Chapter 9 Bankruptcy

Municipalities typically raise funds through the sale of municipal bonds. So while the federal government can just print more money, distressed municipalities that run out of money may have to file for Chapter 9 bankruptcy.

This article covers the basics of municipal bankruptcy and what it means for ordinary citizens, particularly those dependent on certain public services and public employees who risk losing at least some of their pension.

Basics and Eligibility for Chapter 9

An entity must be "insolvent" in order to qualify for Chapter 9 bankruptcy reorganization. Bankruptcy law defines being insolvent as the municipality "generally not paying municipal debts" or being "unable to pay its debts as they become due." A bankruptcy judge has the discretion to decide which cases fulfill the eligibility requirements.

Municipalities also need permission from their local government before they can file a Chapter 9 bankruptcy case although some state laws allow municipalities to file for bankruptcy protection on their own.

Chapter 9 Compared to Chapter 13 Bankruptcies

Chapter 9 is similar to Chapter 13 bankruptcy (filed by households or individuals) in that its purpose is to protect a municipality from its creditors while it negotiates its debts.

One of the key differences is the impossibility of liquidation of assets of the municipality. This is because doing so would violate the Tenth Amendment of the Constitution. This means the bankruptcy court cannot compel a city to sell a public park or historical landmark, for example, in order to pay off creditors. A city may choose to do so to satisfy creditors' demands.

The municipality also does not need court approval to lease or sell its property while a Chapter 9 case is pending.

Municipalities also have quite a bit of power to rewrite collective bargaining agreements, which may affect the pensions and benefits of public employees. Unlike a Chapter 11 bankruptcy (usually filed by businesses), Chapter 9 allows municipalities to effectively rework contractual obligations in retiree plans without much opposition.

Municipal debtors also have the freedom to levy taxes, leverage property and real estate, and increase revenue as they see fit.

What Is Chapter 9 Bankruptcy?

When a local municipality runs out of money, one option they have is to file for Chapter 9 bankruptcy reorganization (often referred to as a "municipal bankruptcy") to keep operating key public services. Chapter 9 also may be used by:

• Towns and villages
• Taxing districts
• Municipal utilities
• School districts

The bankruptcy process can last from a few months to a few years, depending on the complexity of the case and the amount of debt.

Eligibility for Chapter 9: Can States File?

No. States can't file for a Chapter 9 bankruptcy. Congress hasn't given them the authority to do so.

Filing a Chapter 9 Petition

Once the municipality files for bankruptcy, the case will be assigned to a judge. But unlike other bankruptcies where judges are randomly selected, here it is the chief judge of the court of appeals for the circuit that assigns the bankruptcy judge.

The U.S. Bankruptcy Code states that creditors must be given notice when the case begins. Creditors can object to the filing for a few reasons, including:

• Whether the municipality was given authorization from the state
• Whether the petition was filed in good faith

The bankruptcy court will only have limited power over the municipality's operations. In general, the court is limited to:

• Reviewing whether the municipality is eligible to file
• Approving the bankruptcy petition
• Reviewing and confirming the repayment plan, and overseeing its implementation

Chapter 9 Filing Fees and Administrative Fees

The Chapter 9 filing fee is $571. If you want to reopen a dismissed Chapter 9 case, the cost is $1,167.

Required Information to Submit When Filing Chapter 9

You will be asked to create a list of your creditors and the debt owed when you file your bankruptcy paperwork.

The "Automatic Stay"

As with Chapter 7 and Chapter 13, the filing of a Chapter 9 reorganization triggers an automatic stay, which stops all collection actions against the debtor (the city, town, public agency, etc.). But Chapter 9 limits the role of creditors by prohibiting the proposal of competing reorganization plans.

Bondholders and Other Creditors

Creditors with general obligation bonds will not be given special consideration in a Chapter 9 case. This means, while the case is pending, the municipality doesn't have to pay the creditors the principal debt or the interest rates. In such cases, the municipality can negotiate and offer possible restructuring under the plan of adjustment.

However, when it comes to special revenue bonds, the creditors can get paid during a Chapter 9 case if there are special revenues available.

How Chapter 9 Bankruptcy Affects You

Public employees (including union members) typically are hit the hardest by a municipal bankruptcy because of the following reasons:

• They may see their pensions and benefits reduced or even wiped out entirely
• Municipal employees may have to pay more for healthcare benefits
• There may be across-the-board layoffs and hiring freezes

This can cause a ripple effect in both the private and public sector. Some examples of this include:

• Harm to businesses that depend on municipal contracts, and a reduction in the value of municipal bonds
• Harm to the reputations of nearby municipalities. For instance, many cities and towns in Alabama experienced credit downgrades after Jefferson County, Ala. filed for Chapter 9 in 2011.
• Private companies may reconsider opening new facilities in a city once it has gone bankrupt. Not only does this hurt economic growth, but residents may opt to relocate for better opportunities.

Of course, a municipality that files for bankruptcy will likely have been dealing with substantial budget problems for some time. Indeed, the bankruptcy should be no surprise by the time Chapter 9 papers are filed.

Notable Chapter 9 Bankruptcy Filings

The following is a list of notable Chapter 9 bankruptcy reorganizations:

• Orange County, California. (1994) – $1.7 billion in investment-related losses
• Prichard, Alabama. (1999) – Inability to meet pension obligations
• Vallejo, California. (2008) – Inability to meet pension obligations
• Jefferson County, Alabama. (2011) – More than $4 billion in debt related to a bribery scandal involving JPMorgan
• Detroit, Michigan. (2013) – The largest municipal bankruptcy in U.S. history, estimated at $18.5 billion in debt

Talk to an Attorney to Learn About Chapter 9

Chapter 9 bankruptcy offers multiple strategies to help municipalities that are struggling with excessive debts. But these bankruptcies may affect public employees and other stakeholders.

If you are affected by a bankruptcy proceeding or want to learn more about the Chapter 9 bankruptcy basics, speak to a bankruptcy lawyer near you.