To the extent authorized by a State, Chapter 9 of the Bankruptcy Code allows municipalities (defined as a “political subdivision or public agency or instrumentality”) of that State – including public hospitals – to reorganize their debts in the face of insolvency. Municipalities achieve this goal through implementation of a court-approved plan of adjustment. Although the standards for confirming (approving) a Chapter 9 plan resemble the well-established standards for confirming a Chapter 11 plan, differences exist. These differences can be particularly impactful on the ability to confirm a plan that does not pay creditors in full over their objection. Accordingly, public hospitals should be aware of Chapter 9’s different standards for ensuring continuity of the hospital’s operations and preserving funds to enable continued operations and necessary improvements.

A recent and successful plan confirmation in the Northern District of Texas illustrates these differences. In March 2013, after a decade of struggling with financial issues, the Hardeman County Memorial Hospital in Quanah, Texas (approximately 200 miles northwest of Dallas-Fort Worth) filed bankruptcy under Chapter 9. More than two years later – on November 2, 2015 – the Bankruptcy Court confirmed the hospital’s Chapter 9 plan over the dissent of its unsecured creditors. See In re Hardeman County Hospital District, 540 B.R. 229 (Bankr. N.D. Tex. 2015).

The hospital’s plan impaired the rights of all its creditors, secured and unsecured alike. Although the hospital’s secured creditors accepted the plan, its general unsecured creditors rejected it. Further, the largest of these unsecured creditors filed an objection to the plan’s confirmation, questioning the hospital’s good faith in proposing the plan. Good faith is a requirement under both Chapter 9 and Chapter 11, but courts apply it differently under each chapter. As the Hardeman County Bankruptcy Court explained, unlike Chapter 11, the purpose of Chapter 9 “is to permit a financially distressed public entity to adjust its debts in light of the fact that it is an operating municipality, which, by its nature, [and in contrast to private business bankruptcies,] is not subject to liquidation.” Id. at 237. The Court described the plan’s twin objectives: (1) the hospital’s continued operation under its statutory mission to provide medical care to the needy residents of Hardeman County; and (2) the satisfaction of its creditor claims in a manner that preserved funds needed for hospital operations, improvements, and maintenance, both now and in the future. With these objectives, the Court found that the hospital presented a plan that aligned with Chapter 9’s underlying purpose, and thus presented its plan in good faith.

Raising another aspect unique to Chapter 9, the objecting creditor also argued that the hospital should raise its tax rate to enable a higher plan payout for the general unsecured creditors. In addressing this argument, the Bankruptcy Court noted that other courts did not require a tax increase where the municipality’s demographics and economic issues rendered any attempt to raise taxes a “futile exercise.” Moreover, the Court reasoned that neither the Bankruptcy Code nor the Tenth Amendment allowed the Court to interfere with a Chapter 9 debtor’s property, revenue, or governmental powers. The Court recognized that in this hospital’s case: the value of taxable properties had substantially declined; taxpayer sentiment was strongly opposed to increasing the hospital’s tax revenue; and the state government had expressly supported confirmation of the existing plan. The Court therefore held that plan confirmation did not require the hospital to raise taxes.

Confirmation did, however, require the Court’s conclusion that the plan treated the dissenting class of creditors fairly and equitably. In Chapter 11, the fair and equitable treatment of creditors most commonly implicates the “absolute priority rule.” In simple terms – and among other things – this rule prohibits confirmation of plans that provide anything to any class of claimants junior to a dissenting class, where that dissenting class is receiving less under the plan than the full amount of its allowed claims. Thus, a court cannot confirm a Chapter 11 plan that violates this rule and provides, for example, that shareholders retain their controlling equity interests in a debtor while dissenting unsecured creditors receive only a fraction of their allowed claims.

But unlike Chapter 11, “[i]n a Chapter 9 case, the fair and equitable requirement has been interpreted to mean that [h]olders of [c]laims must receive all they can reasonably expect under the circumstances of the [c]ase.” Id. at 239. The Court observed that, “because there are no equity holders in a Chapter 9 case, the absolute priority rule does not prevent the debtor from continuing to operate the hospital[,]” even when unsecured creditors as a class have voted against confirmation and are not otherwise being paid in full. Id. (quoting In re Corcoran Hosp. Dist., 233 B.R. 449, 458 (Bankr. E.D. Cal. 1999) (internal quotation marks omitted)). It then elaborated that, unlike a Chapter 11 business bankruptcy, “‘[t]he primary purpose of debt restructure for a municipality is not future profit, but rather continued provision of public services. The insolvency test [for Chapter 9 eligibility] measures whether a municipality can pay for the services it provides. Since insolvency is the foundation of Chapter 9 eligibility, it would make little sense to confirm a reorganization plan [that] does not remedy the problem. Stated differently – there is no purpose in confirming a Chapter 9 plan if the municipality will be unable to provide future governmental services.’” Id. (quoting In re Mount Carbon Metro. Dist., 242 B.R. 18, 34 (Bankr. D. Colo. 1999) (emphasis added)). Under this standard, the Court found that the hospital’s plan provided the maximum amount the hospital could pay while simultaneously maintaining its health care services. It ruled that, in this way, the hospital’s plan provided the best recovery for the unsecured creditors under the circumstances, and thus treated the unsecured creditors fairly and equitably.

As this public hospital bankruptcy case demonstrates, although plan confirmation under Chapter 9 bears similarities to plan confirmation under Chapter 11, the standards differ in meaningful ways. The distinct purpose of Chapter 9 creates standards that are, in some respects, more flexible for public entity debtors than Chapter 11. Some courts have found that Chapter 9 deeply emphasizes the continued operation of the public entity, and requires careful attention to the needs and overall economic climate of the municipality it serves. In so finding, these courts allow the public entity to impair its creditors in a way that might not pass muster under Chapter 11. And this may be a powerful tool that public hospitals should consider in deciding whether to file bankruptcy under Chapter 9.