Public Works Projects And Municipal Bankruptcies

The good news is that public works construction projects for municipalities are projected to remain a major sector of construction activity for the foreseeable future. The not-so-good news is that municipal bankruptcy filings are on the rise, and they are likely to increase. The issues facing parties under contract with a municipality when it files for bankruptcy protection are playing out nationally in places like Stockton, California, and Detroit, Michigan. Construction lawyers now more than ever need to know the risks of a public owner filing for bankruptcy protection before project completion, and what they can do in the event it does so before the project is closed out—thereby jeopardizing the owner's ability to pay.

A public owner or municipality may file for protection under Chapter 9 of the Bankruptcy Code if it is insolvent, desires to effect a plan to adjust its debts and satisfies the other eligibility requirements under 11 U.S.C. §109(c). (How a municipality establishes "insolvency" and other "eligibility" requirements is beyond the scope of this article. These issues are complicated, invariably contested and always time-consuming to resolve.) On the petition date, and before eligibility is determined, the automatic stay provisions of Bankruptcy Code Sections 362 and 922(a) kick in, and all contract claim proceedings and legal actions against the municipality are stayed.

The stay creates complications for all creditors, including both ordinary course of business contracting parties and claimants seeking disputed amounts owed. Ordinary course of business creditors may continue to be paid post-petition, although prudence may lead them to file claims to protect their rights pending payment. Claimants seeking disputed amounts must file timely their claims with the Bankruptcy Court. Then, depending on whether the claim is contested and its priority, it ultimately may be paid only pennies on the dollar.

Municipal bankruptcy filings under Chapter 9 present many additional, unique issues not found in Chapter 11 or Chapter 7 filings. Unlike a more typical Chapter 11 or Chapter 7 filing, no bankruptcy "estate" is created in a Chapter 9 case, no trustee is appointed, and the municipality continues to be governed and controlled by its same officials. In deference to notions of sovereignty, under Chapter 9, there is no authority to order a liquidation of the entity and there exists a general reluctance by the Bankruptcy Court to interfere...