Fiscal Distress

The First Circuit Court of Appeals Ruling on ‘Assured’ Should be Reheard or Reversed; Recent Ruling Sends a Harsh Message to Municipal Bond Market


“Puerto Rico’s ‘Assured’ Decision Should be Reconsidered or Reversed” by James Spiotto( )

Why the Municipal Bond Market Expects Pledged Special Revenues to be Timely Paid to Bondholders in a Chapter 9 Proceeding.  And, Why the First  Circuit’s Assured Ruling in Puerto Rico’s PROMESA Title III Proceeding Should Be Reheard or  Reconsidered on Appeal.

Update on “Puerto Rico’s ‘Assured’ Decision Should be Reconsidered or Reversed” (Originally appeared  in Muninetguide on  Feb 05, 2018)

by James Spiotto

On March 26, 2019, The United States First Circuit Court of Appeals ruled on the Appeal from the Title III adjustment of debt proceeding for the Commonwealth of Puerto Rico.  The First Circuit affirmed the ruling of the District Court dismissing the Amended Complaint of Assured Guaranty Corporation (“Assured”) and held that special revenues pledged to revenue bondholders are only exempt from the automatic stay (preventing creditor enforcement action for payments to bondholders) if the municipality voluntarily pays the special revenues to the bondholders, and that such timely payments are not mandatory in Title III or purportedly a Chapter 9 proceeding.

MuniNet previously has described the well-established justification of timely payments of special revenues pledged to bondholders in Title III and Chapter 9 proceedings and why the district court rulings should have been reversed in an article last year.  (Link “Puerto Rico’s Assured Decision Should Be Reconsidered or Reversed” February 5, 2018, James E. Spiotto.)

The First Circuit in ruling on this appeal saw no reason to write at length justifying this ruling, which was contrary to all prior case law precedent by courts hearing Chapter 9 cases, the recognized commentaries on special revenues and the legislative history for the 1988 Amendments to the Federal Bankruptcy Code 11 U.S.C. § 101 et seq. (“Bankruptcy Code”) which added Sections 902, 922(d), 927 and 928, among other provisions, into the Bankruptcy Code.  These sections were interpreted by the First Circuit in its opinion.

I. The First Circuit in Its Opinion Attempted to Reason to Answer the Following Questions:

    • Was the disputed language unambiguous?

      Section 922(d) and 928(a) are unambiguous, according to the First Circuit and therefore there is no need to consult the legislative history to understand the meaning of those sections.  According to the First Circuit, the plain meaning and interpretation of these sections should not be capable of a different interpretation.  However, this unique interpretation of the First Circuit was contrary to virtually every prior precedent, namely the prior rulings of every Chapter 9 bankruptcy court that had substantively considered special revenues and the automatic stay, recognized commentators on special revenues and the 1988 Amendments legislative history regarding Section 922(d) and 928(d) of the Bankruptcy Code.

    • Are only voluntary payments of special revenue exempt from the stay?

      Section 922(d) of the Bankruptcy Code provides: “a petition filed under this chapter [Chapter 9] does not operate as a stay [preventing creditor enforcement action to be paid] of application [defined by Black’s Law Dictionary as related to payments] of pledged special revenues in a manner consistent with [s]ection 927[8], which provides the lien of bondholders on special revenues continues to be effective on special revenues collected after the municipal debtor files for the Chapter 9 protection] of this title [Chapter 9] to payment of indebtedness secured by such revenues.”  The First Circuit limits the nonoperation of the stay (of creditor actions) to voluntary payments made by a municipality after the filing of a Chapter 9 or Title III proceeding and not to mandatory payments required by a broader reading of Sections 922(d) and 928(a) of the Bankruptcy Code or state law mandates.

    • Is Section 922(d) needed so that the municipality can pay and bondholders can accept voluntary payments?

