Bankruptcy Scholar Melissa Jacoby Discusses Chapter 9

by Cate Long and Gil Hall

In the conversation with Cate and Gil, Melissa B. Jacoby outlines some of the legal theories behind bankruptcy in the United States, and discusses how they might impact Puerto Rico. Jacoby is the Graham Kenan Professor of Law at the University of North Carolina at Chapel Hill.

Municipal bankruptcy (Chapter 9) is a rarely used and unique type of bankruptcy that is frequently confused with other types of bankruptcy. It differs from the more familiar personal bankruptcy (Chapter 7) and corporate bankruptcy (Chapter 11) in important ways.

In Chapter 7 and Chapter 11 cases, for example, the bankruptcy court has broad powers of restructuring (including the adjustment of debts and requiring asset sales).

By contrast the court’s role in Chapter 9 is limited. Under Chapter 9, the substantial control of the process is given to the municipality (or public entity) that is seeking to restructure its liabilities. In Chapter 9 the judge cannot force a municipality to liquidate assets, reduce pension payments or layoff employees.

While creditors have no rights to impose a restructuring in municipal bankruptcy,  federal law requires that they be treated equitably, according to their creditor class.

The  bankruptcy judge serves as the final arbiter of fairness.

Jacoby has written extensively about the Detroit bankruptcy (which is the largest municipal bankruptcy to date in the United States). The Detroit bankruptcy involved the participation of Chief Judge Gerald Rosen of the U.S. District Court of the Eastern District of Michigan. Rosen served as an advisor to the bankruptcy judge overseeing the case, Steven Rhodes, and lead extensive extra-judicial negotiations involving the city’s art museum and public pensions.

Rosen’s negotiations involved raising a $816 million fund that included contributions from state taxpayers, private foundations and Detroit Institute of Art donors. Rosen, working outside the courtroom, facilitated a solution that spared Detroit retirees from more onerous pension cuts. It is unlikely that this deal could have been reached within an adversarial court setting. Rosen’s agreement forestalled appeals by retirees that could have prolonged the bankruptcy.

Jacoby explains the dynamic of municipal bankruptcy:

The key aspect to any kind of bankruptcy is that, because it can bind holdouts [creditors unwilling to take the same terms as other members of their creditor class], because they might be forced to accept a deal that they didn’t agree to originally, it brings all the constituencies to the table for negotiations and it provides some sort of backdrop to those negotiations. And that’s an incredibly important power.

What bells and whistles, what substantive protections you give to creditors in that process are also extremely important. What do they get to rely on as a backdrop to the negotiations they engage in is absolutely a piece of the conversation. But the element that’s common to bankruptcy, at least in the United States, the idea of the possibility of a discharge of debt and getting to restructure those obligations actually is a fairly conservative concept that’s been in the United States for quite some time.

Jacoby’s paper “Federalism Form and Function in the Detroit Bankruptcy” centers on what what she calls the “Detroit Plan”, the core point of which is that a Chapter 9 bankruptcy court “can adhere formally to the noninterference rules … while functionally becoming quite involved in the restructuring.”

In other words: the court can exert indirect, soft power to affect they way in which negotiations proceed and are managed.

Puerto Rico is not eligible to file Chapter 9 under current federal law. It was removed from the statute in the mid-1980s for unknown reasons.

U.S. Representative Sean Duffy, Republican of Wisconsin, has filed legislation to extend Chapter 9 bankruptcy to Puerto Rico (H.R.4199 – Puerto Rico Financial Stability and Debt Restructuring Choice Act). Duffy’s bill would also impose a control board.

So-called “Super Chapter 9” bankruptcy does not exist under current bankruptcy law and is a term used by different parties to refer to a broad range of policy suggestions. There have been no proposals published for a “Super Chapter 9” and there appears to be little support for it a broad restructuring of Puerto Rico’s debt in Congress.

Creditors are divided as to whether legislation should be approved to allow Puerto Rico to file bankruptcy under traditional Chapter 9.

Note: we will shortly record a companion piece with Melissa, in which we discuss technical aspects of Chapter 9. Submit your questions in the comments below.

*** contacts:
Cate Long: @cate_long
Gil Hall: @gillamhall

Melissa Jacoby: @melissabjacoby

About Gil Hall

Currently writing book on PR crises. Working title: "Los Pertrechos: the Story of an Economy". Polyglot prone to prolixity in English, German &, Spanish. Based between San Juan and North Carolina. MBA/MHA.


  1. Forget the law. What will we be doing to the muni mkt. it used to be a conservative investment that people bought not for the great returns but the safety . Where is the incentive for mom n pop when the laws issued will be changed to in essence protect union pensions and health care as these expenses are not cut in proportion to bondholders and there expenses are the biggest part of debts

  2. Great piece. I would like to hear what Melissa has to say about (1) the issue of PR’s clawbacks on bonds that have statutory liens on revenues, and effect if the entities issuing the bonds entered CH9 on ultimate payment, and (2) her thoughts on the public policy considerations that are a part of CH9 when considering the fairness of a plan of adjustment, particularly when it comes to the potential impacts of impairment of pensions, and knockon effects in the community creating a vicious cycle post-petition — whether she believes this was the reason that the Detroit plan contained relatively low levels of impairment to pension and health plans.

    Thank you Gil & Cate.

  3. One more question for Melissa Jacoby — If Puerto Rico were to be granted access to Ch 9 by Congress (or SCOTUS), what does she think is the likelihood of success of a challenge by bondholders based upon impairment of contract or potential takings claims?
    Thank you!