When can a municipality declare bankruptcy under chapter 9 of the Bankruptcy Code? An issue explored the headline-grabbing chapter 9 case of Detroit, that’s the question illuminated by a decision dealing with the travails of Chester, Pennsylvania, issued by the United States Bankruptcy Court for the Eastern District of Pennsylvania (“Bankruptcy Court”) on March 14, 2023.

Chester’s Long Road to Insolvency 

Background

Having evolved from a hub for early business (18th – 19th centuries), to Greater Philadelphia’s fabled “Saloon Town” (early 20th century), to a manufacturing powerhouse (up to the mid-20th century), Chester’s primary manufacturers shuttered factories, and jobs disappeared, throughout the 1960’s and the 1970’s. By the 1980’s, Chester lacked much, if any, substantial industry. In 1995, Pennsylvania placed Chester in its Act 47 Financial Recovery Program (“Act 47”). Chester’s terminally dire financial situation peaked in 2006, when it obtained a deficit-funded loan to meet payroll and deliver basic services. While improvement followed, it took only a few years for Chester to slip back into terminal distress.

Bankruptcy Case: Disputing Eligibility 

On November 2022, Chester, through the receiver appointed under Act 47 on June 1, 2020, sought a determination from the Bankruptcy Court that it was eligible for the relief offered by chapter 9.

Opposition came from two quarters. Both the mayor and certain city councilmembers disputed Chester’s eligibility because they, as elected officials, had not expressed a desire to effect a plan to adjust the city’s debts. Separately, one of the holders of certain bonds issued by Chester, PHCC LLC, d/b/a Preston Hollow Community Capital (“Preston Hollow”), claimed that Chester had fatally failed to engage in good faith—and practical—negotiations with it prior to its filing.

In its March ruling, the Bankruptcy Court rejected these objections and, finding Chester to be a suitable chapter 9 debtor, entered the requisite order for relief.

Statutory Language at Issue

So what was the statutory language upon which these parties focused?

Primarily, section 109(c).

Under this provision, for a party to qualify as a chapter 9 debtor, it must first show itself to:

1. be a “municipality”;
2. be specifically authorized by a state law to file for chapter 9 relief;
3. be insolvent (usually on a cash flow basis);
4. be willing to put in effect a plan to adjust its debts; and
5. either (a) have obtained the agreement of creditors holding at least a majority in the amount of claims of each class that the municipality intends to impair; (b) have attempted to negotiate in good faith, but was unable to do so; (c) have determined that it was impractical to negotiate with its creditors; or (d) must reasonably believe one or more of its creditors is improperly attempting to obtain a preference over other creditors.

While the burden of proof as to its every element is on the municipality, federal courts “broadly” construe section 109(c) to ensure ready bankruptcy access.

Opinion's Future Utility

In its discussion of the eligibility of the Chester for Chapter 9 relief, the Bankruptcy Court provided the latest manual for municipalities and their creditors on how to evaluate this key threshold issue.