By LEN WEISER-VARON and BILL KANNEL

A few thoughts on Tuesday’s oral arguments before the U.S. Supreme Court in the litigation over whether Puerto Rico’s Public Corporations Debt Enforcement and Recovery Act, an insolvency statute for certain of its government instrumentalities, is void, as the lower federal courts held, under Section 903 of the U.S. Bankruptcy Code:

  • Due to Justice Scalia’s death and Justice Alito’s recusal, only 7 Justices heard the case and only 4 votes are needed for a majority.  Almost all of the questioning at oral argument came from Justices Sotomayor, Kagan and Breyer, plus a couple noteworthy questions from Justice Ginsburg.  With the standard disclaimer that questions at oral argument are not necessarily predictive of a Justice’s votes, it seems clear from the questioning that Justice Sotomayor will vote to reinstate the Recovery Act and is the most passionate of the Justices about the issue, and, even if the relatively silent Chief Justice Roberts and the silent Justice Kennedy and Justice Thomas vote to affirm,  the questions and musings of Justices Kagan, Breyer and Ginsburg suggest that Justice Sotomayor could sway them to her position and thereby obtain the 4 votes necessary for reversal of the First Circuit’s holding and reinstatement of the legislation.
  • All that can be said about the actual statutory language that the Supreme Court will interpret is that the drafting does not represent Congress’s finest work.  (Justice Breyer provided the only moment of merriment on the Scalia-less panel when, after a suggestion that the opaque statutory language requires a contextual reading, he responded, “That may be, but I can’t say that an ‘airplane’ means a horse.”) There is no relevant legislative history, so it is not clear that Congress, when it amended the Bankruptcy Code to exclude Puerto Rico’s (and the District of Columbia’s) government instrumentalities from Chapter 9 eligibility, thought about the question of how that would or should impact Puerto Rico’s and D.C.’s right to enact their own insolvency statutes.  So while nominally a statutory interpretation case, this is, on a technical level, almost purely a “what makes the most sense” case.
  • The First Circuit was persuaded that it would make no sense for Congress to act affirmatively to withhold from Puerto Rico the right to authorize its insolvent instrumentalities to file for bankruptcy under Chapter 9, while intending that Puerto Rico have the right to authorize such filings under some insolvency statute of its own creation.  That seems almost unassailably correct; basic common sense suggests that whatever distrust of Puerto Rico must have motivated Congress to close the door to Puerto Rico’s ability to authorize its instrumentalities to file under Chapter 9 cannot be reconciled with Congressional intent that Puerto Rico be allowed to authorize such filings under its own version of an insolvency statute that might be identical to, or differ in unpredictable ways from, Chapter 9.
  • However, Puerto Rico seems to have gotten some traction before the Supreme Court with the proposition (which the First Circuit correctly rejected) that Congress cannot have intended to leave Puerto Rico’s instrumentalities in a “no man’s land” where they had no access to Chapter 9 and no access to an alternative insolvency regime. The short answer is that there is a high likelihood that Congress, if it had an intent on the matter when it eliminated Puerto Rico instrumentalities from Chapter 9 eligibility, precisely intended that Puerto Rico instrumentalities would not have access to an insolvency process unless and until Congress specifically authorized the applicable process (as it is currently being pressed to do by Puerto Rico and the U.S. Treasury.)  Such federal control would be and is consistent with Puerto Rico’s status as a U.S. territory, however it is labeled in the Bankruptcy Code.
