Municipal bankruptcies under Chapter 9 of the Bankruptcy Code, 11 U.S.C. §§ 901-946 (Chapter 9), are rare. These cases are often filed to adjust bonded indebtedness and pension obligations. Congressional authorization for Puerto Rico and its instrumentalities to file for bankruptcy under the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) was similarly out of concern for excessive bond debt and pensions.
Nonetheless, bonds and pensions are not the only liabilities that municipal or territorial debtors incur. Like corporate debtors, governmental entities incur trade debts and other liabilities. Creditors providing goods or services during a debt adjustment case may face obstacles in collecting what are typically considered “administrative claims” in a corporate reorganization.
Introduction to Chapter 9 and Title III of PROMESA
Chapter 9 generally provides for the adjustment of municipal debts in bankruptcy court. Although it incorporates many sections from the Bankruptcy Code, Chapter 9 has unique provisions and differences from corporate bankruptcies.
For example, unlike cases of individual or corporate debtors, bankruptcy courts have limited authority to control a Chapter 9 debtor. These limitations are mandated by the states’ reservation of powers in the 10th Amendment to the Constitution. See, United States v. Bekins, 304 U.S. 27 (1938). The 10th Amendment accordingly underlies many of the policies reflected in Chapter 9, including a prohibition against the bankruptcy court interfering with the municipal debtor’s political powers, governmental powers, property, or revenues. See, 11 U.S.C. § 904. Consequently, these differences can have a substantial effect on creditors’ claims and recoveries in Chapter 9 as opposed to other bankruptcies.
Title III of PROMESA, 48 U.S.C. §§ 2161-2177 (Title III), provides a remedy similar to Chapter 9 that enables Puerto Rico and its “territorial instrumentalities” to adjust their debts without the consent of creditors. See, id. §§ 2104, 2162, 2166. Among other things, PROMESA established a Financial Oversight and Management Board for Puerto Rico (the Oversight Board). Although Puerto Rico is not a state for purposes of the 10th Amendment — see, Franklin California Tax-Free Tr. v. Puerto Rico, 805 F.3d 322, 344 (1st Cir. 2015) aff’d, 136 S. Ct. 1938 (2016) — Congress concluded that, much like Chapter 9, Title III should provide the Oversight Board and Puerto Rico with protections and control. See, In re Fin. Oversight and Mgt. Bd. for Puerto Rico, 2017 WL 5501317, at *3 (D.P.R. Sept. 14, 2017). Without limitation, unless the Oversight Board consents, the court may not interfere with the debtor’s political powers, governmental powers, property, or revenues. See, 48 U.S.C. § 2165.
Allowance and Payment of Administrative Claims
Given the autonomy afforded to debtors under Chapter 9 and Title III, debtors generally have discretion to pay prepetition or postpetition debts without prior court authorization. See, e.g., Matter of Sanitary and Imp. Dist. No. 7 of Lancaster County, Neb., 96 B.R. 967, 972 (Bankr. D. Neb. 1989). This discretion is often restricted, however. Cash flow constraints, disputes over goods or services, political pressure, or other causes may force a debtor to pick and choose which postpetition creditors will be paid in the ordinary course.
Both Chapter 9 and Title III provide that — unless the creditor agrees otherwise — claims specified in 11 U.S.C. § 507(a)(2) must be paid in full on the effective date of any confirmed plan of adjustment of debts. See 11 U.S.C. § 943(b)(5); 48 U.S.C. § 2174(b)(4). Section 507(a)(2) provides an order of priority and lists “administrative expenses allowed under section 503(b)” of the Bankruptcy Code as second in line. Thus, an allowed administrative claim is one of the best outcomes for an unsecured...
