November 2012: Bankruptcy Litigation Update

Jefferson County Section 928 Decision: In a matter of first impression and potential importance in the municipal bond market, the Bankruptcy Court for the Northern District of Alabama held in Bank of New York Mellon v. Jefferson County, Alabama, 474 B.R. 725, 763-64 (Bankr. N.D. Ala. 2012), that where a trust indenture provides sufficient funding for operating expenses, the “minimal standard” of “necessary operating expenses” imposed by Bankruptcy Code section 928(b) is inapplicable. Section 928(b) provides that “[a]ny [ ] lien on special revenues, other than municipal betterment assessments, derived from a project or system shall be subject to the necessary operating expenses of such project or system, as the case may be.” 11 U.S.C. § 928(b). The Bankruptcy Court rejected Jefferson County’s contention that section 928(b) overrode the provisions of the parties’ trust indenture and permitted it to characterize depreciation, amortization, capital expenditures, reserves for any of the same, or reserves for professional fees and expenses, as operating expenses that it could deduct prior to funding debt service. The Bankruptcy Court agreed with the plaintiffs that “a pledge of special revenues [is] unaffected unless it is at odds with the policies incorporated in 928.” Id. at 756. It found that “unbridled inclusion of costs that under generally accepted accounting principles are capitalized, whether in the context of a gross revenue or a net revenue pledge, is capable of undoing what the 1988 Amendments were designed to [achieve],” i.e., the post-petition preservation of special revenue liens, protecting the benefits of parties’ bargains, and ensuring continued municipal access to capital markets. Id. at 760-61. Finally, the Bankruptcy Court concluded that the parties’ “mutual exercise of business judgment ... incorporated into a special revenue financing transaction [ ] should not be second guessed in a municipal bankruptcy absent clear evidence of an unreasonable exercise or that it is a certainty that 928(b) is not met. In other words, for pledges that are not gross revenues, a court should defer to the agreed pledge and distributive design representing the business judgments of the parties that is expressed in the contract between them.” Id. at 763.

CIT Section 510(b) Decision: The Second Circuit recently held that mandatory subordination under section 510(b) of the Bankruptcy Code must be interpreted narrowly in accordance with its underlying...