  • Justice Sotomayor also raised the issue of whether the principles of federalism and state sovereignty that make the federal Chapter 9 available only to instrumentalities of states that have elected into the Chapter 9 regime would be violated if Chapter 9 were the only insolvency regime available to a state, i.e. whether interpreting Section 903 of the Bankruptcy Code as applicable to states that have not exercised such option (as well as to Puerto Rico and D.C., which have no such option to exercise) would be unduly coercive and raise Tenth Amendment issues.  The First Circuit left that question unaddressed on the grounds that Puerto Rico is not protected by the Tenth Amendment.  But as Section 903 applies to any “State”, if the Supreme Court interprets it, and its restriction on a “State’s” ability to enact insolvency legislation for its instrumentalities, as applying to Puerto Rico, it also will be interpreting it as applying to the 50 states, including those that have not opted to authorize their instrumentalities to use Chapter 9.  Whether or not any of the other Justices would view such an interpretation as presenting a substantial Tenth Amendment concern cannot be discerned from the oral argument, but the Court often interprets ambiguous statutes in a manner that avoids a potential constitutional concern, and Sotomayor’s apparent invocation of that principle may be targeted at her fellow Justices as a counterweight to the proposition that Congress, in eliminating Chapter 9 access for Puerto Rico’s instrumentalities,  must have intended to preclude any access to bankruptcy by such  instrumentalities absent direct authorization by Congress.  In divining what Congress intended by Section 903, Sotomayor appears to be suggesting, the Supreme Court cannot focus myopically on what Congress would have intended for Puerto Rico.
  •  As we have previously discussed, even if the Court revives the Recovery Act, the Recovery Act is, from Puerto Rico’s perspective, a problematic, and possibly ineffective, insolvency process.  A principal purpose of bankruptcy is to adjust, restructure and impair contracts.  The federal government is not subject to the constitutional restriction on impairment of contracts, and therefore the federally-enacted Chapter 9 process can impair debts and contracts.  Puerto Rico, and therefore its Recovery Act, have been held to be subject to the constitutional restriction on impairment of contracts.  A couple of the Justices noted this constraint, both in questioning what benefit Puerto Rico would derive from a reinstatement of the statute and as a potential protection that Congress might have taken into account if it did not intend to preclude non-federal insolvency law.  If the Recovery Act is reinstated and used by Puerto Rico, one can expect years of litigation on the question of whether any debt adjustment (or other contract adjustment) effected thereunder does or doesn’t meet the high bar of public necessity and unavailability of reasonable alternatives required for such adjustment not to constitute an unconstitutional “impairment.”
  • Puerto Rico’s persistence in seeking reinstatement of the Recovery Act reflects a calculus that an insolvency process that produces a legally questionable and potentially unenforceable result is better than no process, and provides creditors more incentive for consensual resolutions than no process.  Chapter 9 eligibility for Puerto Rico’s instrumentalities, and, if Congress were to grant it, “super Chapter 9“ eligibility for Puerto Rico itself,  would clearly, in Puerto Rico’s view, constitute a far more advantageous and conclusive process.  However, there is some risk to Puerto Rico that if the Supreme Court reinstates the Recovery Act before Congress acts on federal legislation to address Puerto Rico’s financial woes, the revival of the Recovery Act would undercut any Chapter 9 momentum, leaving Puerto Rico with its legally wobbly Recovery Act.  But Puerto Rico appears willing to gamble that the Supreme Court will issue its decision after Congress has done whatever it will do, and, in any event, to believe that a constitutionally vulnerable local bankruptcy statute in the hand is worth a constitutionally bulletproof federal bankruptcy statute in the bush.

