On April 22, 2020, in a radio talk show interview, Senate Majority Leader Mitch McConnell—a lawyer—responded to “softball questions” (i.e., leading questions) from the host Hugh Hewitt. His answers betray an appalling ignorance of the federal system.
Among other errors, McConnell stated that “I would certainly be in favor of allowing states to use the bankruptcy route [referring to municipal bankruptcy under Chapter 9 of the Bankruptcy Code]. It saves some cities. And there’s no good reason for it not to be available.” The backdrop to the question was whether there is any alternative to Congress appropriating money to assist the states with the unexpected and huge costs of dealing with the COVID-19 pandemic.
His answer was correct in only one respect. Since the 1930s municipalities (as opposed to States) have been authorized, if their state governments have granted approval, to file bankruptcy cases under the national bankruptcy law in order to restructure debts they cannot pay and otherwise deal with conditions of insolvency. That law, originally known as “Chapter IX of the Bankruptcy Act of 1898” and since 1979 called “Chapter 9 of the Bankruptcy Code of 1978,” is in place because of the work of Hatton W. Sumners (1875-1962) who was Dallas’s Congressman from 1913-1947.
During the Great Depression, literally thousands of cities, school districts, and water and irrigation districts found themselves unable to pay the bonds they had issued during the Roaring Twenties. The worst problems were in the irrigation and special purpose taxing districts of the Texas Rio Grande Valley, young Florida towns founded during its spectacular land boom of the 1920s, and agricultural districts of California, although major cities such as Detroit, Cleveland, and even Houston also suffered serious financial distress. With the collapse of property values, collection of taxes from which to pay the bonds and other obligations was severely impaired.
Sumners knew about this because he had visited the Valley over several decades and had witnessed its rapid development of orchards and truck farms after World War I, enabled by water infrastructure projects funded by bonds issued by special purpose taxing districts. Moreover, he personally was an experienced real estate lender and investor in Texas agricultural properties. The bill to add Chapter IX to the Bankruptcy Act was introduced in early 1933 by a Florida congressman, but Sumners was Chair of the House Judiciary Committee and he took the lead to revise and enact it—twice.
The first version of municipal bankruptcy was signed by President Roosevelt in 1934, but declared unconstitutional by the Supreme Court in 1936. So Sumners slightly tweaked it and re-enacted it in 1937; and when it came to the Supreme Court in 1938, he personally argued the case for its constitutionality and won. While only a few hundred Chapter IX municipal bankruptcy cases were filed, the new ability of agricultural and other taxing districts—and cities—to utilize the federal bankruptcy law enabled those debtors, gave them enough bargaining leverage, to be able to consensually effectuate restructurings of their debts.
The modern Chapter 9 does the same thing. In the past ten years, for instance, Chapter 9 municipal bankruptcy has enabled large cities such as Detroit and tiny rural public hospitals such as the one in Quanah, Texas, to restructure their debts through bankruptcy court proceedings, and also has provided negotiating power to all types of political subdivisions of those states—about half of the fifty—that have authorized such subdivisions to access the relief afforded by Chapter 9.
States, too, teetered on the brink of financial default in the early thirties. For example, in 1933 Arkansas ran out of cash and stopped payments on all of its highway bonds. The State government asserted sovereign immunity and proposed to refinance all highway and road district bonds into a single tranche of new bonds stretched out so as to be due in 25 years, which would have inflicted substantial losses on the bondholders, and they resisted. Due to external pressure, the State was compelled to make a deal with the bondholders under which, as one financial historian put it, “[t]he people of Arkansas suffered greatly.”
States were not included in Chapter IX. Sumners’ thinking was that relief from creditors for States was unobtainable because of the provision of Article I, section 10, clause 1 of the Constitution that “No State shall . . . pass any . . . Law impairing the Obligation of Contracts,” and its Tenth Amendment, which reserves powers not delegated to the United States by the Constitution, nor prohibited by it to the States or to the people. Consequently and subsequently, municipal bankruptcy under the national bankruptcy law, both Chapter IX and Chapter 9, has never included states. Legal scholars today agree.
So McConnell—who is a lawyer—must not know or has forgotten the history of Chapter 9 bankruptcy. The ludicrousness of his answer is demonstrated in the response on April 23 of Andrew Cuomo, the Governor of New York, in his press conference: “I dare you to enact Chapter 9 for the states!”
-Josiah Daniel
(c) 2020
(c) 2020