Municipal bankruptcy is a type of bankruptcy available for financially troubled municipalities. This is provided under Chapter 9 of the Bankruptcy Code. The purpose of Chapter 9 bankruptcy is to create a debt resolution plan between the municipality and its creditors. Debts of a municipality are reorganized by extending debt maturities, reducing the amount of principal or interest, or refinancing the debt by obtaining a new loan. A municipalities’ ability to re-write collective bargaining agreements makes Chapter 9 stand apart from all other types of bankruptcies.
Chapter 9 bankruptcy courts approve a municipality’s petition confirming a debt adjustment plan, and ensure its proper implementation. A municipality is defined by its state and is under state jurisdiction. According to the 10th Amendment, bankruptcy proceedings are not a part of the constitution, and therefore creditors can in no way force the liquidation of a municipality’s assets.
Chapter 9 bankruptcy cases are complex due to their size, the parties involved, and because the law treats them differently. In order to file for Chapter 9 bankruptcy, a municipality must be specifically authorized by law. It must be insolvent and have a desire to adjust its debts. The municipality should also obtain evidence as to the attempts made to negotiate payments with the creditors.
Some of the states require municipalities to engage in pre-bankruptcy activities, such as attempting to negotiate with creditors before filing bankruptcy petition. 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. Officers and officials of a municipality are also protected by the automatic stay clause.
As in a Chapter 11 case, a Chapter 9 debtor (a municipality) should also file a plan. The plan should set forth the municipality’s mode of working to reorganize its debts within the limits of bankruptcy. This plan must be confirmed by the bankruptcy court. Once the plan is confirmed, the municipality receives a bankruptcy discharge.