Chapter 9 Bankruptcy

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Chapter 9 bankruptcy allows a financially distressed municipality to negotiate and develop a plan for repaying its debts. This is usually done by extending debt maturities, reducing the amount of principal or interest or by refinancing the debt with a new obligation. During this time of reorganization the municipality is protected from its creditors.

The first municipal bankruptcy legislation was enacted during the Great Depression. Congress tried to word the law so that it didn’t interfere with the sovereign powers of the states as guaranteed by the Constitution. Since then the law has been amended several times. In more than 60 years, less than 500 municipal bankruptcies have been filed. Probably the best known case is Orange County, California in 1994.

Chapter 9 is different from other types of bankruptcy in that there’s no provision for liquidation of the assets and the trustee has less power. Only a municipality may file a chapter 9. Bankruptcy Code defines a municipality as a “political subdivision, public agency or instrumentality of a State.” This can include cities, counties, townships, school districts, and public improvement districts. Revenue producing bodies such as bridge authorities, highway authorities and gas authorities also qualify.

In addition to being a municipality, the following four requirements must be met:

  1. the municipality must be specifically authorized to be a debtor by state law or by a government officer
  2. the municipality must be insolvent
  3. the municipality must have the desire to create a plan to adjust its debts
  4. the municipality must either: obtain the agreement of at least a majority of their creditors; negotiate in good faith with creditors and fail to obtain the agreement of creditors; be unable to negotiate with creditors because such negotiation is impracticable; or reasonably believe that a creditor may attempt to obtain a preference.

Bankruptcy Code requires that municipalities publish their intent to declare bankruptcy at least once a week for three successive weeks in at least one newspaper of general circulation. Objections are allowed but don’t automatically stop the petition. Once the petition is filed creditors can’t attempt to collect past due debts. They are allowed to join a creditors’ committee where their concerns are heard.

Unlike other types of bankruptcy the municipality has greater authority and the appointed trustee has less authority. The trustee does not monitor the behavior of the municipality or get involved in the day to day activity. While a municipality is reorganizing it can raises taxes, use property in any way it deems necessary and make needed expenditures. They can even borrow more money.

Once the municipality has determined a plan of reorganization it must be presented to the bankruptcy court. The plan is approved only when all the conditions specified by Bankruptcy Code have been met. Because there are no assets to liquidate the creditors don’t always get the full amount owed them. They usually agree to this because receiving something is better than the alternative – receiving nothing.

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