14 April 2015

Taxpayer Standing in Municipal Bankruptcy: I Report, You Decide

By now you should have downloaded and read my article Who Pays the Price? The Necessity of Taxpayer Representation in Chapter 9 (download here). I argue that while taxpayers do not have the right to vote on a municipal plan of adjustment, they nonetheless have standing to be heard on the issue of the feasibility of the plan when the time comes for its confirmation. (For even more background on the nature of municipal bankruptcy read my Municipal Bankruptcy: When Doing Less Is Doing Best.)

I come to this conclusion because I do not believe taxpayers are creditors of a city. While in ordinary conversation we may say that a city owes a political debt to those who fund its operations, such a use of the word "debt" is metaphorical, not legal, and the Bankruptcy Code's definition of debt includes the legal-economic side but not the political.

Professor Christine Sgarlata Chung of Albany Law School comes to a different conclusion on this point. In her article, Municipal Bankruptcy, Essential Municipal Services, and Taxpayers' Voice, she argues that taxpayers are creditors of their municipality and thus have get to vote on the plan. Recognizing taxpayers as creditors could have a significant effect on plan confirmation. Rather than a voice at confirmation, albeit a significant one, a negative vote by taxpayers could prevent confirmation by normal means and force a city to attempt an arduous cramdown of its plan.

Professor Chung makes an impassioned argument in support of her conclusion. She takes advantage of an opening created by Judge Rhodes in the Detroit bankruptcy. Judge Rhodes used the phrase "service insolvency" to describe in part the access of the city to the relief afforded by Chapter 9. Drawing on Judge Rhodes's opinion that Detroit was indeed eligible for Chapter 9, Professor Chung provides a gut-wrenching account of the failure of Detroit to provide many of its residents with a modicum of the benefits of civil government. If insolvency encompasses anything apart from a balance sheet, Detroit was insolvent. (Of course, Detroit was insolvent in the financial sense as well.)

But can the term insolvency, defined as it is by the Bankruptcy Code, be extended from the financial to the political? In other words, is there such a state of affairs as service insolvency?

Without belaboring a blog post, suffice it to say that I considered and rejected the notion of service insolvency in my article, Who Bears the Burden: The Place for Participation of Municipal Residents in Chapter 9 (download here). The notion, as intuitively appealing as it may be, is inconsistent with the Bankruptcy Code. In addition, I believe that insuring taxpayer representation at the confirmation of a Chapter 9 plan--my conclusion-- is adequate.

In any event, I commend Professor Chung's article (as well as my own, of course) to my readers' attention. I'll let the discerning among you evaluate who has the better of this disagreement.

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