In a recent episode of the NBC comedy series Parks and Recreation, the program’s characters were forced to confront a complete and unexpected cessation of city services after a disappointing audit. See Parks and Recreation, “The Master Plan” (NBC television broadcast May 13, 2010). While the episode focused on the humorous effects of the shutdown on the city’s parks and recreation department, it paid little, if any, attention to the underlying causes of the crisis.

If the show’s fictional city, Pawnee, Ind., is intended to represent an average American city, then a central factor in the crisis likely was the dramatic and growing shortfall in public pension funds. Estimated by some to be as high as $4 trillion nationwide, municipal pension shortfalls could reach as much as $500 billion in California alone. Because public pensions are not regulated by the Employee Retirement Income Security Act and do not enjoy the insurancelike protection of the Pension Benefit Guaranty Corp., municipalities have largely been left in a vacuum, free to make their own choices about vesting, benefits, qualifications and funding. This nonuniform atmosphere has produced several decades of increasingly rich benefits packages, often resulting from negotiations with a municipality’s collective-bargaining units, coupled with a less-than-rigid fiscal approach to paying for those benefits.

In light of the desperation many public entities face, there is a growing expectation that bankruptcy may be the only alternative for some. While private entities may turn to Chapter 11 of the U.S. Bankruptcy Code and its well-­developed body of law to address their ­problems, public entities are far more limited. Chapter 9 of the Bankruptcy Code, available only to “municipalities,” is a little-used (and little-understood) chapter of the Bankruptcy Code made up of a patchwork of federal laws that borrows concepts and particular sections from other chapters of the Bankruptcy Code. In essence, Chapter 9 provides a forum of last resort to allow a municipality to deal with its problems outside of the confines of otherwise applicable state law. However, a significant question remains whether public pension obligations can be addressed through Chapter 9. Although commentators have repeatedly suggested that a public pension sponsor simply has no ability to alter pension rights through bankruptcy, the reality is that very little is certain. What is certain is that the economic crisis will force many municipalities to consider all of their options, including bankruptcy. And, despite popular opinion, there is support for the notion that municipal pension obligations can be addressed through Chapter 9.

Public pensions enjoy considerable state law protections and any attempts to modify pensioners’ rights outside of bankruptcy are unusually difficult. This difficulty can be traced to several sources. For example, public pension benefits represent an item of utmost importance to large unions and their public employee constituents. Any attempt to terminate or reduce promised benefits usually is met with significant resistance, sometimes involving coordinated media campaigns, picket lines and other methods of exerting political pressure.

In addition, the law in many states considers public pensions to be “vested rights,” imposing a high burden for even minute changes. In such states, benefits can be modified only by legislative amendment and, more important, only to the extent that affected employees are compensated with comparable offsetting advantages. Otherwise, modification may be deemed to be an improper violation of the contracts clause of the U.S. Constitution and, in many instances, the applicable state constitution. Any modification likely to pass this standard is unlikely to provide the municipal plan sponsor with substantial cost savings. Because of these protections, even when a municipality is in grave financial distress, plan participants possess significant leverage to dictate the terms of any modification. Thus, municipalities seeking to reduce or fully terminate retirement benefits outside of bankruptcy face a challenging, sometimes impossible, task.

Chapter 9 does not offer a magic bullet that can, in a single shot, provide a struggling municipality with the means to modify its pension obligations in any manner it deems necessary. However, this limitation should not lead to the conclusion that municipal pension obligations cannot be affected by a Chapter 9 bankruptcy filing. In fact, recent Chapter 9 cases have demonstrated that municipal pension obligations can be affected in a number of ways.

THE PRICHARD AND VALLEJO CASES

In perhaps the clearest example of the treatment of pension obligations under Chapter 9, the city of Prichard, Ala., has undertaken efforts to reduce its pension obligations through bankruptcy on two occasions. In the first of two Chapter 9 proceedings filed by Prichard, the municipality successfully reduced its current and future pension benefit payments by 8.5% (among other modifications) through a confirmed plan of adjustment, the Chapter 9 equivalent of the better-known plan of reorganization under Chapter 11. See In re City of Prichard, Ala., No. 99-134659 (Bankr. S.D. Ala. Oct. 6, 2000). Nearly 10 years later, Prichard filed its second Chapter 9 proceeding (creating, perhaps, the world’s only “Chapter 18″ filing) and as recently as Aug. 30 proposed a plan of adjustment imposing even more cuts on its pension plan.

