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James A. Chatz is a senior partner and certified mediator with the Chicago-based law firm of Arnstein &
Lehr LLP. He has more than 50 years experience in the practice of law. Mr. Chatz has five decades of
experience in the field of commercial insolvency and creditors’ rights law, representing clients
throughout the United States. He also practices in the areas of corporate law and business law, mergers
and acquisitions, financial planning, and commercial litigation. Mr. Chatz spends a significant portion of
his time in South Florida with the firm’s Boca Raton, Fort Lauderdale, Miami, Tampa, and West Palm
Beach offices, providing his knowledge and experience as a resource to businesses and individuals with
significant interests in South Florida. Leveraging the skills of our Florida-licensed attorneys, he is able to
assist clients in understanding their alternatives the strategic direction of their matters and in other
phases of the relationship.
Marc S. Zaslavsky is an associate in the Chicago office of Arnstein & Lehr LLP who focuses his practice
on bankruptcy issues. Mr. Zaslavsky was a member of the Law Review at DePaul University College of
Law where he graduated magna cum laude. He was awarded the CALI Award for Excellence in Legal
Drafting: Transactions and was a recipient of the CALI Award for Excellence in Legal Writing I and II.
Mr. Zaslavsky was nominated to the Order of the Coif by the faculty at DePaul University College of
Law. He is also a member of both the Illinois State Bar Association and the Chicago Bar Association.
Chatz and Zaslavsky: How Chapter 9
Can Solve the Pension Crisis
2
Since I’ve been a commercial and bankruptcy lawyer for the past 52 years, I recently
was asked by a member of an ad hoc committee of an Illinois city with less than
100,000 population if I could discuss and recommend some remedies to help solve the
city’s more than $100 million shortfall in their police and fire departments’ pension
funds.
rising taxes and ever-falling property values, its easy to push aside the pink elephant in
the room—unfunded public employee pension funds. But as surely as ashes from a
volcano in Iceland has the potential for affecting everything in its path, so too will the
I recommended to the members of the ad hoc committee that they consider using the
employees unions or leadership and city officials to the bargaining table. The
committee members did not accept the advice, and they took no action in the matter. In
contrast, the City of Vallejo, California, did seek relief for its pension obligations under
The State of California has been forced to take extreme measures to deal with its
colossal $500 billion dollar unfunded pension debt. Writing in the Los Angeles Times
explains why Chapter 9 of the Untied States Bankruptcy Code must be understood by
Chatz and Zaslavsky: How Chapter 9
Can Solve the Pension Crisis
3
the movers and shakers of local government. Crane points to the “$5.5 billion diverted
[in California] from higher education, transit, parks and other programs in order to pay
just a tiny bit toward current unfunded pension and healthcare promises” as evidence
that California is facing real and shocking budget shortfalls. Crane warns that
California’s “real unfunded pension debt clocks in at more that $500 billion, nearly eight
which face many local governments, in the near future, Chapter 9 of the Bankruptcy
Code may end up filling Bankruptcy court dockets just as Chapter 7 of the Code filled
The purpose of this article is not to discuss the rights or wrongs of the enormous
shortfalls which are coming due for pension plans for public employees. Nor is it my
purpose to discuss the role of city councils in their granting liberal pensions which
include early retirement, payment at the highest level of previous income, and payments
to policemen and fire fighters who retire at age 50 or older. Since policeman and
firefighters put their lives on the line for the communities they serve, I have no reason to
think they don’t deserve as much as they can bargain for. However, they must be
realistic when it comes to the question of whether their pensions can be properly funded
in the future. One remedy may be the one I suggested to the Illinois city—the use of
Chapter 9 of the Bankruptcy Code is unique in that it has few operating provisions of its
municipality bankruptcy case.2 In order to file under Chapter 9, state law must
specifically authorize a municipality to file a bankruptcy case.3 Each state has the right
to enact laws that govern a municipality’s right to file for bankruptcy relief. Some states
have very broad statutes, while some require approval from the governor of the state.4
Yet other states require a municipality to pass a law authorizing a bankruptcy filing by
