not accepted the plan.”42
The Code also provides that an exchange of new securities for a claim covered
by the plan, regardless of whether the exchange occurs before or after the filing of the
petition, does not limit or impair the effectiveness of the plan. For purposes of
accepting or rejecting the plan, a creditor who participates in an exchange will vote
according to the number and amount of claims held prior to the exchange.43
11 U.S.C. § 943 directs the court to confirm a plan if: it complies with Code
requirements; expenses incurred in connection with the case and the reorganization
plan are disclosed and are reasonable; the debtor is not prohibited by law from taking
any action necessary to carry out the plan; holders of administrative expense claims
receive cash equal their claim, unless they have agreed to different treatment; any
regulatory or electoral approval necessary under applicable nonbankruptcy law in
order to carry out the plan has been or will be obtained; and, the plan is in the best
interest of creditors and is feasible.
Orange County
On December 6, 1994, Orange County, California, filed under chapter 9. Its
debt adjustment represents the largest municipal bankruptcy filing to date. The
County was overseer of the Orange County Investment Pool (OCIP), comprised of
its funds and those belonging to a wide variety of additional municipal entities, such
as school and irrigation districts. The County Treasurer engaged in a high-risk
investment strategy involving reverse repurchase agreements or “repos.” The OCIP’s
7.5 billion dollars in investment equity was leveraged into 20 billion dollars. The
success of the investment strategy depended upon declining interest rates. When
interest rates began to rise and creditors demanded increased collateral, the County’s
financial liquidity plummeted.44 It filed under chapter 9 and instituted many lawsuits
against its investment bankers and others. A plan of adjustment became effective in
42 11 U.S.C. § 1129(b)(1). The standards imposed by these “terms of art,” though not fully
tested in chapter 9, are supported by a large body of judicial case law and cannot be viewed
as conferring unfettered discretion upon a court applying them.
43 11 U.S.C. § 946.
44 Philippe Jorion, BIG BETS GONE BAD: DERIVATIVES AND BANKRUPTCY IN ORANGE
COUNTY (Academic Press 1995).

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June 1996. In February 2000, the presiding bankruptcy judge closed the case by
approving the distribution of $816 million in litigation proceeds.45
There are, of course, many lessons to be learned from the Orange County filing
— and they encompass principles of municipal management, finance, and oversight,
among others. But the State of California’s policy allowing its municipalities to avail
themselves of relief under chapter 9 appears to be a prudent one. And the Code
itself, as applied by the bankruptcy court, appears to have been sufficiently flexible
to accommodate the operational needs of the County and the interests of its creditors.
Conclusion
The paramount feature of a municipal reorganization is the requirement that the
municipal debtor and a majority of its creditors reach an agreement on the plan to
readjust the municipality’s debts. The outcome of any reorganization cannot be
predicted with certainty. Given the many variables, including applicable state law
and the underlying reason for the insolvency, the parties involved, including the
court, may take an expansive and dynamic approach to reorganization, or a narrow,
more limited view of remedial possibilities. Several basic principles may provide
guidance as one considers the likely course of a major municipal reorganization.
First, the policy underlying chapter 9 is unlike that of other chapters: municipalities
are not subject to liquidation or strict judicial control. Second, development of the
reorganization plan is largely the initiative of municipal authorities, who do not need
judicial permission to exercise governmental functions.
Conversely, even though the Code is designed to give the cash-strapped
municipal debtor “breathing room” and an opportunity to marshal its assets, the Code
does not relieve the debtor from the requirements of applicable nonbankruptcy law.
Filing bankruptcy does not lift from the municipality the burdens imposed upon it by
myriad state and federal laws. Reorganization and, ultimately, repudiation of debt
may be facilitated by a chapter 9 filing. But the manner in which the municipal
debtor reaches its goal for rehabilitation will still be shaped, in large part, by the
constraints of federal and state law under which it operates.
In the Orange County financial crisis, the bankruptcy forum appears to have
provided an appropriate and efficient judicial mechanism for its resolution. The
County qua municipality remained in control of its “political” affairs, that is, the
operation of government and the provision of public services, while the County qua
debtor was free to pursue both litigation and negotiated settlement with its creditors.
The uniquely binding effect of a chapter 9, federally-confirmed reorganization plan
coupled with the inherent limitations creditors face in dealing with a municipal
debtor may promote consensus towards an achievable composition of debt. Whether
45 Daniel Yi, Judge OKs Payments Ending O.C. Bankruptcy, L.A. TIMES, Feb. 3 2000, at B3.
The distribution provided “near total” recovery for many of the agencies that lost money in
the OCIP; schools recovered an average of 97.7%; cities and public agencies, 94.4%; and
the County, 87 cents on the dollar.

CRS-11
chapter 9 will be called upon to aid municipalities grappling with pension and health-
care related debt remains to be seen.