 

By LEN WEISER-VARON and BILL KANNEL

 

A draft of the U.S. Treasury’s proposed debt restructuring legislation began circulating earlier today.  The draft legislation would give Puerto Rico, as well as other U.S. territories, and their municipalities access to U.S. bankruptcy court under a new chapter of the U.S. Bankruptcy Code (so-called “Super Chapter 9”) as well as making Puerto Rico’s instrumentalities (but not Puerto Rico itself) potentially eligible to file for bankruptcy under existing Chapter 9. The prospects for bipartisan cooperation on some form of such legislation appear somewhat more promising than those for the confirmation of a new Supreme Court justice, but whether this trial balloon will fly remains uncertain.

Some initial observations:

  • The legislation would provide access to bankruptcy to Puerto Rico and other U.S. territories (Guam, American Samoa, Northern Mariana Islands and U.S. Virgin Islands) and their municipalities.
  • The availability of bankruptcy to a territory and/or any “municipality” (i.e. political subdivision, public agency, instrumentality or public corporation of a territory) would be conditioned on the establishment of a Fiscal Reform Assistance Council (Council) at the request of the applicable territory’s Governor.  The Council would consist of 5 members appointed by the President of the United States and would have to approve any such bankruptcy filing.  The Council would have a variety of oversight powers including budget and debt issuance approval powers.
  • The legislation preserves the concept of “special revenue” bonds that benefit from more protective provisions under Chapter 9, such as the continued application of a lien on special revenues to such revenues arising after the filing of the bankruptcy petition, and the inapplicability of the bankruptcy stay to the application of special revenues to payment of debt service on special revenue bonds.  However, the definition of “special revenues” is narrower under the draft legislation than it is under Chapter 9.  As under Chapter 9, “special revenues” include “receipts derived from the ownership, operation, or disposition of projects or systems of the debtor that are primarily used or intended to be used primarily to provide transportation, utility, or other services, including the proceeds of borrowings to finance the projects or systems.”  However, for Puerto Rico and other territories, the draft legislation would not include as “special revenues” “special excise taxes imposed on particular activities or transactions,”  “incremental tax receipts from the benefited area in the case of tax-increment financing,” “other revenues or receipts derived from particular functions of the debtor, whether or not the debtor has other functions” or “taxes specifically levied to finance one or more projects or systems, excluding receipts from general property, sales, or income taxes (other than tax-increment financing) levied to finance the general purposes of the debtor.”  Accordingly, debtors that under the legislation could file under either Chapter 9 or this new chapter would have an incentive to file under this new chapter if their revenues would constitute “special revenues” under Chapter 9 but not under the new chapter.
  • The legislation creates a one-year stay (from the date of establishment of a Council) on (i) the commencement or continuation of any action or proceeding that seeks to enforce a claim against the territory and (ii) the enforcement of a lien on “or arising out of” taxes or assessments owed the territory.  Note that the stay becomes effective without regard to whether a bankruptcy petition is filed.
  • A territory may be a debtor upon the establishment of a Council and approval of the filing by the Council.  A municipality of a territory must, in addition, be specifically authorized by territory law to be a debtor.
  • In contrast to Chapter 9, a debtor need not be insolvent in order to be eligible to file for bankruptcy under the proposed new chapter.
  • A territory and its municipalities may file bankruptcy petitions and plans of adjustment jointly.
  • If the debtor is a territory, the presiding judge in the bankruptcy is appointed by the Chief Justice of the U.S. Supreme Court.  If the debtor is a municipality filing separately from a territory, the presiding judge is appointed by the chief judge of the applicable federal circuit court of appeals (the 1st Circuit, in the case of Puerto Rico).
  • Among the various conditions for confirmation of a plan, noteworthy conditions include that “the plan does not unduly impair the claims of any class of pensioners.”  The draft legislation does not define what is meant by “unduly.”
  • The legislation provides a limited degree of protection for Puerto Rico’s general obligation bonds, including as a plan approval condition that “if feasible, the plan does not unduly impair” the claims of holders of the territory’s general obligation bonds that are “identified in applicable nonbankruptcy law as having a first claim on available territory resources.”   Notably, this protection is provided “if feasible” whereas there is no feasibility requirement on the protection of pensioner claims.  Again, the protection of general obligation bonds, “if feasible” is against being “unduly” impaired, without clarity as to what constitutes undue impairment.  Oddly, the implication is that general obligation bonds can be “unduly impaired” if it is not feasible to “duly” impair them.
  • The draft legislation makes many but not all of the general provisions of the Bankruptcy Code, many but not all of the provisions of Chapter 9, and some of the provisions of Chapter 11, particularly those relating to plan confirmation,  applicable to a bankruptcy involving a territory or a territorial municipality.

By LEN WEISER-VARON and BILL KANNEL

At the end of “The Candidate”, Robert Redford’s title character, having won, famously asks, “What do we do now?”

