Chapter 9 Update: Alabama Municipalities Eligible As “Debtors” Under Section 109(c)

Contributed by Will Hueske
In Alabama, two municipalities—Jefferson County and the City of Prichard—recently found themselves unable to cope with their economic hardships and filed voluntary petitions for relief as municipality debtors under chapter 9 of the United States Bankruptcy Code. These petitions, like many chapter 9 petitions, both were met with motions to dismiss filed by creditors arguing that the municipal debtors were ineligible to seek chapter 9 relief for failing to satisfy the requirements of Bankruptcy Code section 109(c).  On April 20, 2012, however, the Alabama Supreme Court ruled in City of Prichard v. Balzer, Case No. 11-00950 (Ala. April 20, 2012), that the Alabama Code does not restrict authority to file a chapter 9 case only to municipalities holding certain types of debt, but that all municipalities organized under Alabama law are eligible, clearing the way for both cases to proceed.
In 2009, the number of municipalities filing for chapter 9 restructuring hit its highest level since the recession of the early 1990’s, with twelve cities, counties, or other municipalities seeking chapter 9 relief. See American Bankruptcy Institute, “Chapter 9 Quarterly Filings, 1980-Present.”  Another six filed in 2010, and nine in 2011.  The 2008-09 global financial crisis impacted municipalities from multiple directions: (i) the economic recession and collapse of real estate values reduced the tax base and tax revenues generated at the local level; (ii) the same economic forces hit the state and federal budgets, resulting in cuts to funding for municipalities; and (iii) some municipalities that depended on short-term financing defaulted on their obligations when credit froze, which in turn caused additional cross-defaults on other credit obligations.
City of Prichard
On October 27, 2009, the City of Prichard, Alabama, filed its petition under chapter 9 in the United States Bankruptcy Court for the Southern District of Alabama due to a mountain of pension obligations owed to former municipal employees.  Prichard previously had filed for chapter 9 relief in 1999, also owing to pension woes, but the $16.5 million increase in the pension fund mandated in the 1999 plan was never implemented by the City and so the retirement burden continued to grow.  In September 2009, when the pension fund ran dry, the City simply stopped issuing checks to its retirees.  Litigation ensued to enforce the City’s pension obligations, precipitating a chapter 9 filing in October 2009.  The City submitted a proposed chapter 9 plan in May 2010, which substantially restructured and capped the outstanding pension obligations owed to municipal retirees.
On August 11, 2010, Prichard’s creditors filed a motion to dismiss the chapter 9 case, arguing that the City had never been authorized to seek chapter 9 relief under the laws of Alabama, as it had no “refunding or funding” bond debt as allegedly required under Alabama Code section 11-81-3, and therefore did not satisfy the requirements for being a “debtor” under Bankruptcy Code section 109(c).  On August 31, 2010, the Bankruptcy Court granted the motion to dismiss and Prichard appealed.  The bankruptcy court stayed the case and the district court certified to the Alabama Supreme Court the question of whether section 11-81-3 of the Alabama Code grants all municipalities authority to seek relief under chapter 9, or if such relief is limited to municipalities holding “refunding or funding debt.”
Jefferson County
On November 9, 2011, Jefferson County, Alabama, filed its petition under chapter 9 in the United States Bankruptcy Court for the Northern District of Alabama after several years of attempting to resolve and restructure its municipal debts.  With over $4.2 billion in liabilities, the Jefferson County bankruptcy is the largest chapter 9 filing in U.S. history.  The case of Jefferson County stems from a perfect storm of misfortune that hit amid the financial crisis, including a change in Alabama tax law and alleged criminal acts of corruption and bribery in connection with the sewer system financing.
The principal form of debt held by the County is more than $3 billion in non-recourse warrants issued to finance an improved sewer system, as mandated by a federal court decree in a 1996 Clean Water Act case brought by the U.S. EPA.  Jefferson County’s ability to service this debt was dramatically curtailed when in 2011 the Supreme Court of Alabama ruled that the state’s occupational tax, which the County was authorized to collect from workers employed in the County, was unconstitutional, stripping the County of its principal source of unrestricted revenue.  As Alabama municipalities have no “home rule” powers, the County was left without a paddle when the Alabama legislature failed to replace the occupational tax with a constitutional version in the 2011 session, resulting in the County’s chapter 9 filing on November 9, 2011.
As in the City of Prichard case, on December 9, 2011, the County’s creditors filed a motion to dismiss the case, on the same grounds that section 11-81-3 of the Alabama Code requires a municipality to hold “refunding or funding bond” debt in order to be eligible as a debtor under Bankruptcy Code section 109(c).  On March 4, 2012, in an opinion interpreting the Alabama Code, Bankruptcy Judge Thomas Bennett rejected the creditors’ Alabama Code and section 109(c) arguments and ruled that Jefferson County was indeed eligible to file chapter 9.  In his construction of the Alabama statute, Judge Bennett dismissed the creditors’ reading as inconsistent and contrary to the reason for and purpose of the law.  The creditors appealed Judge Bennett’s ruling to the district court, which stayed the matter pending the Alabama Supreme Court’s ruling in City of Prichard.
Alabama Supreme Court Decision in City of Prichard v. Balzer
In its decision on April 20, 2012, in City of Prichard v. Balzer, the Alabama Supreme Court held that Alabama Code § 11-81-3 (1975) does not require municipalities to hold “refunding or funding” bond debt in order to file for chapter 9, clearing the way for both City of Prichard and Jefferson County to proceed in their cases.  The court’s opinion consisted of a careful analysis of the Code provision’s legislative history, as well as the employment of various canons of statutory construction, ultimately holding, as Judge Bennett did in his Jefferson County decision, that the creditors’ reading of the Code violates the Alabama legislature’s clear intent “to authorize every county, city, town, or municipal authority organized under [Alabama law] to proceed under the federal bankruptcy provisions.”
Based on the Alabama Supreme Court’s ruling, on May 7, 2012, the bankruptcy judge in the City of Prichard case withdrew the order dismissing the case and ordered that the case proceed, with the City’s proposed chapter 9 plan currently under consideration.  The Jefferson County case had not been stayed pending the outcome of the Supreme Court case, but the City of Prichard decision removes any doubt over Judge Bennett’s ruling on the County’s eligibility.  A chapter 9 plan has yet to be proposed in Jefferson County, and the Alabama legislature is currently considering the Alabama Financially Distressed Counties Act, which would replace the Occupational Tax and provide the County with a much needed source of revenue to service its restructured debt out of bankruptcy.
These fights over eligibility under section 109(c) reflect one of the unique and fundamental elements of chapter 9 cases, in that a municipality’s eligibility to be a “debtor” and file a case first depends on the existence and interpretation of state law permitting it to do so.  While these Alabama municipalities were found to be eligible in the end, the 2011 case of the City of Harrisburg, Pennsylvania, presents an example of creditors successfully obtaining dismissal of a chapter 9 bankruptcy, as Harrisburg failed to follow the state law requirements for a chapter 9 filing and thus were ineligible to be debtors under 109(c).  As states and municipalities continue to face lingering budgetary struggles following the financial crisis and the mounting pension obligations of an aging population, bankruptcy judges may expect to face continuing questions of municipal eligibility as a “debtor” under section 109(c) and state laws.