What is Chapter 9 Bankruptcy?

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Chapter 9 is one of the more obscure or lesser known types of bankruptcy. In fact, most people will go their whole lives without ever having heard of or been affected by a Chapter 9 bankruptcy. But Chapter 9 is a vital part of the Bankruptcy Code for the entities that have to make use of it.

Chapter 9 is specifically designed for "municipalities." But it is a bit broader than just cities and towns.

Counties, taxing districts like hospital taxing authorities, municipal utilities, and school districts can employ Chapter 9 to reorganize debt. Chapter 9 can be utilized to extend the timeline for repayment, allow for the refinance of debt or for reduction of principal or interest on existing debts. Unlike what happens in a Chapter 7 straight bankruptcy case, the assets of a municipality are not liquidated under Chapter 9.

Who May File?

Only municipalities may file for Chapter 9 bankruptcy. The Bankruptcy Code defines a municipality as a "political subdivision or public agency or instrumentality of a State." This is a very broad definition, and as set forth above, can include a wide variety of governmental entities.

Municipalities must meet four other requirements to file for Chapter 9: 1) it must be specifically authorized to file for Chapter 9 under state law, 2) it must be insolvent, 3) it must have a desire to adjust its debts, and 4) it must obtain agreement of the majority of certain types of creditors (or if no agreement, evidence that an attempt to negotiate was made or it would be impractical to obtain an agreement).

Examples of Chapter 9

From 1937 through 2013 municipalities have filed only about 650 cases. Usually fewer than 10 Chapter 9 cases are filed each year.

Some recent cases include:

  • Vallejo, California in 2010
  • Jefferson County, Alabama in 2011
  • Stockton, California in 2012
  • Mammoth Lakes, California in 2012
  • San Bernadino County, California in 2012
  • Central Falls, Rhode Island in 2011, and
  • Detroit, Michigan in 2013.

Prior to and Filing

Prior to the filing of a bankruptcy petition, some states require municipalities to engage in pre-bankruptcy activities, such as attempting to negotiate with creditors. Once those requirements are met, the municipality may file for Chapter 9. The municipality must prepare and file all of the necessary bankruptcy paperwork with the clerk of the bankruptcy court. If the municipality fails to fulfill the requirements set forth by the state in which it is located, it runs the risk of having to defend an objection to its filing Chapter 9. 

In some cases, the court can decide that a Chapter 9 filing is improper. This usually occurs when a creditor objects and argues that the municipality has not followed the procedures laid down in state law, the court finds that the municipality was not in fact insolvent, or when the court determines that more appropriate options are available to the municipality.

Bankruptcy Judge

Unlike other bankruptcy cases, wherein a bankruptcy judge is chosen at random by the clerk, in Chapter 9, the chief judge of the Court of Appeals where the bankruptcy court is located must choose the judge to oversee the case.

This is because Chapter 9 cases can be very complex and may involve elements of politics.

Automatic Stay

The automatic stay also goes into effect to halt any actions to collect on debts against the municipality. Under certain circumstances, the stay also protects officers/officials of the municipality.

Power of the Court

Normally a bankruptcy court has broad power over a Chapter 11 corporate debtor that wishes to reorganize. However, the Bankruptcy Code imposes limits on that power in connection with Chapter 9 cases because municipalities are unique entities. Generally, the law states that the court cannot interfere with the governmental powers of the debtor or its revenue or property. Also, the court cannot convert the case to another chapter or appoint a trustee in a Chapter 9 case.

Chapter 9 Plan

Similar to a Chapter 11 case, a Chapter 9 debtor must file a plan.

The plan sets forth how the municipality is going to reorganize its debts within the limits of bankruptcy. Similar to Chapter 11, the plan must be confirmed by the bankruptcy court.

Discharge

A municipality receives a bankruptcy discharge at a point after the plan is confirmed and the debtor deposits the funds or property with the court needed for the plan.

Conclusion

A Chapter 9 bankruptcy can often be one of the most complex and rare bankruptcy chapters. Very few bankruptcy lawyers are involved in Chapter 9 cases. Not only are these cases complex due to their size and the parties involved, but the law treats a Chapter 9 case quite differently. This difference in treatment is the result of the limited power of the federal government to control and/or give bankruptcy relief to governmental units of the states.

LEGAL DISCLAIMER

This article is for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem. Use of and access to this article does not create an attorney-client relationship between the author of this article and the user or browser.

 

Updated by Carron Nicks April 2017.