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Can North Riverside, Illinois Pull a Detroit?

North Riverside, Illinois, like many municipalities in Illinois (and the state itself), is beset by burgeoning public employee pension fund liabilities.  The village of about 6,672 souls faces an operating budget deficit of $1.9 million, with $1.8 million due to fire department pension obligations (annual required payments have septupled over the past ten years).  Most of the village’s revenue is sales taxes collected by the North Riverside Mall.  The state of Illinois is empowered to garnish sales tax revenue of any municipality that fails to meet its pension liabilities, and is prepared to begin that process in North Riverside in 2016.  To paraphrase Ulysses Everett McGill in “O Brother, Where Art Thou?”, they’re in a tight spot.

Can North Riverside follow Detroit’s example and use bankruptcy — that is, chapter 9 of the United States Bankruptcy Code — to hold off the state’s action and to deal with pension obligations and other obligations?  In an able and elegant explanation of North Riverside’s plight, a reporter for the Chicago Sun-Times suggested that a privatization scheme “might prevent the village from declaring bankruptcy.”  The reporter’s premise was probably, though not definitively, incorrect.  While filing chapter 9 bankruptcy may have (or may not have, we’ll have to see) gotten Detroit out of its tight spot, North Riverside almost certainly does not have that option.

Don’t like lawyers with the “almost certainly” qualifier?  Let us explain.[i]  First, chapter 9 of the Bankruptcy Code provides for reorganization of a municipality, defined as a “political subdivision or public agency or instrumentality of a State.”[ii]  To be eligible to become a debtor under chapter 9, a municipality must be insolvent, as in not paying or being unable to pay its debts as they become due.  In addition, the municipality must want to effect a plan to adjust its debts and must get sufficient creditors to agree to a haircut on their claims, negotiate with creditors and fail to come to an agreement, or be unable to negotiate with creditors because such negotiation can go nowhere.[iii]   So far, so good, North Riverside probably qualifies.

The principal barrier North Riverside faces is the requirement that the municipality be “specifically authorized to be a debtor by state law or by a governmental officer empowered by state law to authorize the municipality to be a debtor.”[iv]  Michigan law unambiguously provides the latter, and so Detroit could be a debtor.  California law unambiguously provides the former, so Stockton, Vallejo, and Orange County could become debtors.[v]  No specific Illinois state statute does either with respect to Illinois municipalities in general.[vi]

So where to turn?  For a town under 25,000 in population, like North Riverside, the Illinois Local Government Financial Planning and Supervision Act[vii] provides that if the town determines that a fiscal emergency exists, it may petition the Governor to agree with the town and establish a financial planning and supervision commission.  Before agreeing, the Governor must give notice and reasonable opportunity for a hearing to all creditors.  The town gets to nominate 3 of the commission’s eleven members, with the rest being specified senior state government officials.

There are circumstances under which the commission can, after efforts prove unavailing, “[r]ecommend that the unit of state government file a petition under Chapter 9 of the United States Bankruptcy Code.”[viii]  But the power to “recommend” most likely will not cut it as the necessary authorization by the state required to become a chapter 9 debtor because it is not specific enough.[ix]  However, the issue has not been tested in Illinois courts.

[i]     Our discussion relies heavily upon two superb articles: Mark McClenathan, “Municipal Bankruptcy  – Can an Illinois Municipality File for Bankruptcy Protection?” (2014), found here; and James E. Spiotto, “The Role of the State in Supervising and Assisting Municipalities, Especially in Times of Financial Distress,” The Municipal Finance Journal (Spring 2013).

[ii]   11 U.S.C. § 101(40).  Note that the definition of “municipality” does not include states themselves.  There is no provision under the Bankruptcy Code for reorganizing states.

[iii]   The requirements of this sentence and its predecessor are paraphrases of the requirements set forth in 11 U.S.C. § 109(c)(2)-(4).  We omitted a final alternative under subsection (c)(4): “reasonably believe that a creditor may attempt to obtain a preference,” which refers most often to a creditor being poised to execute on collateral, effect an offset, or draw on a payment escrow or letter of credit.

[iv]   11 U.S.C. § 109(c)(1).

[v]    According to Spiotto, note 1 above, 12 states have statutes specifically authorizing the filing of a chapter 9 petition; another 12 states authorize a filing conditioned on a further act of the state, a state official, a state entity, or some designate other party; 3 states grant a limited authorization; 2 states expressly prohibit the filing of a petition; 2 more prohibit but with an exception; and 21 states are unclear or lack a specific authorization.

[vi]   One statute specifically provides that the Illinois Power Agency, an entity the state created in 2007 to develop electricity procurement plans, may be a debtor.

[vii]  50 I.L.C.S. 320/1 et seq.  Spiotto, note 1 above, counts  23 states as having implemented municipal debt and restructuring mechanisms and discusses several examples in detail.

[viii] 50 ILCS 320/9(b)(4).

[ix]   McClenathan, note 1 above, discusses case law holding that the state authorization to file a bankruptcy must be “exact, plain, and direct.”

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The editors and editorial board of DailyDAC include preeminent restructuring and insolvency professionals, journalists, and editors. They are devoted to providing reliable and plain English education and deal intelligence about assignments, corporate bankruptcy, receiverships, out-of-court workouts and similar topics.

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