The role of a municipality should take in a bankruptcy proceeding depends on the form of relief sought by the debtor. The issue of filing a Proof of Claim, however, will be relevant in all cases.
Generally, a municipality is a secured creditor of the debtor because the liability owed is secured by a lien against the debtor's real estate. A secured creditor need not file a Proof of Claim to have an allowed claim. The lien of the municipality, if unchallenged, survives the debtor's bankruptcy discharge. A municipality occasionally has an unsecured claim against a taxpayer, however, and must file a Proof of Claim.
Chapter 7
In a Chapter 7, the Trustee will liquidate the assets of the Debtor and generally the municipality will be paid from the proceeds. If the municipality has charges against the real property of the debtor, the municipality will be paid once the property is sold. In a "no asset" Chapter 7 case, the property will be abandoned back to the debtor. This will allow the secured creditor to foreclose on the property.
Chapter 13
A chapter 13 proceeding should not be a protracted proceeding. The Chapter 13 debtor, typically, when it files a Chapter 13 bankruptcy petition will also file a Plan of Reorganization. The Plan must provide for the curing of all arrearages to secured creditors, which would include property taxes and other charges against the property. The debtor must also stay current with all of its obligations while it is in Chapter 13. A municipality should review the proposed plan of the debtor to insure that the liabilities to a municipality are satisfied.
The payment to a municipality for the curing of the pre-petition arrearages will, typically, come from the Chapter 13 Trustee, unless the debtor proposes to make payments outside the Plan. This is the case, because the debtor makes monthly payments to the Chapter 13 Trustee and the Trustee is then responsible to make distribution of pre-petition debts from these payments.
A municipality should inform the Chapter 13 Trustee if the debtor is not current with its post petition obligations. The Trustee may then file a Motion to Dismiss the Chapter 13 proceeding. A municipality may also file such a Motion or a Motion For Relief From Stay if the debtor is not current with its post petition obligation.
The Chapter 13 Trustee is responsible to make sure that the debtor is making payments proposed under the Chapter 13 plan. If the debtor is not making such payments, then the Chapter 13 Trustee will file a Motion to Dismiss the bankruptcy case.
Chapter 11
General
The more complex cases are proceedings in Chapter 11. A municipality should participate in the Chapter 11 Bankruptcy proceedings from the day the Petition is filed through post confirmation. The debtor's attorneys and the Bankruptcy Court should know that a municipality will aggressively protect its interest in all stages of the bankruptcy. The Bankruptcy Code may be used to aggressively collect tax liabilities from debtors while they are in Chapter 11.
Post Petition Activity
A municipality should actively monitor its bankruptcy inventory to insure that debtors are current with all post-petition obligations. A debtor is obligated to stay current while it is under the protection of the Bankruptcy Court.
Motion for
A municipality may file a Motion to Convert a Chapter 11 case to a Chapter 7 where the debtor fails to timely remit post petition obligations. The controlling statutory provision under the Code is 11 U.S.C. §1112(b) which provides:
Except as provided in subsection (c) of this section, on request of a party in interest or the United States Trustee, and after notice and hearing, the Court may convert a case under this chapter to a case under Chapter 7 of this title or may dismiss a case under this chapter, whichever is in the best interest of creditors and the estate for cause, (1) continuing loss to or diminution to the estate and absence of a reasonable likelihood of rehabilitation.
A request of a party in interest after notice and hearing is the only prerequisite to trigger the discretionary power of the Bankruptcy Court to convert a Chapter 11 case to a Chapter 7 for cause. In Re Micro Acoustics Corp., 49 B.R. 630, 632 (Bkrtcy. S.D. N.Y. 1985); In Re Blanton Smith Corporation, 37 B.R. 303 (Bkrtcy. M.D. Tenn. 1983.)
Motion for allowance and Immediate Payment of Post-Petition
A municipality may also file a Motion for Allowance and Immediate Payment of Post Petition Obligations. This pleading provides that a debtor must make immediate payment of post petition obligations that have become due. Once the Court has entered such an Order, if the debtor still does not make payment, it will be in violation of the court order. The municipality can then move to have the case dismissed or converted to Chapter 7. Typically, the Motion to Compel Payment will require the taxpayer to make some arrangement with the municipality for payment of the post petition obligations. Bankruptcy Court Judges generally do not look favorably on taxpayers who are not current with their post petition obligations because such failure to make payments shows an erosion of equity in the estate.