      Section 904 of the Bankruptcy Code provides “Notwithstanding any power of the court, unless the debtor [the municipality] consents or the plan so provides, the court may not, by any stay, order, or decree, in the case or otherwise interfere with … any revenue of the debtor; or (3) the debtor’s use or enjoyment of any income producing property.”  The First Circuit interpreted this to limit its power only to permit nonoperation of the automatic stay under Section 922(d) to voluntary payments by the debtor of special revenues to bondholders after the filing of a Chapter 9 petition.  The First Circuit claims Section 922(d) was necessary to allow the municipality to make the special revenue payment and for the bondholder to accept and receive the payment without violating the automatic stay.  However, under Section 904, the municipality’s use or enjoyment could not be stayed or interfered with and under municipal law, the municipality could not use or consent to a use contrary to state law including those state laws that mandate the timely payment of special revenues to bondholders.  The First Circuit’s interpretation of Section 922(d) is flawed and superfluous given Section 904 prohibition against the court’s interference with any use of revenues the municipality deems appropriate.

    • Is there credible support for the First Circuit ruling?

      The First Circuit’s support for its limited reading of Section 922(d) and the lower court ruling, was Collier’s (a commentary on the Bankruptcy Code) interpretation of Section 922(d) and its claim that the Jefferson County Chapter 9 case ruling was not applicable because Jefferson County had consented to the payment of special revenues post-bankruptcy to the bondholders and the only dispute was over the definition of “special revenues”.  However, this asserted support of the First Circuit’s interpretation is thin to the point of being invisible.  The Jefferson County Chapter 9 case had been, up to the issuance of the Assured decision, the major Bankruptcy Code decision on special revenues and the automatic stay in Chapter 9.  Contrary to the First Circuit assertion, the Jefferson County court ruled that special revenues collected post-bankruptcy not in the possession of the indenture trustee must be paid to the bondholders (warrantholders) timely as received by the County during the Chapter 9 case.  Jefferson County had sought to limit Section 922(d) to being applicable only to special revenues in the possession of the trustee as of the filing of the Chapter 9 petition and no further.  This was expressly rejected by the Jefferson County court, and the court ordered the County, contrary to its expressed position, to pay special revenues collected post-bankruptcy filing to the bondholders.  This was an order of mandatory payment where Section 922(d) was held to make the automatic stay nonapplicable.  It was after this basic ruling that Section 922(d) applied to lift this automatic stay for all special revenues collected post-bankruptcy filing as required under the documents and Sections 928(a) and (b) of the Bankruptcy Code to be timely paid to bondholders.  Further, the Jefferson County court specifically rejected the Collier limited interpretation of Section 922(d) and the nonoperation of the stay as flawed and found that Collier incorrectly cited the legislative history.  A number of other commentators had previously noted this deficiency in the reasoning of Collier.

    • Are there serious adverse consequences of the First Circuit’sruling?

      The insurers and the amici had pointed out to the First Circuit social policy and consideration of fairness rooted in the purpose and intent of the 1988 Amendments, the importance of timely payments uninterrupted by any Chapter 9 filings to the municipal bond market and the severe adverse effect to the municipal market if there were any stay in the timely payment to the bondholders of pledged special revenues collected postpetition.  These adverse effects include the impairment of needed access at a reasonable borrowing cost to revenue bond financing for essential infrastructure improvements and other services.  The First Circuit response was unmoved by the dire consequences to the municipal market resulting from its ruling by stating, “Our duty is to interpret the law not to re-write it.”

As noted in the previous article on the lower court ruling in the Assured case, the intent and purpose of the 1988 Amendments, especially their legislative history that the First Circuit refused to consider, and the past rulings and practices by Chapter 9 courts, especially in Jefferson County, support a broader interpretation of Sections 922(d) and 928(a) that post-bankruptcy special revenues collected must be paid timely to bondholders.  This is the expectation of the municipal market and commentary, both legally and by credit analysts, that timely payment of special revenues postpetition is essential to access to the market and lower borrowing costs that revenue bond have up to now enjoyed.

