Depending upon which pundit you listen to, municipal bankruptcy is either a wave about to break over the country or a dull-edged tool to be used only on rare occasions. Since the original legislative enactment of Chapter 9 in 1934, there have been fewer than 650 cases filed. In comparison, since 1980, there have been more than 22 million Chapter 7 and 449,000 Chapter 11 bankruptcies.

Because of the political sensitivity related to the potential municipal oversight by a federal judge, a Chapter 9 petition can only be filed if the municipality is expressly authorized to do so under state law. Section 109(c)(2) of the Bankruptcy Code provides that a debtor must be “specifically authorized, in its capacity as a municipality or by name, to be a debtor under such chapter by state law, or by a governmental officer or organization empowered by state law to authorize such entity to be a debtor under such chapter.” Permission to file Chapter 9 is a statutory patchwork across the country, with some states providing blanket authorization, while others, like Pennsylvania, utilizing a multitiered approach that is dependent upon the particular type of municipality or “class” a city may fall into.

In a recent decision arising out of a certified question presented by the U.S. District Court for the Southern District of Alabama, Southern Division, the Supreme Court of Alabama was asked “whether Ala. Code § 11-81-3 (1975) (as amended) requires that an Alabama municipality have refunding or funding bond indebtedness as a condition of eligibility to proceed under Chapter 9 of Title 11 of the U.S. Code” in City of Prichard v. Balzer , No. 1100950, 2012 Ala. Lexis 46 (April 20, 2012). In effect, the question was whether bond debt was a prerequisite for the filing of a Chapter 9 petition. The bankruptcy court had earlier dismissed the Chapter 9 petition, which was then appealed to the district court. The Supreme Court of Alabama answered the district court’s question in the negative, effectively clearing the way for the bankruptcy proceeding.

In October 2009, the city of Prichard commenced a Chapter 9 bankruptcy. The Alabama statute controlling the city’s right to make such a filing provides in relevant part:

“‘The governing body of any county, city or town, or municipal authority organized under Article 9, Chapter 47 of this title which shall authorize the issuance of refunding or funding bonds may exercise all powers deemed necessary by the governing body for the execution and fulfillment of any plan or agreement for the settlement, adjustment, refunding, or funding of the indebtedness of the county, city or town, or municipal authority organized under Article 9, Chapter 47 of this title not inconsistent with the provisions of law relating to the issuance of refunding or funding bonds. Without limiting the generality of any of the foregoing powers, it is expressly declared that the governing body shall have the power to take all steps and proceedings contemplated or permitted by any act of the Congress of the United States relating to the readjustment of municipal indebtedness, and the state of Alabama hereby gives its assent thereto and hereby authorizes each county, city or town or municipal authority organized under Article 9, Chapter 47 of this title in the state to proceed under the provisions of the acts for the readjustment of its debts,’” according to the opinion.

A group of the city’s employees challenged the bankruptcy filing, arguing that state authorization to file Chapter 9 required there to be outstanding bond indebtedness, which in this case did not exist. Among other parties joining the fray was Jefferson County, Ala., now in its own Chapter 9 bankruptcy proceeding, which filed an amicus brief arguing that the existence of bond debt was not a condition precedent. However, the indenture trustee for the holders of certain warrants issued by Jefferson County to fund improvements to the sewer system filed briefs arguing to the contrary, according to the opinion. The bankruptcy court in the Jefferson County case ruled on March 4, 2012, that Jefferson County was eligible to be a Chapter 9 debtor under §109(c). That decision was appealed, which made the outcome of the Prichard case highly significant.

The Alabama Supreme Court considered the issue to be one of statutory construction. Quoting from Archer v. Estate of Archer , 45 So. 3d 1259, 1263 (Ala. 2010) and Ex parte Exxon Mobil Corp ., 926 So. 2d 303, 309 (Ala. 2005), the court noted: “‘[I]t is this court’s responsibility in a case involving statutory construction to give effect to the legislature’s intent in enacting a statute when that intent is manifested in the wording of the statute. … [I]f the language of the statute is unambiguous, then there is no room for judicial construction and the clearly expressed intent of the legislature must be given effect. … In determining the intent of the legislature, we must examine the statute as a whole and if possible, give effect to each section.”

In applying the foregoing statutory construction guidelines as well as others under Alabama state law, the Prichard court disagreed with the employees’ argument that the Alabama Chapter 9-enabling statute was ambiguous. While the first sentence does authorize governing bodies that have issued bond indebtedness to file Chapter 9, in light of the second sentence in the legislation, which is substantially broader, the first sentence does not serve as a limitation. Specifically, the second sentence provides, “‘Without limiting the generality of any of the foregoing powers, it is expressly declared that the governing body shall have the power to take all steps and proceedings contemplated or permitted by any act of the Congress of the United States relating to the readjustment of municipal indebtedness, and the state of Alabama hereby gives it assent thereto and hereby authorizes each county, city or town, or municipal authority organized under Article 9, Chapter 47 of this title in the state to proceed under the provisions of the acts for the readjustment of its debts,’” according to the opinion.

Based on the foregoing, and notwithstanding the first sentence within Article 9 of the state enabling statute, the Alabama Supreme Court effectively found that the state had provided municipalities with blanket authorization to commence a Chapter 9 federal bankruptcy proceeding, regardless of whether outstanding bond debt existed.

The Prichard decision highlights the overarching importance of the state enabling statutes and the statutory construction problems that can arise should an ambiguity be found. Luckily, for both the city of Prichard and Jefferson County, no ambiguity was deemed to exist and the path was cleared for their respective Chapter 9 filings. Given the importance of each state’s enabling statute, there is little question that any municipality contemplating Chapter 9 protection must become well-acquainted with those gating issues that will impact its ability to file bankruptcy and take all steps necessary to clear them in advance.

Francis J. Lawall, a partner in the Philadelphia office of Pepper Hamilton, concentrates his practice in national bankruptcy and reorganization matters. He routinely lectures to various creditor groups concerning general bankruptcy issues, including preferences, reclamation, the role of creditors committees and related issues.