financial planning and supervision commission recommends the filing and permission is
In my recommendation to the ad hoc committee member who had asked for my opinion
regarding unfunded pension obligations, I set fourth an outline of Chapter 9, how to use
it and what the necessary basic requirements are for the municipality in question to file
Chapter 9 and take advantage of the Federal Bankruptcy Code. A landmark case from
the United States Bankruptcy Court for the Eastern District of California clearly
illustrates that once a municipality files and is deemed eligible for Chapter 9, any state
law or constitutional provision that attempts to limit or circumvent the provisions of the
In In re City of Vallejo, the Bankruptcy Court of the Eastern District of California was
faced with the issue of whether Chapter 9 permits a municipality to reject collective
Chatz and Zaslavsky: How Chapter 9
Can Solve the Pension Crisis
5
bargaining agreements with its public employee unions.6 The City filed a Motion for
Approval of Rejection of Collective Bargaining Agreements.7 The Court noted that “by
authorizing the use of Chapter 9 by its municipalities, California must accept Chapter 9
in its totality; it cannot cherry pick what it likes while disregarding the rest.”8
uniform bankruptcy laws. Pursuant to Article VI of the Constitution, federal laws are the
supreme law of the land, and state laws to the contrary must yield. Thus, the Court
stated that California may not superimpose its labor laws and modify the provisions of
The Court went on to hold that unexpired collective bargaining agreements are
executory contracts subject to rejection under section 365 of the Bankruptcy Code, and
municipality shows: (1) the collective bargaining agreement burdens the municipality’s
ability to reorganize; (2) after careful scrutiny, the equities balance in favor of contract
rejection; and (3) reasonable efforts to negotiate a voluntary modification have been
made, and are not likely to produce a prompt and satisfactory solution.10 Although the
agreement, the Court refrained from deciding whether the City had met its burden,
noting that the City was involved in negotiations with the unions.11 Thus, the City of
Vallejo opinion demonstrates that by filing for bankruptcy, a municipality will gain the
Chatz and Zaslavsky: How Chapter 9
Can Solve the Pension Crisis
6
protections of Chapter 9 of the Bankruptcy Code, and restrictive state laws will be
preempted.
In light of this opinion, local governments have an option to restructure their pensions.
In Illinois, for instance, Article 13, Section 5 of the Illinois State Constitution prohibits
impaired.13 However, the City of Vallejo opinion demonstrates that this aspect of the
Illinois State Constitution, insofar as it conflicts with Chapter 9 of the Bankruptcy Code,
otherwise go through the proper channels to get state authorization to file, local
governments may utilize the federal bankruptcy code to restructure their pensions.
Local governments must be careful, however, to go through the proper procedures for
One distinct advantage of Chapter 9, and one of the major departures from Chapter 11,
is the limited involvement of the Bankruptcy Court while cities or other local government
entities are debtors under Chapter 9.15 As such, a mayor does not need to seek court
approval and obtain court orders to continue governing his or her city. Mayors do not
need to seek court approval to expend monies for municipal services.16 The Court, in
essence, does what it is asked to do. The Chapter 9 debtor does, however, need to
Chatz and Zaslavsky: How Chapter 9
Can Solve the Pension Crisis
7
obtain court approval for the assumption or rejection of executory contracts and
Chapter 9 provides arrows in a quiver for negotiations and some real weapons to create
leverage for settlement. Under Chapter 9, a Bankruptcy Judge can review and reject
previous pension plans and can provide temporary and long-term relief for monies going
into the program. A bargaining power is created between the citizens represented by
the city or suburb and the unions or leaders which represent the public workers, forcing
reasonable payout.
This bargaining power is clear in the City of Vallejo opinion. When the City filed its
bargaining agreements affected by the motion involved the Vallejo Police Officers
the International Brotherhood of Electrical Workers, Local 2376 (“IBEW”), and the
(“CAMP”).18 Prior to the hearing on the Motion, an agreement was reached between
the City and the VOPA.19 Further, an agreement was reached between the City and
CAMP. Thus, unions and public employee leadership may be more willing to negotiate
agreement rejected under the authority of section 365 in a Chapter 9 Bankruptcy case.
