Chapter 9 Bankruptcy

The first Chapter 9, municipal bankruptcy, became law in 1934 amid the Great Depression. The stock market crash wiped out banks, individuals, and employers. Counties, cities, towns, and school districts struggled. Chapter 9 bankruptcy gave financially distressed municipalities a way to reduce their debts.

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

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

What Is Chapter 9 Bankruptcy?

Chapter 9 is a section of the federal bankruptcy code reserved for municipalities. When a local municipality runs out of money, it can file for Chapter 9 bankruptcy reorganization to keep operating key public services. Chapter 9 allows the city to continue functioning while restructuring its debts and finances.

Filing for Chapter 9 bankruptcy is a serious decision for a municipality. The bankruptcy process can last from a few months to many years, depending on the complexity of the case and the amount of debt. Bankruptcy may damage the municipality's reputation. Its employees risk losing essential benefits, like cuts in salary, pension deficits, and loss of benefits. Attracting new revenue streams can take time and effort. As a result, people may move away or avoid the community, making recovery difficult.

Chapter 9 Basics

An entity must be insolvent 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 can decide which cases fulfill the eligibility requirements.

Municipalities generally need local government or state permission before filing a Chapter 9 bankruptcy case. Some state laws allow municipalities to file for bankruptcy protection on their own.

Chapter 9 Compared to Chapter 13 Bankruptcy

Municipal bankruptcy is like Chapter 13 bankruptcy for people because it aims to protect a town from creditors while negotiating debts. The city must make a good-faith effort to settle its debt and be open to negotiation.

One key difference from other types of bankruptcies is that a municipality can't be forced into liquidation of its property. This would violate the 10th Amendment of the Constitution. This means the bankruptcy court can't compel a city to sell a public park or historical landmark, for example, to pay off creditors. A municipality may choose to do so to meet creditors' demands.

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

Municipalities have considerable power to rewrite collective bargaining agreements. This power may affect the pensions and benefits of public employees. Unlike a Chapter 11 bankruptcy filed by businesses, Chapter 9 allows municipalities to 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.

Municipality Defined: Who Can File?

The Bankruptcy Code defines a municipality as a "political subdivision or public agency or instrumentality of a State." 11 U.S.C. § 101(40). Essentially, Chapter 9 relief is available to:

• Towns and villages
• Cities
• Counties
• Municipal utilities
• School districts
• Taxing districts
• Public improvement districts
• Other instrumentality of a state

States are not eligible to file for Chapter 9 bankruptcy, and Congress has not given them the authority to do so.

Filing a Chapter 9 Petition

Once the municipality files for bankruptcy, the court designates a judge for the case. Unlike other bankruptcies where judges get randomly selected, the chief judge of the court of appeals for the circuit assigns the bankruptcy judge.

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

• Whether the municipality has authorization from the state
• Whether the petition is filed in good faith

The Bankruptcy Court will only have limited power over the municipality's operations. In general, the court can:

• Review whether the city is eligible to file
• Approve the bankruptcy petition
• Review and confirm the repayment plan and oversee its implementation

Required Information to Submit When Filing Chapter 9

The town must be insolvent and willing to work with its creditors to arrange adjustment of debts. To inform all creditors of the filing, a notice of the bankruptcy filing gets published once a week for three weeks. Creditors may object to bankruptcy.

When you file your bankruptcy paperwork, you must list your creditors and the debt owed.

The Automatic Stay

Once the court accepts a Chapter 9 reorganization filing, it triggers an automatic stay. An automatic stay stops all collection actions against the debtor town. But Chapter 9 limits the role of creditors by banning the proposal of competing reorganization plans.

Bondholders and Other Creditors

Creditors with general obligation bonds don't get special consideration in a Chapter 9 case. While the case is pending, the city doesn't have to pay the creditors the principal debt or the interest rates. In these cases, the district can negotiate and offer possible restructuring under the plan of adjustment.

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

How Chapter 9 Bankruptcy Affects You

Public employees, including union members, suffer the hardest with municipal bankruptcy because of the following reasons:

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

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

• Harm to businesses that depend on city 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, Alabama, filed for Chapter 9 in 2011.
• Private companies may reconsider opening new facilities in a city once it has gone bankrupt. This hurts economic growth, and residents may move away for better opportunities.

A municipality that files for bankruptcy likely has been dealing with big budget problems for some time. Indeed, bankruptcy should be no surprise when the city files Chapter 9 papers.

Notable Chapter 9 Bankruptcy Filings

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

• Orange County, California (1994) — $1.6 billion in investment-related losses
• Prichard, Alabama (1999) — Inability to meet pension obligations
• Vallejo, California (2008) — 1,000 to 5,000 creditors, liabilities of $100 million to $500 million
• Jefferson County, Alabama (2011) — More than $4 billion in debt related to a bribery scandal involving J.P. Morgan Chase
• Detroit, Michigan (2013) — The largest municipal bankruptcy in U.S. history, estimated at $18 billion in debt
• Chester, Pennsylvania (2022) — Once a factory boomtown, it is reported to have had $500 million in debt and owe $100 million to its pensions

Talk to an Attorney to Learn About Chapter 9

Chapter 9 bankruptcy offers multiple strategies to help municipalities struggling with excessive debt. These bankruptcies may affect public employees, people suing the city, pensioners, and other stakeholders.

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