Although the dramatic modifications achieved in Prichard’s first Chapter 9 case may have been the product of a consensual resolution, the reductions sought in Prichard’s second Chapter 9 case clearly were unilateral and were not well received by the pensioners. However, as the mayor of Prichard noted in response to cries of injustice, “You can’t expect to get what we don’t have.” “Prichard Bankruptcy Brings Pensioners to Council Meeting” Local 15 TV (Oct. 29, 2009), www.local15tv.com/news/local/story/Prichard-Bankruptcy-Brings-Pensioners-to-Council/NMnXDMYgu0iIn9OvlFhjYQ.cspx. While the clash between the municipality and its pensioners may yet provide useful guidance for other municipalities considering similar strategies, Prichard’s second Chapter 9 case was dismissed based upon a close reading of Alabama law that rendered Prichard ineligible for Chapter 9. The dismissal has been appealed to the U.S. District Court for the Southern District of Alabama. In re City of Prichard, Ala., No. 09-15000 (Bankr. S.D. Ala. Oct. 5, 2010) (Notice of Appeal to District Court).

Aside from the dramatic relief sought in both of Prichard’s Chapter 9 cases, other cases have demonstrated how Chapter 9 can be used in less obvious ways that, nonetheless, may have a direct effect on pension obligations. For example, in one of the more well-publicized Chapter 9 cases, In re City of Vallejo, Calif., No. 08-26813 (Bankr. E.D. Calif. 2008), the municipal debtor publicly stated its intention to avoid a direct attack on its pension obligations. Despite these public admissions, the debtor has taken several steps that may, indirectly, allow the debtor to accomplish similar goals in a less obvious fashion.

VALLEJO REJECTS AGREEMENTS

For example, Vallejo successfully rejected its burdensome collective-bargaining agreements — one source of municipal pension obligations — pursuant to § 365 of the Bankruptcy Code. See International Bhd. of Elec. Workers, Local 2376 v. City of Vallejo, No. 2:09 cv-02603, 2010 WL 2465455, at *11 (E.D. Calif. June 14, 2010). Although most municipal pension obligations enjoy state law protection that is superior to the protection afforded a collective-bargaining agreement (and, thus, likely will continue in some form even after rejection of a collective-bargaining agreement), rejection of CBAs provides an opportunity for the municipality to effectively force a renegotiation of all of the terms that normally would be part of a CBA, including, in some instances, pension benefits. Under state law, unilateral termination of a CBA simply would not be possible.

In addition, Vallejo has used the claims process — the process by which a debtor forces its creditors to specifically identify the amount and priority of any claim for which such creditor intends to hold the debtor liable — to force certain pension beneficiaries to file proofs of claim within a specified time or risk losing their right to challenge Vallejo’s unilateral determination that certain employees were only entitled to a reduced pension benefit. City of Vallejo’s Submission of Proposed Notice of Nov. 1, 2010, Bar Date For Creditors with Claims Based on Retiree Benefits, at Exhibit A, Vallejo (No. 08-26813).

Finally, in both Prichard and Vallejo, the municipal debtor was subject to lawsuits filed by pension beneficiaries (or, in the case of Vallejo, retiree health beneficiaries) seeking to require the municipal debtor to recommence the payment of benefits unilaterally discontinued on or before the filing of the bankruptcy petition. In both instances, the municipal debtor was successful in using the automatic stay of § 362 of the Bankruptcy Code to stymie the efforts of the relevant beneficiaries and force them to argue their case in front of a bankruptcy judge. See Prichard, No. 09-15000 (Bankr. S.D. Ala. Dec. 15, 2009) (minute entry denying without prejudice Prichard retirees’ motion for relief from the automatic stay); Vallejo, No. 2010 02136 (Bankr. E.D. Calif. March 11, 2010) (bankruptcy adversary proceeding commenced in an effort to force the city to recommence paying full benefits). Absent the powers granted to a municipal debtor under Chapter 9, both Prichard and Vallejo likely would have found their decision to cut off benefits much more difficult to execute.

In sum, the examples provided above cast doubt on the conventional view that Chapter 9 provides no benefit to a municipal debtor. This view appears to be based upon both an incomplete understanding of Chapter 9 and the fact that there is very little precedent addressing these issues. Certainly, pension benefits enjoy significant protections under state law and, as a result, there is no single remedy to the significant and growing shortfall in public pension funds. However, as demonstrated above, Chapter 9 may provide a municipal debtor with the tools necessary to, at the very least, effect a shift in negotiating leverage from the pension claimant to the municipal debtor and pave the way for a modification that will be acceptable to all parties.

Robbin Rahman is an associate in the Atlanta office of Kilpatrick Stockton who focuses his practice on corporate bankruptcy, financial restructuring and other insolvency-related and debtor-creditor matters, both in litigation and transactional contexts. Matt Hindman, another associate in that office, contributed to this article.