What is Chapter 9 bankruptcy?

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Chapter 9 bankruptcy allows financially distressed municipalities to reorganize their debts and seek protection from their creditors. This type of bankruptcy is relatively rare, though it can involve significant amounts of debt. About 680 municipal authorities in the U.S. have filed for Chapter 9 protection within the past eight decades. Comparatively, there were more than 280,000 Chapter 13 filings in 2019 alone. If your town or another local municipality recently filed Chapter 9, here’s what you should know about it.

What is Chapter 9 bankruptcy?

Chapter 9 bankruptcy is a legal proceeding that allows cities and other types of municipalities to restructure their debts without selling off their assets.

A municipality might consider bankruptcy as a last resort when it owes money to creditors but can’t pay. For instance, the city might make a bad investment, become insolvent and subsequently miss payments to its pension recipients and loan servicers.

But cities aren’t always allowed to declare bankruptcy. They must meet eligibility requirements and have permission from their state government. Every state has its own process. Some allow municipalities to declare bankruptcy on their own, some require municipalities to take certain steps before filing and some states don’t allow Chapter 9 bankruptcy at all.

If permission is granted from the state, the municipality can then file a petition to the federal government to restructure its debts. The petition filing triggers an automatic stay, which stops all collection actions against the municipal debtor. It may also protect officials of the municipality in some cases.

Under Chapter 9, the municipality comes up with a plan to repay its creditors. The plan should make repayment more affordable, so it may include:

  • Decreasing the principal or lowering the interest rate on outstanding debt.
  • Extending the loan term, which may lower the municipality’s payments.
  • Refinancing the debt by taking out a new loan with better terms.

The municipality must file the necessary paperwork with the clerk of the bankruptcy court, which may move the case forward. But the court may decide that a Chapter 9 filing is improper if the municipality doesn’t meet requirements or has more appropriate options available.

The Chapter 9 timeline may stretch from a few months to a few years, depending on the complexity of the case and the amount of debt owed.

Examples of Chapter 9 bankruptcy

Jefferson County, Alabama, filed for Chapter 9 bankruptcy in 2011 as a result of a bad investment in a local sewer system. The county was on the hook for a $4 billion debt load — the largest municipal bankruptcy in U.S. history at the time — and its lawyers had to negotiate with more than 4,000 creditors.

But Detroit became the largest municipality in the U.S. to file for Chapter 9 bankruptcy in 2013. By some estimates, the city owed $18 billion in debt to more than 100,000 creditors.

Terms of eligibility for Chapter 9 bankruptcy

Chapter 9 applies only to a “political subdivision or public agency or instrumentality of a state.” Generally, that includes cities and towns, counties, taxing districts, revenue-producing bodies such as highway authorities, municipal utilities and school districts. It does not apply to state governments.

To file for Chapter 9 protection, a municipality must:

  • Be authorized to file for Chapter 9 under state law.
  • Be insolvent, which means that the municipality has not or cannot pay its debts.
  • Be willing to devise a plan to restructure its debts.
  • Make a good-faith attempt to negotiate a settlement with its creditors.

What is the difference between Chapter 9 and Chapter 11?

In both Chapter 9 and Chapter 11, the debtor negotiates with its creditors to change the terms on its debts. The main difference between Chapter 9 and Chapter 11 bankruptcies is who can use them. While Chapter 9 applies to certain government entities, Chapter 11 bankruptcy allows a business or individual to reorganize its debts and obligations. Many big U.S. companies have filed for Chapter 11 protection, including General Motors and United Airlines.

A bankruptcy court generally has broad powers over a Chapter 11 case, but it’s limited when it comes to Chapter 9 cases. Municipalities are federally protected, so bankruptcy courts can’t make spending or other policy decisions on behalf of the locality. The court’s role in a Chapter 9 case is only to approve the petition, confirm the plan and ensure that it’s implemented.

Final takeaways

When a city or another type of municipality files Chapter 9 bankruptcy, it could motivate residents or businesses to leave — making any budget problems worse. Government workers might worry about slashed salaries, while residents might worry about reduced services or abandoned public projects.

But it first helps to understand what Chapter 9 is and how it’s handled. If your municipality is filing Chapter 9, start following news reports on the situation and sit in on public meetings if you can. Voicing your concerns and voting on issues can help you get a say in what happens next. From there, you can figure out whether the Chapter 9 bankruptcy will affect you and how you can prepare.

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