Background
After decades of financial distress, the city of Chester, Pennsylvania filed for Chapter 9 bankruptcy in November 2022. Before filing, Chester had pledged multiple revenue streams to secure debt: revenues from a waste incinerator operated by Covanta; gaming-related payments from Harrah’s Philadelphia Casino (including slot machine license fees and table game revenues); and other miscellaneous payments. Delaware County had secured an interest in certain revenues under a 2009 Contribution Agreement, while Preston Hollow Capital and U.S. Bank held secured interests in multiple revenue streams under a 2017 Trust Indenture backing $19.2 million in bonds.
When Chester filed for bankruptcy, the Revenue Fund contained approximately $4.4 million. The secured creditors argued that their liens survived the bankruptcy filing under three theories: (1) they were “statutory liens” created by municipal ordinances that survive under the Bankruptcy Code; (2) the revenues constituted “special excise taxes” exempt from the general cutoff rule; and (3) their security interests extended to “proceeds” that could survive. The Bankruptcy Court rejected all three arguments and ruled that Section 552(a) cut off the creditors’ liens on post-petition revenues, requiring the return of excess funds to the city.
The Court’s Holding
The Third Circuit affirmed the Bankruptcy Court on the principal issues but remanded narrower questions about proceeds and pre-petition accruals. On the threshold question, the court held that the creditors’ liens were consensual liens dependent on contracts, not statutory liens. Although the 2009 and 2017 ordinances authorized liens, they were “inherently dependent” on the operative effect of the Contribution Agreement and Trust Indenture. The ordinances alone could not create liens; the subsequent contractual agreements were essential to their formation. Because consensual liens are subject to the general rule of Section 552(a)—which cuts off liens on post-petition property acquired by the debtor—the ordinances did not shield the creditors’ interests.
The court also rejected the argument that the revenues qualified as “special excise taxes” under the Bankruptcy Code’s exemption. Despite the creditors’ characterization, the Slot Machine Revenues and Table Game Revenues are fees, not taxes, under both Pennsylvania law and federal functional analysis. Pennsylvania statutes explicitly label them as “license operation fees” and “local share assessments,” and they are payments for benefits (the privilege of operating gaming activities) not shared by the general public—the hallmark of a fee rather than a tax. The court affirmed that these revenues do not survive bankruptcy discharge.
However, the court identified an issue requiring remand: whether the Trust Indenture’s “Granting Clause”—which assigned U.S. Bank “a security interest in all of the right, title and interest of the City in and to the [Pledged] Revenues”—conveyed a distinct right to payment (collateral) from which post-petition proceeds could arise under Section 552(b)(1). The Bankruptcy Court had only considered narrower “to be received” language but not this broader clause. The court distinguished between agreements that convey only an interest in revenues themselves (as in the Contribution Agreement) versus agreements that convey an interest in the right to receive revenues (potentially in the Trust Indenture). This distinction determines whether proceeds can survive. The court affirmed that excess funds must be transferred to Chester under the Trust Indenture’s express terms.
Key Takeaways
- Municipal ordinances purporting to create liens do not themselves constitute “statutory liens” under the Bankruptcy Code when their operative effect depends on contractual agreements; the liens remain consensual and subject to Section 552(a) cutoff.
- Gaming-related payments to municipalities are “fees” for individualized privileges, not “taxes” supporting general government, and do not qualify for bankruptcy’s special-revenues exception even when authorized by statute.
- Whether a security interest in a revenue stream extends to “proceeds” requires fact-intensive analysis of contract language: courts must determine whether the agreement conveys only an interest in revenues themselves or also in a distinct right to payment.
- Trust indenture language stating excess funds “shall be transferred to the City” is not made conditional by a separate requirement to specify an account, and creates an enforceable obligation in the debtor’s favor.
Why It Matters
This decision clarifies the interplay between municipal ordinances and bankruptcy law in the context of revenue-secured financing. Municipalities frequently pledge tax and fee revenues to secure bonds without relying solely on statutory authority; this ruling confirms that such pledges create consensual liens vulnerable to Section 552 cutoff, rather than statutory liens. The distinction between taxes and fees also affects priority and survival: municipalities cannot evade bankruptcy law by labeling charges as taxes when they compensate for individualized benefits. The ruling may reshape how distressed municipalities structure revenue-secured debt and how creditors evaluate security in municipal bankruptcies.
The remand on proceeds raises a practical issue for future cases: the precise language creditors use to describe collateral—whether they claim an interest in revenues, in the right to receive revenues, or both—can determine survival of post-petition returns. This fact-specific analysis may encourage greater care in drafting security agreements but creates some uncertainty until the Bankruptcy Court’s remanded rulings are final. The decision also establishes that excess funds held in trust accounts must be returned to the debtor when bond obligations are satisfied, even if creditors seek to retain them.