Municipal Revenue Bond Holders Suffer Another Legal Setback

Municipal Revenue Bond Holders Suffer Another Legal Setback

Revenue bonds depend on the revenue from a specific project or source, not the full taxing power of the issuer. This can make them riskier than general obligation bonds.

Yet, revenue bonds issued by entities eligible for relief under Chapter 9 of the U.S. Bankruptcy Code enjoy an advantage over general obligation bonds if the pledged revenues meet Chapter 9’s definition of “special revenues.” In bankruptcy, pre-petition security interests usually do not apply to property acquired after filing. However, even after filing, special revenues remain subject to pre-petition security interests. §928.

Additionally, the automatic stay does not apply to “application of pledged special revenues […] to payment of indebtedness secured by such revenues.” §922(d).

These protections were generally understood to require the payment of revenue bonds even after the issuing entity filed a Chapter 9 petition. That said, such understanding ended abruptly after Puerto Rico initiated debt adjustment proceedings under Title III.

According to the First Circuit, sections 922 and 928 merely allow the payment of special revenue bonds post-petition; they do not require it. The First Circuit also held that §305 of PROMESA, analogous to Chapter 9’s §904, bars the court overseeing the debt adjustment proceedings from compelling the debtor to remit the pledged revenues to the bondholders.

A recent ruling from the bankruptcy court overseeing the City of Chester’s Chapter 9 reorganization proceeding delivered yet another blow to holders of revenue bonds. The court held that the revenues backing certain revenue bonds issued by the city did not meet the definition of “special revenues”, because the revenues could not be considered a tax for purposes of §928.

Since the liens against the pledged revenues were consensual and not statutory, this meant that they did not attach to post-petition revenues, pursuant to §552(a).

Although it probably would have been a more contentious path than the one taken by the city in this case, it is interesting that the city did not advance the argument set forth by the FOMB in the Title III cases to the effect that, even if the pledged revenues were special revenues, the city could not be compelled to remit those revenues to the bondholders.

Lastly, it bears noting that the court concluded that the pledged revenues were a “payment intangible” or “account” under the Pa. UCC and thus the security interests were properly perfected by the filing of a financing statement. The city had argued that the pledged revenues were akin to “money”, which would have meant that the security interests had to be perfected by possession.