A similar question can be asked now that the federal district court in Puerto Rico has struck down the Puerto Rico Public Corporation Debt Enforcement and Recovery Act.

In a February 6, 2015 opinion, Judge Besosa rejected enough of Puerto Rico’s ripeness and standing arguments to reach the merits of the plaintiffs’  challenges to the validity of the Recovery Act.  As we had anticipated, Judge Besosa held that the Recovery Act is preempted by Section 903(1) of the federal Bankruptcy Code, which provides that “a State law prescribing a method of composition of indebtedness of [a] municipality may not bind any creditor that does not consent to such composition.”  The Recovery Act contains provisions that purport to permit changes to the debt obligations of eligible Puerto Rico public corporations without the consent of all affected debtholders. The court held that Section 903(1) applies to Puerto Rico, and that it not only invalidates those provisions of the Recovery Act that purport to bind non-consenting creditors, but preempts the Recovery Act entirely.

Puerto Rico enacted the Recovery Act because the federal Bankruptcy Code precludes Puerto Rico’s public corporations from availing themselves of Chapter 9 of the federal Bankruptcy Code to restructure their debts. Puerto Rico’s public officers are now asking themselves the Spanish version of Redford’s question: “Y ahora que hacemos?” Certain creditors of PREPA and other overleveraged Puerto Rico issuers may be asking variations of that question.

Some potential answers:

1)      The Recovery Act may yet recover. In addition to the ripeness and standing issues, Judge Besosa’s opinion rests on a textual analysis of Section 903(1), including the definition of the word “creditor” as used therein and elsewhere in the Bankruptcy Code and its applicability to creditors of an entity that is not a debtor in a federal proceeding. Puerto Rico is likely to appeal the federal district court’s ruling, both as to the ripeness and standing analysis and as to the applicability of Section 903 to Puerto Rico and the Recovery Act. The ruling is certainly a victory for the plaintiff bondholders and takes the Recovery Act off the table for the near future. In addition, Judge Besosa’s discussions of the contract clause and taking clause issues with the Recovery Act highlight the obstacles the Recovery Act has faced from the beginning as legislation that does not benefit from the federal bankruptcy power’s override of the contracts clause. Accordingly, a resurrected version of the Recovery Act, if any, would continue to face substantial legal challenges. But the Recovery Act, or something like it, will remain hovering in the background of any restructuring discussions during the pendency of the likely appeal.

2)      The invalidation of the Recovery Act, whether or not it proves permanent, eliminates the only existing process under which those public entities that would have been eligible to restructure under that legislation could do so over the objections of holdouts.  Both for Puerto Rico and for those creditors who believe that PREPA and/or certain other Puerto Rico issuers are incapable of sustaining their existing debt and must restructure, the invalidation of the Recovery Act may provide additional impetus to try to persuade the U.S. Congress to amend the Bankruptcy Code to authorize Puerto Rico to authorize its public corporations, or certain of its public corporations, to file for bankruptcy under Chapter 9. Such legislation was filed in the prior session of Congress and its viability may be somewhat enhanced by Judge Besosa’s ruling.

3)      While any Recovery Act appeal wends its way through the higher courts, and while any  legislation to amend the federal Bankruptcy Code seeks to wend its way through Congress, PREPA and PREPA’s creditors, and any other Puerto Rico issuers who seek debt relief and their creditors, will need to negotiate without a forum, without a final arbiter, and without the ability to impose a majority or supermajority consensus on holdouts. That process can be a messy and difficult one, but not necessarily an impossible one. In contrast to Robert Redford’s most recent movie, the working title for the as-yet-unfinished movie about Puerto Rico and its creditors remains All Is Not Lost.

 

 

 

By William Kannel and Adrienne Walker

Pennsylvania’s legislature recently approved House Bill No. 1773, an overhaul to its Municipalities Financial Recovery Act, commonly known as “Act 47.”  HB 1773 was signed into law by Governor Tom Corbett on October 31, 2014.

