Chapter 9 of the U.S. Bankruptcy Code provides a legal remedy for insolvent municipalities to "provide adequate municipal services" to residents (In re City of Detroit). Specifically, the provisions permit municipalities to file for bankruptcy and address their fiscal shortcoming through a reorganization plan. Because a municipality provides essential services to its residents, an insolvent municipality cannot sell its assets to satisfy creditor claims through a liquidation (In re City of Stockton). Instead, chapter 9 provides municipalities the ability to adjust their debts through an adjustment plan to "foster the continuance of municipalities rather than their dissolution." (In Re Addison Community Hosp.).
Only municipalities may file bankruptcy under chapter 9, and no other chapter is available to municipalities. The definition of "municipalities" is relatively broad enough to include cities, counties, townships, school districts, and public improvement districts. As noted in In Re County of Orange, the definition also includes public bodies that provide public services paid for by users, not taxpayers– such as bridge, highway, and gas authorities.
Chapter 9 is modeled after chapter 11. Accordingly, the Code protects a municipality from creditors, much like a commercial debtor receives protection in a chapter 11 case. In both proceedings, debtors enjoy an automatic stay. This provision protects debtors from creditors bringing any action against the municipality and grants debtors a "breathing spell" for negotiations on debt readjustment (In Re Addison Community Hosp.). In turn, the municipality has the option–much like chapter 11 debtor–to reach an agreement with its creditors or "cram-down" a readjustment plan in the face of creditor objections. Sections 1129 and 943 specify conditions that the readjustment plan must meet to gain the approval of the bankruptcy court. If the municipality meets these conditions, then the municipality is discharged of its pre-petition debts, minus the debts assumed under the plan.
Nonetheless, chapter 9 differs from chapter 11 in several important respects. Chapter 9 requires municipalities to qualify for chapter 9 protections through eligibility requirements that go beyond those prescribed in chapters 11 and 7. Indeed, a debtor under chapter 11 or 7 only needs some connection to the United States to file for bankruptcy. By contrast, a debtor under chapter 9 must meet five conditions to be eligible.
According to 11 U.S. Code § 109(c): “An entity may be a debtor under chapter 9 of this title if and only if such entity:
- is a municipality;
- is specifically authorized, in its capacity as a municipality or by name, to be a debtor under such chapter by State law, or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor under such chapter;
- is insolvent;
- desires to effect a plan to adjust such debts; and
- has obtained the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter;
- has negotiated in good faith with creditors and has failed to obtain the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter;
- is unable to negotiate with creditors because such negotiation is impracticable; or
- reasonably believes that a creditor may attempt to obtain a transfer that is avoidable under section 547 of this title.”
As the court noted in In re City of Bridgeport, the barrier to eligibility is much higher in a chapter 9 case than in alternative bankruptcy proceedings. Courts regularly reject a chapter 9 filing because the municipality cannot meet these threshold requirements. However, the greater powers municipal debtors hold in the proceeding offset the higher thresholds for filing.
Once these threshold prerequisites are met, and the filing is approved, a municipality has more power than a corporate debtor in a chapter 11 case. This power is derivative of federalism concerns embodied in the Tenth Amendment, which forbids the federal government from interfering with the sovereign powers of the states, including the states' powers over their localities. Accordingly, Congress cannot pass laws that limit the states' sovereign control over their local governments. In other words, the Constitution grants municipality debtors greater latitude in the bankruptcy process than their counterparts in chapter 11. For example, under chapter 9, a municipality has exclusive rights to submit debt readjustment plans for confirmation; the exclusivity period is not limited in time, as in chapter 11. Creditors are barred from submitting plans of their own, even if there is a prolonged delay caused by the municipality.
Moreover, a trustee is generally not permitted to be appointed for the locality. The municipality continues its operations as a going concern with the same leadership, even if the leadership may impair the creditors' interests. The operations of the municipality are left to the local leaders' complete discretion. Indeed, the bankruptcy court may not interfere with any of the debtor's political or governmental powers, any of the property or revenues of the debtor, or the debtor's use or enjoyment of any income-producing property. In short, the court's hands are tied in guiding the debtor towards rehabilitation.
[Last updated in July of 2022 by the Wex Definitions Team]