What Is Chapter 9 Bankruptcy?

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DEFINITION

Chapter 9 bankruptcy, also known as municipal bankruptcy, is a process that allows a municipality, county, or other taxing authority to seek protection from creditors in order to reorganize or adjust its debt obligations. Although rare, Chapter 9 cases can involve significant amounts of debt.

Definition and Example of Chapter 9 Bankruptcy

Chapter 9 is specifically designed for municipalities, but it applies to more than just cities and towns. Counties, taxing districts such as hospital taxing authorities, municipal utilities, and school districts can employ Chapter 9 to reorganize debt.

The bankruptcy code defines a municipality as a "political subdivision or public agency or instrumentality of a State." A municipality 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.
  4. It must obtain the agreement of the majority of certain types of creditors (or at least evidence that an attempt to negotiate was made or that it would be impractical to obtain an agreement).

Chapter 9 can be used to extend the timeline for repayment and 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 cannot be liquidated under chapter 9.

  • Alternate name: Municipal bankruptcy

The city of Detroit, Michigan filed for Chapter 9 bankruptcy in June of 2013. It had been plagued by several issues that had led to the filing, including a weakened tax base, high unemployment, and a lot of debt.

How Chapter 9 Bankruptcy Works

When Detroit filed for Chapter 9, there were several steps the city was required to take in order to get rid of some debt and restructure the rest. In most Chapter 9 cases, there are several key aspects of the Chapter 9 bankruptcy process.

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 may have to defend an objection to its filing under 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 insolvent, or 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 and 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 with constitutional protection.

Generally, the law states that the court cannot interfere with the governmental powers of the debtor or its revenue or property. The court also 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. Also 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 any required funds or property with the court-appointed disbursing agent.

In just 13 months, Detroit was able to emerge from Chapter 9. Through Chapter 9, Detroit was able to get rid of $7 billion in debt, restructure $3 billion, and put $1.7 billion into badly needed city services improvements.

Notable Happenings

From 1937 to 2018, American municipalities filed only about 680 cases of Chapter 9 bankruptcy. Usually, there are fewer than 10 Chapter 9 cases each year.

Some recent cases include:

  • Vallejo, California, in 2008
  • Jefferson County, Alabama, in 2011
  • Stockton, California, in 2012
  • Mammoth Lakes, California, in 2012
  • San Bernardino County, California, in 2012
  • Central Falls, Rhode Island, in 2011
  • Detroit, Michigan, in 2013

Key Takeaways

  • A Chapter 9 bankruptcy allows a municipal government entity to reorganize its debts and seek protection from creditors.
  • The ability of courts and creditors to interfere in municipal affairs under Chapter 9 is limited due to constitutional restrictions.
  • Municipalities' assets are protected from creditors under Chapter 9.

Article Sources

  1. United States Courts. "Chapter 9—Bankruptcy Basics." Accessed Jan. 26, 2022.

  2. Harvard Business School. "Bankruptcy in the City of Detroit." Accessed Jan. 26, 2022.

  3. The Detroit News. "Detroit Emerges From Bankruptcy Today." Accessed Jan. 26, 2022.

  4. MuniNet Guide. "Chapter 9 Municipal Bankruptcy Statistics: Use by Number, Type and Year." Accessed Jan. 26, 2022.