Bankruptcy
When a municipality is unable to pay its debts, one of its options is to pursue a Chapter 9 filing under the U.S. Bankruptcy Code. The Bankruptcy Code aims to provide, in its words, a “workable procedure so that a municipality of any size that has encountered financial difficulties may work with its creditors to adjust its debts.” While this does not mean that all of its debts will be erased, they may be “impaired,” that is, lessened or altered.
Municipalities are the only entities to whom Chapter 9 applies. Municipalities are defined as towns, cities, counties, and public improvement districts. They also include revenue-producing bodies that provide services that are paid for by the users, such as highway authorities.
However, a municipal entity must be authorized by state law to proceed with filing under Chapter 9. Additionally, to meet the requirements to file Chapter 9, the municipal entity has to be insolvent or has to have debts that it will not be able to pay when they reach maturity. It must also have a desire to create a plan to handle its debts. In other words, it must voluntarily seek to file Chapter 9.
The municipality must attempt to get the agreement of its creditors to file Chapter 9. If it does not get the agreement of the creditors, it must demonstrate that it engaged in good faith negotiation with the creditors to get their agreement. If negotiation is, for whatever reason, not feasible, then it is not required.
If the court proceeds with a bankruptcy claim that has not been agreed to by creditors, this is known as a “cramdown.”
The purpose of a Chapter 9 bankruptcy is to protect a municipality from creditors while it creates a bankruptcy plan to modify its debts. The plan may involve reducing principal or interest payments or extending maturities. Taking out new loans to cover its obligations may be necessary. The plan must outline how it will handle its outstanding debt and how much it