Act 47 was established in 1987 to provide the Commonwealth, largely through the Governor’s office, greater oversight over financially troubled municipalities.  Under Act 47 (currently and after the amendments go into effect), if a municipality is found to be in financial distress the Commonwealth is authorized to pursue a series of escalating steps to address the municipality’s financial problems, ranging from a coordinator to a receiver selected by the Governor.  At each level of state oversight, municipalities are required to adopt or abide by recovery plans to address their respective financial distress.  No Act 47 plan may unilaterally alter the rights of bondholders.

The primary changes to Act 47 include the following:

  • Termination Date:  The amendments establish a maximum 5 year exit strategy.  While the amendment does not stop a municipality from returning to Act 47, its intent is to move municipalities more quickly through an Act 47 rehabilitation.  This change will impact municipalities, such as Pittsburgh, which is presently under Act 47 oversight.  The amendment will require all current Act 47 municipalities to exit Act 47 oversight within 5 years from the date of their most recently enacted recovery plan.
  • Early Intervention Program:  With the goal of preventing municipalities from experiencing significant financial distress, the Commonwealth will establish an early intervention program to provide resources to municipalities to manage potential financial distress.  This early intervention program may provide financial support to municipalities through grants (subject to partial matching by the municipality) to develop plans for fiscal stability.
  • Ability to Raise Certain Taxes:  The amendment will allow a municipality under certain circumstances to petition to triple the applicable local services tax.  However, the amendments exempt Pittsburgh from this potential opportunity.
  • Disincorporation:  While it is unlikely to be a common occurrence, the amendments outline a process for disincorporation of “nonviable municipalities.”  For purposes of the disincorporation provisions, the definition of municipality excludes any city of the first class – which only includes Philadelphia. The process of disincorporation involves both state court and gubernatorial oversight. Upon disincorporation, the municipality is established as an unincorporated services district and the municipality’s assets (including bondholder collateral) would vest in the Commonwealth and be held in trust for the residents, property owners and other parties in interest.  While the amendments appear to preserve bondholder rights to collateral and payments of debt obligations, bondholders involved with a municipality that may disincorporate must be vigilant in preserving their rights to both their collateral and future debt service payments.

By LEN WEISER-VARON and BILL KANNEL

On August 11, Franklin Funds and Oppenheimer Rochester Funds filed a second amended complaint, opposition to motion to dismiss and cross-motion for summary judgment in the litigation they previously filed in the United States District Court for Puerto Rico challenging the constitutionality and validity of Puerto Rico’s so-called Recovery Act.  The second amended complaint reiterates that a PREPA filing under the Recovery Act, which establishes debt adjustment procedures for most of Puerto Rico’s public corporations, is both “probable and imminent.”  The motion seeks summary judgment on two of the plaintiffs’ claims: that the Recovery Act is constitutionally and statutorily preempted, and that the Recovery Act’s automatic stay provisions are illegal to the extent they purport to preclude a federal court action.  The motion asserts that these two claims are “purely legal, and will not be clarified by further factual development.”

The summary judgment motion re-enforces our prior assessment that, once the court is persuaded to address the merits, one of the plaintiffs’ strongest arguments is that Section 903 of the federal Bankruptcy Code precludes enforcement of any Recovery Act debt adjustment against non-consenting bondholders.

The motion, referencing legislative history and prior case law,  effectively dispenses with Puerto Rico’s relatively weak arguments that Section 903 cannot or should not be read as applicable to Puerto Rico’s public corporations.   Puerto Rico has argued that Congress could not have intended to leave its public instrumentalities without access to any debt adjustment process, which, given Puerto Rico’s express exclusion from eligibility under Chapter 9 of the Bankruptcy Code, would be the effect of  applying Section 903 to Puerto Rico’s own public corporation insolvency legislation.  Whether Congress indeed intended to leave Puerto Rico in such a predicament is unclear.  The plaintiff’s brief suggests that because Puerto Rico’s bonds, unlike any state’s bonds,  benefit from nationwide triple tax-exemption (which accounts for Puerto Rico’s status as the third highest volume issuer of tax-exempt bonds after California and New York), “Congress did not want Puerto Rico to restructure its municipal debt through either its own laws or Chapter 9.”  Whether this or any other rationale for Puerto Rico’s statutory treatment under the Bankruptcy Code exists, the plaintiffs’ motion argues that the statutory language in Chapter 9 is explicit, and that if Puerto Rico is unhappy with its position, “Puerto Rico’s remedy lies … with Congress.”