Chatz and Zaslavsky: How Chapter 9
Can Solve the Pension Crisis
8
It is important to note that in order to utilize Section 365 under Chapter 9 of the
Bankruptcy Code and reject an unexpired collective bargaining agreement, the City
must engage in meaningful negotiations with the unions.20 Only after it is determined
too may make unions and public employee leaders more willing to engage in
negotiations.
Despite the Court’s blessing, the City of Vallejo decided not to reject its existing
being conservative in its new contracts. For instance, in an Opinion piece in the Wall
Street Journal, Steven Greenhut noted that, “the city did approve a new firefighter
contract that trims pension benefits for its new hires and requires existing firefighters to
pay more into their pensions.”22 Greenhut said that the Vice Mayor indicated, “[t]he
majority [of council members] did not have the political will to touch the pink elephant in
Given the current economic climate, other cities may too consider the prospect of
Chapter 9, or may seek to bargain with Chapter 9 in the foreground. Traditionally, sales
tax and property tax have been the big revenue generators for municipalities.24 With the
state of the economy, consumer spending is down and property values have
plummeted. Thus, these traditional sources of revenue have not been sufficient to meet
Pennsylvania’s state capital, Harrisburg, is faced with more than $2,500,000 in loan
9, but the city’s Mayor disagreed.26 The mayor was concerned that a bankruptcy filing
would make the city unattractive to future lenders.27 Similarly, Cari Tuna reported that a
Stanford University study indicates that the three largest state-operated public-
employee pension funds in California have more that a $500 billion shortfall.28 Similar
to the approach taken by the City of Vallejo, the Stanford approach recommended
scaling back pension benefits for future employees, increasing contributions, and
Detroit, Michigan faces similar problems. With a sharp decrease in population and large
increase in unemployment, the city’s budget is far from balanced. A report published by
The Citizens Research Council of Michigan entitled “The Fiscal Condition of the City of
structure must reflect both the reduced tax base and the limited ability of state
The Illinois legislature recently passed pension reform that seeks to address the
shortfalls of Illinois’ current pension scheme.31 Governor Pat Quinn signed the
legislation into law, which will take effect on January 1, 2011. As one commentator
by Charles Wheeler of the University of Illinois Springfield, the State of Illinois has
Chatz and Zaslavsky: How Chapter 9
Can Solve the Pension Crisis
10
roughly thirty-five cents per dollar of money it needs to fund its pension plans.33 The
pension reform passed by the Illinois legislature will increase the retirement age from 55
to 67, reduce the highest annual pension from $391,000.00 to $106,800.00 per year,
and prohibit those receiving a public paycheck from concurrently receiving pension
benefits.34 However, these reforms only apply to new employee hires.35 Interestingly,
There is sharp disagreement within the media regarding the above mentioned
legislation. A Chicago Tribune editorial points out that, although the legislation prevents
fiscal problems from arising in the future, the legislation does nothing to alleviate the
problems facing government today: “[t]he state [of Illinois] still has unfunded pension
and retiree health obligations of some $130 billion, and its current annual pension costs
don’t decline. Legislators need to cut those current costs before their session ends.”37
The editorial notes that lawyers disagree as to whether the state can alter current
In light of this background and with all parties knowing their rights under Chapter 9 of
the Bankruptcy Code, discussion and consideration of what is fair and reasonable is
essential at the outset. The “I will not negotiate” mindset will not work when local
government is beset by extreme financial difficulties. Good will and fairness must
prevail. The best solution is for each side to negotiate and reach an equitable
employed so that the negotiation process can begin. If all parties know the framework
Chatz and Zaslavsky: How Chapter 9
Can Solve the Pension Crisis
11
of Chapter 9 and the likely outcomes that will come from a Chapter 9 filing, a settlement
can be achieved at the outset, thus avoiding the expense of going through bankruptcy.