II.  Why the Traditional Broader Reading of Section 922(d) and the 1988 Amendments Is Correct!

Revenue bond financing represents generally over 50% of the municipal bonds issued annually, and is the primary source of financing for needed services and infrastructure such as bridges, roads, school building, hospitals, sewers, water, waste collection and disposal, park and recreation facilities and other infrastructure.  Changes to the federal bankruptcy legislation to resolve corporate law issues in the late 1970’s created some serious problems for municipalities and the municipal market.  After the enactment of the Bankruptcy Reform Act of 1978, Congress noted:

“At that time, Chapter 9 generally was amended to apply commercial bankruptcy law concepts to municipal corporations.  However, due to the different nature of the evolution of municipal finance, some of the specific effects of the sweeping application of commercial law concepts to municipal corporations have raised serious concerns by municipalities.  Those efforts were not entirely successful because the resulting application of commercial law concepts to municipal corporations runs afoul of the traditional structure of revenue bond finance.”

1988 Amendments Senate Report pages 3-4.

 

Congress enacted Sections 902, 922(d), 927 and 928 among other changes to the Bankruptcy Code in the 1988 Amendments for the following reason, among others, to insure the benefit of the bargain and rights of revenue bondholders and to comply with basic principles of municipal finance and state law:

  • Revenue bondholders in a Chapter 9 are to receive the benefit of their bargain and to have their right to timely payments of special revenues unimpaired in a Chapter 9 case as Congress noted:

“Various questions have been raised that a pledge of municipal revenue and the lien created thereby will be terminated in a municipal bankruptcy due to the application of Section 552(a) to Chapter 9.  To eliminate the confusion and to confirm various state laws and constitutional provisions regarding the rights of the bondholders to receive the revenues pledged to them in payment of debt obligations of a municipality, a new section is provided in the amendments to ensure that revenue bondholders receive the benefit of their bargain with the municipal issuer and that they will have unimpaired rights to the project revenues pledged to them.”

1988 Amendments Senate Report page 12.

 

  • There was no doubt, in the words of Congress, that the purpose and intent of the 1988 Amendments were to insure the automatic stay was inapplicable to special revenues and the needs of an orderly market.  To assure the continued availability of revenue bond financing for state and local governments, the automatic stay must be inapplicable to the timely payment of special revenues to the bondholders in a Chapter 9 case.  As Congress has noted in the legislative history:

“Likewise, the automatic stay that becomes effective against creditors of a municipality is made inapplicable to the payment of principal and interest on municipal bonds paid from pledged revenues.  In this context, “pledged revenues” includes funds in the possession of the bond trustee as well as other pledged revenues.”

1988 Amendments Senate Report page 13.

 

  • The municipal market and investors in revenue bond financing have contracted for and expect timely payment if state and local governments can continue to issue revenue bonds in an orderly market:

“Reasonable assurance of timely payment is essential to orderly marketing of municipal bonds and notes and continued municipal financing…”

1988 Amendments Senate Report page 21.

 

  • Any limited interpretation of Section 922(d) of the 1988 Amendments (as was done by the First Circuit and the lower court) not to permit timely payment of special revenues collected to the bondholder would be disruptive of the financial market, contrary to the purpose and intent of the 1988 Amendments and Section 904 of the Bankruptcy Code and would interfere with government, affairs and the municipality’s use and enjoyment of its revenues consistent with state law:

“Where a pledge of revenues survives under Section 927, it would be needlessly disruptive to financial markets for the effectuation of the pledge to be frustrated by an automatic stay.  Further, the use of automatic stay may be contrary to Section 904 and interfere with the government, affairs and the municipality’s use or enjoyment of income producing property.”

1988 Amendments Senate Report page 21.

 

  • The First Circuit and lower court ruling that impair the benefit of the bargain and right of revenue bondholders to be paid timely in Chapter 9 are precisely what Congress attempted to prevent by enacting the 1988 Amendments.  As Congress warned in the 1988 Amendments:

“The amendments protect the future effectiveness of revenue bond financing against the possibility of an adverse judicial determination in connection with a municipal bankruptcy … the amendment insure that revenue bondholders receive the benefit of their bargain with the municipal issues, namely they will have unimpaired right to the project revenues pledged to them.”

