As the Massachusetts economy worsens, local governments may not be able to rely on state-collected revenues to offset the cost of vital municipal services.

Those individuals charged with balancing municipal budgets may find it impossible to maintain services and honor debt obligations. Economically distressed municipalities that are unable to meet financial obligations may opt to reorganize their debt pursuant to chapter 9 of the United States Bankruptcy Code.

Federal bankruptcy law protection is available for debt laden municipalities, subject to certain eligiblity requirements set forth in Section 109(c) of the United States Bankruptcy Code. City and town creditors and contract employees should be aware that collective bargaining agreements with the bankrupt municipality may be at risk, owing to the power accorded a bankrupt municipality to reject any executory contract, including collective bargaining agreements, if burdensome to the municipality.

Chapter 9 v. Chapter 11

Municipal bankruptcy is perhaps a misnomer since it is more analogous to corporate reorganization under Chapter 11 of the bankruptcy code. Municipalities, unlike corporations, have no power under the bankruptcy court to shut down operations and liquidate assets to use the proceeds to pay creditors. If a municipality chooses to file bankruptcy under chapter 9 of the bankruptcy code, it must continue to operate and to provide the services for which it was created.

Accordingly, the purpose of chapter 9 is to allow a municipality which is experiencing financial difficulties to obtain protection from its creditors while it formulates a plan to readjust its debts.

There is a danger, however, in equating municipal bankruptcy with corporate reorganization. The tension between the desire of Congress to provide a mechanism for the adjust of the debts of a municipality and the Tenth Amendment of the United States Constitution protecting the sovereignty of the states can be seen throughout chapter 9.

For instance, section 903 of the bankruptcy code provides that chapter 9 "does not limit or impair the power of a state to control, by legislation or otherwise, a municipality or in such state in the exercise of the political or governmental powers of such municipality, including expenditures for such exercise ..."

Section 909 of the code severely limits the bankruptcy court's jurisdiction and power over a bankrupt municipality by providing that, without the municipality's consent, a court cannot interfere with the political or governmental pwers of the municipality, the property or revenues of the municipality, or the municipality's use or enjoyment of any income producing properties.

This tension has resulted in a series of code provisions which, in addition to those above, limit the bankruptcy court's power vis a vis a bankrupt municipality to a few basic areas, such as approved of a bankruptcy petition, if filed correctly, formulation, confirmation, and implementation of a plan of reorganization, approval of post-filing borrowings, review of executory contract issues, and so forth.

In order to avail itself of the protections of chapter 9 of the bankruptcy code, a municipality must file a plan of reorganization. Unlike chapter 11 cases where after a certain period of time creditors and other parties in interest are entitled to file competing plan of reorganizations, only the bankrupt municipality may file a plan of reorganization.

If not file when the bankruptcy case is commenced, the plan must be filed within the time set by the bankruptcy court.

A disclosure statement summarizing the plan, the operations of the debtor, and providing other information to enable creditors to make an informed judgment about the plan, must also be filed with the plan or within a time fixed by the court.

Once the disclosure statement is approved by the bankruptcy court, copies of the disclosure statement, the plan, and a ballot are sent to each creditor entitled to vote for the plan.

The linchpin of the plan is the classification of similar claims into classes and treatment (i.e., payment under the plan) of those claims according to their priority in the statutory scheme.

The plan usually includes extending the maturity date on obligation, reducing the contract interest rate, or otherwise restructuring the indebtedness to fit within the reorganized debtor's projected ability to pay, and must account for all creditors.

How a Plan Is Confirmed

In order to be confirmed, the plan must comply with a number of provisions of the bankruptcy code, including the requirements under section 1129 of the code that the plan be proposed in good faith and that each class of impaired creditors have voted to accept the plan.

In the alternative, if the municipality cannot obtain the approval of all classes of impaired creditors, a plan can still be approved if at least one class of impaired creditors has voted to accept the plan and the plan is fair and equitable with respect to the dissenting classes of creditors.

Section 943 sets forth additional standards for confirmation of a plan, including the requirements that any regulatory or electoral approval necessary under applicable, non-bankruptcy law in order to carry out any provision of the plan has been obtained, or such provision is expressly conditioned on such approval, and that the plan is in the best interests of creditors and is feasible.

Any affected creditor may object to the plan.

It is unclear whether a collective bargaining union has the right to file objections and be heard by the court with respect to the plan, but the better view is that the union probably has standing to be heard.

However, if the requirements of section 943, 1129 and certain other code sections are met, the plan can be confirmed over a creditor's objection to the plan.

A confirmed plan is binding on all creditors who had notice of the bankruptcy case, regardless of whether such creditors filed proofs of claim in the case.

The bankruptcy court retains jurisdiction over the case until successful implementation of the plan.

Ms Stone and Mr. Curtin are attorneys with Mintz, Levin, Cohn, Ferris, Glovsky & Popeo in Boston.

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