Arnstein & Lehr LLP is a full-service law firm celebrating its 117th year in 2010. Our firm includes five
main service groups: Business, Litigation, Local Government, Tax and Estate Planning, and Real Estates.
We serve a diverse client base including large corporations listed on the public stock exchanges, middle-
market companies, nonprofit organizations, and emerging businesses. Clients include government,
healthcare entities, financial institutions, trade associations, and a broad range of businesses in the
retail, industrial, manufacturing, distribution, technology, and services sectors. The firm also counsels
individuals as to their personal needs, including estate planning, probate matters, and the transfer of
wealth and business interests from one generation to another.
1
Section 365 of the Bankruptcy code allows a debtor to assume or reject, subject to
certain limitations, an executory contract or unexpired lease. 11 U.S.C. §365. As
illustrated in the City of Vallejo case, unexpired collective bargaining agreements are
executory contracts subject to rejection under section 365. See Note 6, infra.
2
See 11 U.S.C. §902.
3
11 U.S.C. §109(c)(2).
4
H. Slayton Dabney, Jr., et al., Municipalities in Peril: the ABI Guide to Chapter 9, 16,
American Bankruptcy Institute, 2010.
5
See the Local Government and Financial Planning Supervision Act, 50 ILCS 320 et
seq.
6
In re City of Vallejo, 403 B.R. 72, 75 (Bankr. E.D. Cal. 2009).
7
Id.
8
Id. at 76, citing In re County of Orange, 191 B.R. 1005, 1021 (Bankr. C.D. Cal. 1996).
9
Id. at 77.
10
Id. at 78.
11
Id. at 78-79
12
See Ill. Const. art XIII, §5.
13
Ill. Const. art XIII, §5.
14
As one “municipality” quickly learned, Courts are all too eager to dismiss a Chapter 9
filing for failure to obtain the proper Illinois state authorization. See In re Slocum Lake
Drainage Dist. Of Lake County, 336 B.R. 387 (Bankr. N.D. Ill. 2006).
15
Municipalities in Peril, p. 24.
16
Id.
17
Id.
18
In re City of Vallejo, 403 B.R. at 74.
19
Id. at 75.
20
City of Vallejo, 403 B.R. 78.
21
Id. at 78-79.
Chatz and Zaslavsky: How Chapter 9
Can Solve the Pension Crisis
12
22
Vallejo’s Painful Lessons in Municipal Bankruptcy, Wall St. J., March 26, 2010.
23
Id.
24
Municipalities in Peril, 3.
25
In July, 2009 for example, the Village of Washington Park filed a Chapter 9 petition in
the Southern District of Illinois. See In re Village of Washington Park, Case No. 09-
31744 (Bankr. S.D. Ill. 2009).
26
Romy Varghese, Harrisburg, Pa. May Miss Loan Payment Tied to Troubled
Incinerator, Dow Jones Newswires; Deborah Lynn Blumberg, Harrisburg Misses Bond
Payment – Insurer Steps in as Pennsylvania City Considers Bankruptcy, Wall St. J.
April 30, 2010.
27
Id.
28
Cari Tuna, Shortfall Awaits California’s Big Pension Funds, Wall St. J, April 5, 2010.
29
Id.
30
Leonard Fleming, Detroit Needs Drastic Change to Avoid Bankruptcy, Report Says,
The Detroit News, April 5, 2010.
31
See Ill. Public Act 096-0889, S.B. 1946, 96th Gen. Assem., (Ill. 2010).
32
In Praise of Illinois: Democrats Take Baby Steps on Pension Reform, Wall St. J., April
8, 2010.
33
Id.
34
Id.
35
Id.
36
See Ill. Public Act 096-0889, S.B. 1946, Section 10, 96th Gen. Assem., (Ill. 2010).
37
Editorials, Don’t Run From a Fight, Chicago Tribune, Section 1, p. 20, Sunday, April
18, 2010.