1988 Amendments Senate Report page 12.

 

Accordingly, the reasoning, logic and legal support for the First Circuit affirmance of the lower court’s ruling melts in the sunlight of the purpose and intent of 1988 Amendments as set forth in its legislative history as well as Chapter 9 case law and market commentary for the correct reading of Sections 903, 904, 922(d), 927, and 928.

III. Section 922(d) of the Bankruptcy Code Should Only Be Read as Supporting Timely Payment of All Special Revenues Collected as Required by Section 928.

The First Circuit’s claim that Sections 904 and 922(d) of the Bankruptcy Code limit the court’s power to order, stay or interfere with a municipality’s use and enjoyment of revenues misses the purpose, intent and correct interpretation of the 1988 Amendments.  The First Circuit recognition of the limitation on its powers to interfere with special revenues should not be read as a limitation on the nonoperation of the stay under Section 922(d).  In a Chapter 9, the municipality is free from court rulings and Bankruptcy Code interpretations that interfere with the use of special revenues by a municipality as debtor consistent with the mandate of state law.  It is self-evident that a municipality does not need a lifting of the stay to use special revenues to pay special revenues to the bondholders in a Chapter 9.  The First Circuit appears to agree with this in its voluntary payments versus mandatory payments distinction.  However, if a municipality pursuant to state statutory mandates or the requirements of the 1988 Amendments pays special revenues to bondholders in a Chapter 9, there would be no need for Section 922(d) to allow the municipality voluntarily to pay or the bondholders to accept payment of special revenues.  The court, as conceded in the First Circuit opinion, does not have any power to stay, limit or interfere with such payments under Section 904 and the Bankruptcy Code cannot be interpreted to impair or limit that state law mandate under Section 903.  As noted in the legislative history of the 1988 Amendments, there are fundamental differences between the power of a court in a Chapter 11 or 7, where the corporate debtor cannot act out of the ordinary course or use cash collateral proceeds that are subject to the lien of a creditor, without court approval.  This is in contrast to the unfettered right of a municipality in Chapter 9 to use its revenues in accordance with state law as a function of its governmental powers and affairs under Sections 903 and 904 of the Bankruptcy Code.

Further, the notion that the municipality is free to decide to pay or not pay special revenue to bondholders in a Chapter 9 case is misunderstanding of municipal law and the required benefit of the bargain of revenue bond financing as protected by the 1988 Amendments.  A municipality can only act as authorized and permitted by state law.  To rule, as the First Circuit did, that only “voluntary” payments of special revenues are permitted under Sections 922(d) and 904 misses the mark and the principles of municipal law and Chapter 9.  Numerous states mandate such payments of pledged special revenues to the bondholders and mandate that the special revenues cannot be used for any other purpose.  As the Senate Report to the 1988 Amendments notes, municipalities cannot act contrary to pay a mandate to pay under state law as the pre-1988 Chapter 9 case of the San Jose School District demonstrates:

“The application of Section 552 [which is avoided under Section 928] in a Chapter 9 bankruptcy proceeding may also defy practical reality and state law mandates.  As in the case of the San Jose School District, In re San Jose Unified School District, No 5-83-02387-A-9, (B.C.N.D. Cal. 1983) [prior to the 1988 Amendments], the continued payment of interest to bondholders not only helped ensure the debtor’s continued access to credit markets but also helps fulfill the requirement of state law that such collected fund be used to pay bondholders.  Cal. Educ. Code Ann. 15251.”

Senate Report page 6.

