Municipality bankruptcy is a federal remedy provided by Chapter 9 of the Bankruptcy Code for restructuring a municipality’s debts. It is considered as one of the most complex and rarest forms of bankruptcy due to the complexity of cases, their size, the parties involved, and that the law treats these cases differently.
Chapter 9 of the US Bankruptcy Code is the exclusively for municipalities. All legal and practical respects of Chapter 9 differ from other types of bankruptcies. Pursuant to the Bankruptcy Code, a municipality is a “political subdivision or public agency or instrumentality of a State.” Its assets and debts should not offend constitutional guaranties of state sovereignty. A municipality cannot be liquidated by creditors.
In order to be eligible for filing a Chapter 9 bankruptcy, a municipality should be specifically authorized by state laws. Municipalities of other states should seek special authority from a state governmental official before filing a Chapter 9 petition. Further, a municipality should be declared insolvent for filing under Chapter 9. A municipality is considered insolvent if it is generally not paying its debts as they become due unless such debts are the subject of bona fide dispute, or unable to pay its debts as they become due.
To understand insolvency of a municipality, a prospective analysis is required. Much of a municipality’s revenue is from tax receipts, and therefore the municipality’s ability to impose and collect tax revenue will be critical to any determination of insolvency. Further, to be eligible for Chapter 9 relief, a municipality must demonstrate that it has negotiated to its best with various creditor constituencies before seeking Chapter 9 relief.
Usually, a municipality’s creditors will include bondholder representatives such as indenture trustees or bond insurers and public employee unions. One of the major benefits of Chapter 9 bankruptcy is the Municipalities’ ability to re-write collective bargaining agreements. This is much greater than in a corporate Chapter 11 bankruptcy and can trump state labor protections, allowing cities to renegotiate unsustainable pension or other benefits packages. This negotiation will include reduction of outstanding debt or interest rate, extension of term of the loan and refinancing debts.
All necessary bankruptcy paperwork should be filed with the clerk of the bankruptcy court. If the municipality did not engage in pre-bankruptcy negotiations, the creditors may object to the bankruptcy petition. Immediately upon filing of bankruptcy petition, the automatic stay activates and all creditors are forbidden to initiate any action against the filing entity to collect on debts. The automatic stay clause also provides protection to the officers of the municipality.