Chapter 9 Bankruptcy – A Tool for Municipalities When Raising Taxes Is No Longer an Option

August 5, 2010Articles Bloomberg Law Reports, Vol. 4, No. 29

Financial pressures brought on by unfunded mandates, reduced funding by state and federal sources, long-term legacy obligations, collective bargaining agreements and over-taxed residents and businesses have increasingly confounded efforts by municipal governments and other political subdivisions to address funding obligations for operations and other commitments into the future. A long available, but frequently ignored, alternative for addressing these financial pressures is chapter 9 of the Bankruptcy Code. Chapter 9 is the least used chapter of the Bankruptcy Code, having historically been seen as vehicle of last resort for municipalities. However, the recent recession and economic downturn has forced many governmental and quasigovernmental units to actually consider filing for chapter 9 bankruptcy (municipal bankruptcy) as a way through their financial difficulties.

This article provides a summary of chapter 9 and how a municipality proceeds through the process of commencement of a municipal bankruptcy case and the potential pitfalls that may be encountered. Included is a discussion of the following key issues: (1) what entities may use chapter 9; (2) the requirements for statutory authority and other conditions of individual state law for entities seeking chapter 9 relief; (3) the test for insolvency required for chapter 9 relief; and (4) the requirement on municipalities of good faith attempts to negotiate alternatives before filing for chapter 9 bankruptcy relief.