An Overview of Chapter 9 Bankruptcy -- Municipality Bankruptcy
Congress enacted the first municipal bankruptcy legislation in 1934 during the Great Depression. In the nearly 70 years since the establishment of a federal mechanism to resolve municipal debts, fewer than 500 municipal governments have filed bankruptcy petitions under
Chapter 9
. Although Chapter 9 cases are rare, a filing by a large municipality can—like the 1994 filing by Orange County, California—involve many millions of dollars in municipal debt.
The purpose of chapter 9 is to provide a financially-distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts. Reorganization of the debts of a municipality is typically accomplished either by extending debt maturities (i.e., extending the dates on which the debt balances are due), reducing the amount of principal or interest, or refinancing the debt by obtaining a new loan. Although similar to other chapters in some respects, chapter 9 is significantly different in that there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors.
Only a "municipality" can file for relief under chapter 9. The term "municipality" is defined in the Bankruptcy Code to mean "political subdivision or public agency or instrumentality of a State." The definition is broad enough to include cities, counties, townships, school districts, and public improvement districts. It also includes revenue-producing bodies that provide services which are paid for by users rather than by general taxes, such as bridge authorities, highway authorities, and gas authorities. There are three additional eligibility requirements for chapter 9:
- The municipal entity must be specifically authorized to be a debtor by State law or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor,
- The municipality must be "insolvent" in that:
- the municipality is generally not paying its debts as they become due unless such debts are the subject of a genuine dispute; or
- the municipality is unable to pay its debts as they become due
and - the municipality must desire to implement a plan to adjust such debts and, among other things, either:
- obtained the agreement of the creditors holding a majority of the claims that the municipality intends to be subject to a plan under chapter 9;
- negotiated in good faith with creditors and has failed to obtain the agreement of creditors holding at least a majority holding a majority of the claims that the municipality intends to be subject to a plan under chapter 9;
- cannot negotiate with creditors because such negotiation is impracticable; or
- reasonably believes that a creditor may attempt to obtain a preference in which the creditor claims the right to be paid the balance due on existing debt and will not be subject to the municipality's plan.