 

The origins of Sections 903 and 904 of the Bankruptcy Code were inserted in the 1937 statute to insure the constitutionality of the Bankruptcy Code in respecting the sovereignty of the state and its laws.  Section 903 provides:

“This Chapter [9] does not limit or impair the power of the state to control, by legislation or otherwise [i.e. constitutional provision], a municipality of or in such state in the exercise of the political or governmental powers of such municipality include expenditures for such exercise …”

Accordingly, the Bankruptcy Code cannot be interpreted to limit or impair the mandate of a state law that special revenues must be paid to the bondholders and cannot be used for any other purpose as San Jose School District did in Chapter 9 even before the 1988 Amendments.  Prior to Section 928(a) of the 1988 Amendments, there was a concern that payment of pledged special revenue postpetition was technically contrary to Section 552 of the Bankruptcy Code because the lien was terminated under Section 552 by filing a Chapter 9.  Section 928 continued the lien on special revenues post-bankruptcy to resolve any questions and the conflict the Bankruptcy Code creates under Section 552 with the mandated payment under state law as demonstrated by the San Jose School District case.

Further, the municipality cannot consent or allow a contrary use of special revenues required to be paid to bondholders in a Chapter 9 as mandated by state law because a municipality cannot act and is not authorized to act or consent to actions contrary to state law mandate.  So, there can be no permission to the bankruptcy court under Section 904 by consent of the municipality to order, limit or interfere with the payment of special revenues to bondholders in a Chapter 9.  Accordingly, Section 922(d) can only be interpreted, as the legislative history above clearly demonstrates, to insure the benefit of the bargain and unimpaired right to payment of special revenues to the bondholders in a Chapter 9.  The viability of revenue bond financing would be frustrated by the application of the automatic state, and the requirements of orderly financial markets would be violated.

IV.  The First Circuit interpretation of Sections 922(d) and 928(a) creates an ambiguity with prior Chapter 9 interpretations, explicitly and implicitly, by courts, commentators on special revenues and the actual purpose and intent of the 1988 Amendments.

As noted above, the prior rulings in Jefferson County and other Chapter 9 cases were clearly contrary to the First Circuit’s interpretation of Sections 922(d) and 928(a) of the Bankruptcy Code as well as the financial market’s perception, the statements of recognized commentators on bankruptcy and municipal financing about special revenue treatment in Chapter 9, as well as the legislative history of the 1988 Amendments.  All of this cries out against the acceptance of the First Circuit’s interpretation and creates an ambiguity that necessitates a review of the legislative history.

Respectfully, as Sutherland (the recognized treatise on statutory interpretation) remarks, judicial assertions that a statute needs no interpretation because it is “clear and unambiguous” may indicate “an unwillingness to consider evidence about how a statute should be construed, which can produce a result defined by a judge’s own uninstructed and unrationalized impression of an act’s meaning.”  Courts typically frame the issue by stating that an ambiguity exists when a statute is capable of being understood by reasonably well-informed persons in two or more different senses.

Because of prior conflicting interpretations of the Jefferson County court and other Chapter 9 courts with the First Circuit interpretation, the legislative history of the 1988 Amendments is relevant and persuasive.  There can be no escaping the reference to the legislative history of the 1988 Amendments in interpreting Sections 922(d) and 928(a).  As noted above, the First Circuit interpretation of Section 922(d) and Section 928 cannot stand and be supported by that legislative history.  The legislative history clearly points any reader to the unimpaired rights of the bondholders to be timely paid the special revenues as collected in a Chapter 9.  No other interpretation can be drawn from the correct reading of the purpose and intent of the language in the 1988 Amendments.

V. The First Circuit’s asserted support of Collier and the inapplicability of the Jefferson County rulings for its interpretation that only voluntary payments of special revenues by the municipality are free of the automatic stay fails the test of critical review.

The Collier interpretation of Section 922(d) has been cited as flawed by not only numerous commentators addressing the treatment of special revenues in Chapter 9 but also by bankruptcy court decision such as in Jefferson County.

