Chapter 9: What it Means, How it Works, Example (2024)

What Is Chapter 9?

Chapter 9 is a bankruptcy proceeding that provides financially distressed municipalities with protection from creditors by creating a plan between the municipality and its creditors to resolve the outstanding debt. Municipalities, as defined for Chapter 9 bankruptcy proceedings, include a wide variety of governmental entities such as cities, counties, townships, municipal utilities, taxing districts, and school districts.

Understanding Chapter 9

It is nearly impossible for a creditor to force the liquidation of a municipality’s assets. Chapter 9 significantly differs from other bankruptcy chapters in that there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors.

A municipality is defined by its state and is under state jurisdiction. The 10th Amendment to the Constitution states that any powers not defined in the Constitution are reserved for the state, which has sovereignty over its internal affairs. Bankruptcy proceedings are part of the U.S. bankruptcy courts, which are under federal jurisdiction. Therefore, the federal courts cannot force a municipality to liquidate, as Chapter 9 bankruptcies are limited by the 10th Amendment. In effect, the bankruptcy court generally is not as active in managing a municipal bankruptcy case as it is in corporate reorganizations under Chapter 11. The role of bankruptcy court in Chapter 9 proceedings are limited and focused on approving a plan of debt reduction and overseeing the execution of the plan.

Only municipalities may file for Chapter 9 bankruptcy. Four other eligibility requirements for Chapter 9 as set forth in Section 109(c) of the Bankruptcy Codes are:

• The municipality must be specifically authorized to file for Chapter 9 under state law.
• The municipality must be insolvent.
• The municipality must desire to effect a plan to adjust its debts.
• The municipality must obtain agreement of the majority of certain types of creditors or, if no agreement, it must have evidence of one of three things: that an attempt to negotiate in good faith was made, that it would be impractical to negotiate, or that there is reason to believe that a creditor might attempt to obtain a preference.

The intent of Chapter 9 is to negotiate a repayment plan between the municipality and creditors, which can include reducing the principal or interest rate on outstanding debt, extending the term and timeline of the loan repayments, and refinancing the debt by obtaining a new loan. 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. 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 municipal debtor. Under certain circ*mstances, the stay also protects officials of the municipality.

Examples of Chapter 9

In 1994 Orange County, Calif., filed for Chapter 9 bankruptcy as a result of heavy borrowing and risky investments intended to raise funds to pay for government services. The county faced a $1.5 billion shortfall. In 2013 Detroit became the largest city in U.S. history to file for Chapter 9 bankruptcy. The city carried the largest municipal debt ever to be considered by the courts, estimated at between $18 and $20 billion.

In the wake of the financial crisis in the spring of 2020, Senate Majority Leader Mitch McConnell (R.-Ky.) suggested that rather than receive federal financial assistance, some states should instead declare bankruptcy. That, however, would require Congress to pass new legislation, as the U.S. Bankruptcy code prohibits states from declaring bankruptcy. And even if such legislation were enacted, there are serious concerns in regard to its constitutionality. State governors from both parties objected, and McConnell retreated a bit, saying it was only “a suggestion.”