Trustee or Bank File Pleadings
A municipality, if it does not wish to expend the money to file pleadings with the Bankruptcy Court, may wish to inform the Office of the United States Trustee or the Bank who has a mortgage on the property of the post petition obligations. As discussed earlier in the material, the Office of the United States Trustee monitors all Chapter 11 cases to insure Debtors are current with their post petition obligations. The Office of the United States Trustee, if informed of substantial post petition liabilities owed to a municipality, may be inclined to file a Motion to Convert the proceeding to Chapter 7. The secured creditor, such as a bank, may also be an important ally because very often such creditors have an agreement with the debtor that property taxes must remain current. A secured creditor, once informed that property taxes are not being paid, may file a Motion with the court.
Bankruptcy Court for Relief from Stay
The Bankruptcy Code provides that a creditor having interest in property is entitled to adequate protection for any decline in value of his collateral caused by the bankruptcy. Therefore, if property taxes are not being paid, the secured creditor's equity in the property is being eroded. Once the secured creditor is granted Relief from Stay it will then foreclose on the property.
Motion For Relief From Stay
A municipality may also file a Motion for Relief from Stay to allow it to foreclose on the debtor's real estate. Pursuant to 11 U.S.C. 362 (d)(1) of the Bankruptcy Code, the court may modify the Automatic Stay for cause. The term "cause" is not defined by the Bankruptcy Code but includes among other things a failure to afford adequate protection to a creditor for diminution in the value of the creditor's collateral. Therefore, due cause may exist for the granting of a Relief from Stay on the basis that the property at issue was declining in value and that the continued use of the property by the debtor diminishes the recovery by the municipality of pre-petition tax obligations.
The municipality may also be entitled to Relief from Stay pursuant to 11 U.S.C. §362(d)(2), if it can be shown that the debtor has no equity in the property subject to the lien of the municipality and if such property is not necessary for an effective reorganization. The municipality would argue that the aggregate value of the debtor's property is substantially less than the total amount of liens, encumbrances and security interest asserted against such property. The municipality must also argue that the property is not necessary for an effective reorganization because no reorganization is feasible. The basis for a claim that no reorganization is feasible is that the debtor has been operating and continues to operate its business at a loss and there is an absence of a reasonable likelihood of rehabilitation.
Confirmation
The debtor in a Chapter 11 proceeding must propose a Plan of Reorganization, which will provide for the curing of pre-petition property taxes in full, with interest. If water bills and other charges are also outstanding and a municipality has a lien against the debtor's property for these charges, then these liabilities must also be cured with interest. If there are any liabilities that arose post petition, they must be cured prior to confirmation.
A municipality should review the debtor's proposed Plan of Reorganization to insure that it provides for the payment in full of all secured claims of the municipality. This material will later discuss the rate of interest and the type of payment plan that a debtor must provide to a municipality.
Post-Confirmation
The role of the municipality in Chapter 11 cases does not end upon plan confirmatoin. When a debtor is in default in the payment of taxes required under its plan, the municipality should immediately contact the debtor's counsel and attempt to resolve the delinquency. The court retains jurisdiction over post confirmation matters, as long as the case is still an open bankruptcy case. The municipality, in the event that a delinquency is not cured, should file a Motion in Bankruptcy Court to convert the case to Chapter 7, pursuant to 11 U.S.C. §1112(b)(8). The statute provides that a court may convert a case to Chapter 7 "for cause including: ...material default by the debtor with respect to a confirmed plan."
A debtor's failure to tender plan payments to a municipality as required by the confirmed Plan constitutes a material default with respect to the Plan under the Code. A request of a party in interest after notice and hearing is the only prerequisite to triggering the discretionary power of the Bankruptcy Court to convert a confirmed case to a Chapter 7 case for cause such as a material default under a confirmed Plan. If the debtor's case has been closed by the Bankruptcy court, the municipality may exercise any and all administrative or state court remedies.