Although Section 903 does not technically preempt or prohibit all of the Recovery Act, if a court agrees that Section 903 is applicable, any debt adjustment produced by the Recovery Act’s procedures could not be enforced against non-consenting creditors, thereby rendering the Recovery Act largely ineffective as a debt adjustment mechanism.

For an adjudication of the plaintiffs’ challenge to take place in federal court, plaintiffs must establish standing and ripeness.  The Commonwealth and PREPA have asserted the obvious argument that PREPA has not filed under the Recovery Act, and that therefore there is no case or controversy to adjudicate. The plaintiffs’ summary judgment motion, like the original complaint, argues that the plaintiff PREPA bondholders have suffered a devaluation of their bonds as a result of the Recovery Act’s enactment, and that they are forced to litigate before a filing because the automatic stay provisions of the Recovery Act would preclude them from pursuing federal court litigation after a PREPA filing under the Recovery Act.  (As noted, the plaintiffs simultaneously seek summary judgment on the unconstitutionality of any such application of the Recovery Act’s automatic stay to preclude or freeze a federal court action.) Whether these arguments that the case is ripe for adjudication will find traction with the court remains to be seen.

The filing also previews arguments that will be further litigated if the Recovery Act survives the plaintiffs’ preemption claim.  The plaintiffs assert that the Recovery Act’s provisions effect an unconstitutional impairment of contracts.   As we have previously discussed, courts have interpreted the “Contracts clause” not as an absolute bar to impairment of contracts by state action, but rather as a balancing test in which the state’s interests and needs and the extent of the contractual impairment are weighed against each other.  This makes contract impairment claims highly fact-sensitive and unlikely candidates for summary judgment.  For example, the plaintiffs’ brief argues that PREPA has the following alternatives to impairing its bonds through debt adjustment:

(1)    PREPA can raise rates.

(2)    The Commonwealth of Puerto Rico could repay over $640,000,000 it owes to PREPA.

(3)    The Commonwealth could reduce PREPA’s taxes and subsidies which the brief asserts amount to over $1 billion from 2014 through 2018.

(4)    PREPA should collect its full accounts receivable and pay subsidies after debt service instead of permitting customers to offset subsidies from their payments.

(5)    PREPA should cut costs and address inefficiencies.

(6)    PREPA should strengthen its capital markets reputation by hiring an investment banker and making public presentations.

If PREPA, or any other public corporation, eventually seeks protection and debt adjustment under the Recovery Act, these types of arguments about whether the applicable issuer requires any debt adjustment in order to maintain financial and operational viability (and, if so, whether the proposed amount of debt adjustment is necessary for such viability) will be front and center in such proceedings.

By BILL KANNEL and ERIC BLYTHE

On April 17, 2012, the Northern Mariana Islands Retirement Fund (the “Fund”) became the first United States public pension fund to seek formal bankruptcy protection. The Fund, which provides retirement benefits to government employees of the Commonwealth of the Northern Mariana Islands (the “Commonwealth”) a U.S. territory, listed $256 million in assets and $1 billion in liabilities and has alleged it will exhaust its claims paying ability by as early as 2014.

Various parties including the Commonwealth itself and the United States Trustee’s Office (a division of the United States Department of Justice responsible for overseeing the administration of bankruptcy cases) have challenged the Fund’s eligibility to file a Chapter 11 bankruptcy.

