Chapter 9 bankruptcy is a lesser known chapter of bankruptcy that is specifically designed for "municipalities," which includes cities, towns, counties, taxing districts, municipal utilities, and school districts. Chapter 9 allows municipalities to reorganize their debt by extending the timeline on repaying debts, debt refinancing, or the reduction of principal or interest on existing debts. The assets of a municipality are not liquidated under Chapter 9.
Who May File?
Only municipalities may filed 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).
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. The bankruptcy petition may be objected to, for example, if the municipality did not engage in pre-bankruptcy negotiations as required.
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.
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 of 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.
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.
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.
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