In so holding, the Jefferson County court considered and specifically rejected the interpretation of Collier on Bankruptcy with respect to Section 922(d):

“The County’s position on the § 922(d) “pledged special revenues” is in many respects identical to that espoused in 6 Collier on Bankruptcy ¶ 922.05[2].  This bankruptcy treatise’s conclusions are cited to this Court as authority for the County’s.  One problem with Collier’s view point is the authority Collier’s cites to in its footnote 4 is a quote from legislative history that does not uphold Collier’s reading of § 922(d).  See 6 Collier on Bankruptcy ¶ 922.05[2] n. 4.  Careful reading of the quote evidences that it supports the broader view that a pledge as used in § 922(d) is for all monies pledged including those possessed by a creditor and those not in the creditor’s possession.  The Collier position has also been disagreed with by others See, e.g., David L. Dubrow, Chapter 9 of the Bankruptcy Code: A Viable Option for Municipalities in Fiscal Crisis?, 24 Urb. Law, 539, 572-75 (1992).”

In addition, Jefferson County in its bankruptcy took the position that only special revenues in the possession of the indenture trustee for the warrants at the beginning of the case were unaffected by the automatic stay and not special revenue collected post-bankruptcy by the County and not in the possession of the trustee.  The County argued like the Commonwealth that the use of “pledged” in Section 922(d) limits the stay exception to a possessory lien similar to the voluntary payment by the municipality of special revenues interpretation by First Circuit.  These interpretations were determined by the court in Jefferson County to be too limited and the broader interpretation of the special revenues as collected in a Chapter 9 were to be paid to the bondholders.

The Jefferson County court concluded:

“In summary, this court’s analysis of the interplay of section 922 with section 928 of chapter 9, 11 U.S.C. §§ 922, 928, is that “pledged special revenues” as used in § 922(d) includes all special revenues against which the County granted a lien under the Indenture, not just those in the possession of the Indenture Trustee or receiver.  It encompasses those Net Revenues that are received from the sewer system before and after the filing of the County’s chapter 9.  The structure and intent of what Congress enacted by its 1988 amendments to chapter 9 was to provide a mechanism whereby the pledged special revenues would continue to be paid uninterrupted to those to which/whom payment of the sewer system’s indebtedness is secured by a lien on special revenues.  The result is that 11 U.S.C. § 922(d) excludes continued payment of these “pledged special revenues” to the lienholder from being stayed under 11 U.S.C. § 362(a) or 11 U.S.C. § 922(s).”

The Jefferson County court decision is not inapposite to the Assured case, as the First Circuit claims but is right on point to challenge the interpretation of the First Circuit of Section 922(d) given the position of Jefferson County.  So, the Jefferson County decision is not only relevant but precedent that cannot be distinguished or overlooked.  Accordingly, there is no real support for the interpretation of the First Circuit and its limitation of the exemption from the automatic stay only to voluntary payments by the municipality in a Chapter 9 under Section 922(d).  Clearly, the Jefferson County court ruling holds voluntary and mandatory payment of special revenues were ordered to be paid postpetition to the bondholders as required under Sections 922(d) and 928(a) of the Bankruptcy Code.

This is further clear in the light of Section 927 of the Bankruptcy Code that provides that the revenue bondholders under the 1988 Amendments to the Bankruptcy Code in essence make a forced election to look solely to the pledged special revenue stream of payments and not seek payment from a claim against any other revenues or assets of the debtor municipality.  Absent that forced election, the revenue bondholder could under certain circumstance assert a claim against the general assets of the municipality contrary to the expectation of general obligation bondholders (who look to the full faith and credit and taxing power of the municipality) and the limitation on recourse debt set forth in virtually all state statutes.  The forced election under Section 927 means the special revenue stream can only be used under the provisions of the Bankruptcy Code as set forth above to pay the bondholders, and there is no just reason or legal basis for delay or nonpayment.