The Fund concedes that Chapter 9 is unavailable (a Chapter 9 Debtor must be a “municipality”, and because the Commonwealth is not a state the Fund cannot be a municipality as that term is defined in the Bankruptcy Code.)  The Fund’s Chapter 11 eligibility is arguably a closer call.  A debtor must be a “person” to be eligible to file for Chapter 11 bankruptcy protection. “Person” is defined to include individuals, partnerships, and corporations, but explicitly excludes governmental units. The dispute is whether the Fund is a “governmental unit.”

The objecting parties argue that the Fund’s structure and statutory existence establish that it is a “governmental unit” of the Commonwealth. They argue that providing retirement security and other benefits to government employees is a “traditional governmental function”, that the governance of the Fund is controlled by the Commonwealth both through the passage of legislation and the appointment of the Board of Trustees, and that the Commonwealth’s statutory designation of the Fund clearly confirms the “governmental unit” classification: “The Northern Mariana Islands Retirement Fund shall serve in a fiduciary capacity with respect to employer and employee contributions and shall serve as a fiscal and administrative agent of the government.”

On May 18, 2012, the Fund responded to the motions to dismiss, arguing that it is not a “governmental unit” and therefore Chapter 11 is an available remedy. The Fund’s argument relies primarily on the recent decision in the Las Vegas Monorail case, in which the court found that the Las Vegas Monorail was an eligible debtor under Chapter 11 despite its ties to the state.  That decision introduced a three-part test to identify a “governmental unit”: (a) whether the entity has traditional governmental powers and/or performs traditional governmental functions; (b) the nature and extent of governmental control over the operations of the entity; and (c) the government’s designation of the entity. Focusing on this test, the Fund disputes that actively managing and investing employee and employer contributions is a “traditional governmental function” as such services are regularly performed by private financial institutions. The Fund argues that “governmental control” is determined by governmental involvement in the daily affairs of the entity and that, in this case, the Commonwealth only has the authority to regulate the Fund and that regulation, even if “extensive and intrusive,” does not transform a heavily regulated entity into a governmental unit. Finally, the Fund argues that the government’s designation of the Fund as a “public corporation and autonomous agency” classifies it clearly as a regulated entity, not a governmental unit.

The Fund also advances a secondary argument under the “Alternate Relief Test.” This policy-based analysis favors Chapter 11 eligibility because no other remedy is available to the Fund, other than “maintaining the status quo and barreling headlong towards financial oblivion or receivership.”

Given the increasing number of such “quasi-governmental” entities and the decreasing solvency of pension funds, the case is being closely watched by the market. The hearing on the motions to dismiss is on June 1, 2012.  Expect a blog update upon the court’s ruling.

 

BY BILL KANNEL

As expected the Harrisburg City Council has filed a reply to the numerous objections to the Chapter 9 filing of Harrisburg initiated by the City Council.  The City Council’s brief (Harrisburg response.pdf) appears to be the only timely filed reply to the objections to the Chapter 9 filing.

The brief appears to devote significant space to issues outside of the Bankruptcy Court’s request for briefing.  With respect to specific issues the Bankruptcy Court asked to be addressed the City Council makes the following arguments.

  • Specific State Authority to File

The Council argues that Harrisburg was specifically authorized to file a Chapter 9 bankruptcy under Act 47, the Pennsylvania statute dealing with distressed municipalities.  The Council argues that access to bankruptcy is to be liberally construed and that Act 26, which amended the Pennsylvania Fiscal Code to prohibit “cities of the third class” such as Harrisburg from filing under Chapter 9 until July 1, 2012, was “. . . enacted without debate or ascertainable knowledge of those who voted on it….”  The brief also argues that Act 26 violated the impairment of contract clause of the United States Constitution because the prohibition on filing did not exist when Harrisburg became subject to Act 47 and that Act 26 also violates the equal protection clause of the United States Constitution and the Pennsylvania constitution.

  • City Counsel Authority under Local Law or Ordinance

With respect to the issue of whether the Council itself was authorized under local law or ordinance to file a bankruptcy petition, the Council’s brief is not entirely clear but appears to make arguments based on separation of powers between the City Council and the Mayor’s Office and  the city solicitor’s status as only an “acting solicitor”.

