Small Island Fund, Big Bankruptcy Wave – U.S. Public Pension Fund Deemed Ineligible to Be a Chapter 11 Debtor

Contributed by Marvin Mills
On June 13, 2012, U.S. Bankruptcy Judge Robert J. Faris from the United States District Court for the Northern Mariana Islands concluded that the Northern Mariana Islands Retirement Fund—a public pension fund established for the commonwealth territory—is a “governmental unit” and, pursuant to the Bankruptcy Code, cannot be a chapter 11 debtor.
According to the declaration of the fund’s administrator, the fund was experiencing severe financial problems in the years leading up to its bankruptcy filing.  The fund administrator asserted, among other things, that “chronic underfunding” of the fund by the commonwealth and certain of its agencies necessitated the filing.  Adding to these problems was the fund’s inability to benefit from recent financial market opportunities because the fund is restricted from investing in anything other than “extremely stable, low yield investments.”
On April 17, 2012, the fund filed a petition for relief under chapter 11 of the Bankruptcy Code, claiming that its assets would be entirely depleted within two years absent restructuring of its benefit obligations.  The fund administrator declared that a benefits reduction from 100% to 42% was necessary to sustain the fund as a going concern.  Such a reduction would, according to the administrator, enable the fund to continue to increase its assets and, thereafter, increase or restore benefit payments.
Soon after the fund filed its petition, the government of the Commonwealth of the Northern Mariana Islands, the United States Trustee for the District of the Commonwealth of the Northern Mariana Islands, and certain other parties in interest filed motions to dismiss the fund’s bankruptcy case.  In their respective motions to dismiss, the commonwealth government and the U.S. Trustee contended, among other things, that the fund—as an instrumentality of the commonwealth government—was a governmental unit and, therefore, ineligible to be a chapter 11 debtor.
In its omnibus response to the motions to dismiss, the fund countered that it is not a governmental unit within the meaning of the Bankruptcy Code because (1) the fund’s activities—the collection and investment of contributions—are not traditional government functions, and (2) the commonwealth government lacks “active control” over the fund.  The fund also claimed that public policy considerations warranted a finding that the fund was eligible to be a chapter 11 debtor.  The fund specifically noted that chapter 9 was not an available option because the fund “operates within a territory of the United States rather than a ‘State’ as that term is used in Bankruptcy Code Section 101(52)” and stated that, if the fund is deemed ineligible to be a chapter 11 debtor, it would “‘fall[ ] between the cracks’ of the Bankruptcy Code.”
In his memorandum of decision, Judge Faris concluded that the fund is a governmental unit, as defined by the Bankruptcy Code, and therefore is not eligible for chapter 11 relief.  In reaching this conclusion, the court began with a fundamental observation that, pursuant to section 109 of the Bankruptcy Code, “[o]nly a ‘person’ may be a debtor in a chapter 11 case.”  Section 101(41) of the Bankruptcy Code expressly provides that a “governmental unit” is not a person.  Pursuant to section 101(27) of the Bankruptcy Code, “the term ‘governmental unit’ means United States; State; Commonwealth; District; Territory; municipality; foreign state; department, agency, or instrumentality of the United States . . . a State, a Commonwealth, a District, a Territory, a municipality, or a foreign state; or other foreign or domestic government.”
The court focused on whether the fund was an instrumentality of the commonwealth government.  Because the Bankruptcy Code does not define the term “instrumentality,” the court attempted to derive the “plain meaning” of “instrumentality,” but concluded that the term lacks a unique or single plain meaning.  The legislative history of section 101(27), however, provides guidance as to the term’s meaning, and explains that the relationship between a government and an entity “must be an active one in which the . . . instrumentality is actually carrying out some governmental function.”
Applying this standard, the court concluded that the fund is an instrumentality of the commonwealth government because the fund performs certain functions of the government.  Specifically, the court observed that the government of the commonwealth formed the fund to carry out the government’s benefit obligations to its current and retired employees.  The court opined that “[p]roviding compensation and benefits to government employees is a quintessential government function.”
The court rejected the fund’s argument that managing and investing contributions was not a “traditional government function” because, unlike private financial institutions, the fund administered the plan for the sole benefit of the government’s employees.  The court also rejected the fund’s argument that the commonwealth government lacked the control necessary for a finding that the fund is an instrumentality thereof.  According to the court, the commonwealth maintained substantial ongoing influence over the fund.  The court further explained that the fund’s sole function was to effectuate the obligations of the government.  Put simply, the fund “does literally nothing other than carry out the government’s duties.”
Although the court ruled that chapter 11 was not an option for the fund, the court highlighted the fund’s financial dilemma and commended the fund’s trustees’ efforts to compensate retirees despite the unwillingness of the commonwealth government to pay its contribution debts.  Nevertheless, the court opined that “Congress did not intend that the Bankruptcy Code could solve all problems, least of all the financial problems of governmental units.”
Despite the court’s eligibility ruling, other U.S. public pension funds may have better luck obtaining chapter 11 relief.  Because the Northern Mariana Islands Retirement Fund ruling chiefly turned on the fund’s lack of autonomy and its limited function, public pension funds with greater independence may be able to avoid categorization as instrumentalities, and, consequently, satisfy the eligibility requirements for chapter 11 debtors.  On the other hand, a bankruptcy filing and adverse eligibility ruling could deplete an insolvent fund’s already-limited assets.  In light of a recent announcement by Moody’s that adjusted fiscal 2010 state and local unfunded pension liabilities exceed $2 trillion—an amount “three times the total reported by governments”—some public pension funds’ best bet may be to take their chances in the bankruptcy courts.