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Chapter 9 Bankruptcy

Municipalities typically raise funds through the sale of municipal bonds. So while the federal government can just print more money, a local municipality that runs out of money may have 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, and school districts.

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. See FindLaw's What is Bankruptcy? section for more general information.

Chapter 9 Bankruptcy: The Basics

Chapter 9 is similar to a 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 that the assets of the municipality may not be liquidated. 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, although a city may do so of its own accord to satisfy creditors' demands.

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 increase revenue as they see fit.

An entity must be "insolvent" in order to qualify for Chapter 9 bankruptcy reorganization. This term is defined by federal bankruptcy law as the municipality "generally not paying its debts" or being "unable to pay its debts as they become due." A bankruptcy judge has the discretion to decide which cases to allow or deny.

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, etc.). But Chapter 9 limits the role of creditors by prohibiting the proposal of competing reorganization plans.

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

How Chapter 9 Bankruptcy Affects You

Public employees (including union members) typically are hit the hardest by a municipal bankruptcy, since they may see their pensions and benefits slashed or even wiped out entirely. Municipal employees may have to pay more for health care benefits and there may be across-the-board layoffs and hiring freezes.

This can cause a ripple effect in the private sector, harming businesses that depend on municipal contracts and diminishing the value of municipal bonds. Chapter 9 filings may also tarnish 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 also 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, Ca. (1994) – $1.7 billion in investment related losses;
  • Prichard, Ala. (1999) – Inability to meet pension obligations;
  • Vallejo, Ca. (2008) – Inability to meet pension obligations;
  • Jefferson County, Ala. (2011) – More than $4 billion in debt related to a bribery scandal involving JPMorgan;
  • Detroit, Mich. (2013) – The largest municipal bankruptcy in U.S. history, estimated at $18.5 billion in debt.

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