We did not find the City Council’s brief particularly compelling or effective in rebutting the objections to the Harrisburg’s Chapter 9 filing.

BY BILL KANNEL

As expected a number of objections to the Chapter 9 bankruptcy petition filed by the Harrisburg city council were filed on Friday October 28, the deadline set by the Bankruptcy Court for such objections. As expected both the Commonwealth of Pennsylvania and the Harrisburg Mayor’s Office filed objections.

The Commonwealth’s objection focused on the argument that Harrisburg is not “specifically authorized” by the Commonwealth to file a Chapter 9 petition given the June 30, 2011 amendment to the Pennsylvania fiscal code prohibiting cities of the third class like Harrisburg from filing until July 1, 2012.  The objection further argues that the Bankruptcy Court should defer to the Commonwealth’s control over its financially distressed municipalities under Act 47.

The Mayor’s objection – styled as the “Objection of the City of Harrisburg through its Mayor to the Chapter 9 Petition Filed by City Council” – takes a slightly different approach instead focusing on the Optional Third Class City Charter Law.  The Mayor’s objection argues that the resolution authorizing the filing had no force of law as it had not been submitted to the mayor for approval or veto, was not approved by the City Solicitor and was not a proper exercise of the City’s executive power which is vested with the Mayor. 

Objections to the Chapter 9 bankruptcy petition were also filed by Ambac Assurance Corporation, Assured Guaranty Municipal Corp., National Public Finance Guarantee Corporation, Syncora Guarantee Inc., TD Bank National Association, Manufacturer’s Trader and Trust Company, the American Federation of State, County and Municipal Employees District Council 90, the Fraternal Order of Police Capital City Lodge No.12, Dauphin County and Covanta Harrisburg, Inc. (the operator of the incinerator). These objections incorporate or join the Commonwealth’s, the Mayor’s or both sets of objections.

The City Councils’ replies to these objections are due on November 7th and a hearing on dismissal of the petition has been scheduled for November 23rd.

In another development, the Mayor’s office filed a motion on Thursday, October 27, seeking clarification from the court that the City of Harrisburg had authority to pay pre-petition (i.e. from before the bankruptcy) amounts owed to vendors.  That motion has been set for hearing on Tuesday, November 1, at 10:30 a.m. eastern.

BY BILL KANNEL

The Bankruptcy Court held a status conference in the Harrisburg Chapter 9 earlier today.  The principal purpose of the hearing was for the court to set a schedule for objections to Harrisburg’s chapter 9 eligibility.  Objections to eligibility and supporting briefs are to be filed by October 28, a response by the City Council is to be filed by November 7, and replies on behalf of the objecting parties are to be filed by November 12.  The judge made it clear that the City Council has the burden of showing eligibility.  The court then plans to have a hearing on the legal issues related to eligibility on November 23.  If the court determines there are further factual issues that would require an evidentiary hearing that would likely be held sometime after November 23. 

From the court’s perspective, it appears that the legal issues are whether the City of Harrisburg is specifically authorized under state law to file a Chapter 9 petition (this was the gist of the Commonwealth of Pennsylvania’s objection filed last week) and whether the City Council under local law has the authority to file a chapter 9 petition on behalf of the City (the arguments the Mayor’s office has raised, although the judge indicated the Mayor’s office has yet to file a formal objection).

There were two other interesting developments.  First, while she did not say so explicitly, Judge France seems to be of the opinion that given the limited role bankruptcy courts play in Chapter 9, she could not prevent the City from paying pre-bankruptcy debt (including bonds).  This, of course, is contrary to what the result of the automatic stay would be in a Chapter 11 proceeding.  It appears that the Mayor’s office may well seek a “comfort order” to allow the City to continue to make those payments.  Second, it appears that part of the City Council’s argument to sustain the petition will be that the Act 47 amendments of earlier this summer, which arguably prevented the City from filing a Chapter 9 petition, violate Pennsylvania’s constitutional ban on single purpose legislation because, according to the City Council, the legislation was aimed solely at Harrisburg.