Accordingly, the rulings of the First Circuit and the lower court should be reversed by rehearing en banc or by appeal to and acceptance by the U.S. Supreme Court.  As noted in our previous article, revenue bond financing is essential to needed infrastructure financing.  The American Society of Civil Engineers (“ASCE”) in its 2017 report states that funding required for needed infrastructure improvement to maintain as passable (not exceptional) infrastructure up to 2025 would cost $4.59 trillion.  There is a current funding gap of $2 trillion which traditionally would be filled by use of revenue bond financing.  If the ruling of the First Circuit that places a credit cloud on revenue bond financing is not overturned by a reversal of the First Circuit interpretation of Sections 922(d) and 928 or otherwise, the consequences to the ability of state and local government to finance needed infrastructure improvements would be devasting.  As ASCE notes, the failure to fund the gap would cost the country $3.9 trillion in losses suffered to GDP by 2025, $7 trillion in lost business sales by 2025 and 2.5 million in lost American jobs by 2025.

 



 

 

Even if funding for needed infrastructure improvements was found, the added cost of the risk of no timely payments in Chapter 9 to revenue bond financing could, as we explained in the previous article, cost state and local governments 2% more in interest costs per year which could be a present value of additional cost of 20-25% of the original principal amount of bonds issued.  These are unnecessary additional costs which could otherwise go to pay for infrastructure improvements, essential services, payment to public workers or unfunded pension obligations or to reduce taxes on taxpayers.  Congress in the 1988 Amendments foresaw the dire consequences of impairing the benefit of the bargain and rights of bondholders to timely payment of special revenues in a Chapter 9 case, and mandated the unimpaired right to timely payment of special revenues to the bondholders.

The 1988 Amendments were supported by various financial market participants and associations including the Government Finance Officers Associations, National League of Cities, National Association of Bond Lawyers, Conference of Mayors, National Governor’s Conference, National Conference of State Legislatures and others.  The purpose and intent was as set forth in the legislative history and herein and not as the First Circuit and the lower court have ruled.  The rehearing by the First Circuit or the appeal to the U.S. Supreme Court for the reasons set forth herein should produce the needed reversal.

Is a Model State Law Needed?

This article is not intended to be an exhaustive statement of all the reasons, both legal and practical, why the First Circuit and lower court decision in the Assured case should be reversed, but rather, is an overview of some of the reasons why the financial market expects timely payment of special revenues to bondholders in a Chapter 9 and why reversal of the current Assured ruling is necessary and just.  For a more detailed analysis, there is a forthcoming article in The Journal of Municipal Finance that deals with The History and Justification of Timely Payment of Statutory Lien and Pledged Special Revenue Bond Financing in Chapter 9 Municipal Debt Adjustment Proceeds – Is a Model State Law Necessary or Required?  The article suggests, if quick reversal of the First Circuit and lower court decision in Assured is not possible or probable, there is a solution that does not involve further judicial action: a Model State Law, which the article articulates, that mandates timely payment of special revenues to bondholders under state law before and after a Chapter 9 filing.  All objections raised by the Assured decision in the First Circuit and the lower court, along with others, have been addressed in the draft Model State Law.  The Model State Law is consistent with the prohibition of Section 903 of the Bankruptcy Code, that the Bankruptcy Code cannot be interpreted to limit or impair a state law that mandates the timely payment of special revenues to the bondholders, and the limitation on the bankruptcy court’s power in Section 904 that the court cannot stay, order, decree or interfere with the municipality’s required payment of special revenues because the municipality under municipal law cannot consent to act or act contrary to the mandate of state law.  It appears the First Circuit ruling would support the inability of a bankruptcy court in a Chapter 9 proceeding, to stay, order, decree or interfere with that mandate of the Model State Law that special revenues must be timely paid by the municipality as debtor to the bondholders since a municipality has no other legal option under state law.

Hopefully, there will be a reversal of the First Circuit decision by a rehearing en banc if requested or by ruling of the U.S. Supreme Court if so appealed and permitted.  But in all events, through the enactment of a Model State Law, the cloud of the First Circuit’s Assured decision will not long linger over needed revenue bond financing for state and local governments.

James E Spiotto

James E. Spiotto

James E. Spiotto is a Managing Director of Chapman Strategic Advisors LLC, a consultancy providing educational and strategic insights to market participants concerning municipal finance topics of interest. He is also the co-owner and co-publisher of MuniNetGuide.com.

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