Cities, like people, can go broke. Whether because of poor spending, bad investments, rising expenses, or even embezzlement, a city can find itself with more debt than it can afford to pay. A Chapter 9 bankruptcy is designed for cities and other governmental bodies to address such case.
Before 1937, if a city or other governmental body ran out of money, the body’s creditors would force the body to raise taxes in an attempt to increase income. However, with the Great Depression of the 1930s, people simply could not afford to pay higher taxes.
Therefore, Congress gave municipalities the option of declaring bankruptcy. In 1937, Congress formally made a Chapter 9 bankruptcy for municipalities a part of the Bankruptcy Code.
Definition and Recent Use
A Chapter 9 bankruptcy allows a municipality to reorganize its debts, possibly eliminating some types of debt but overall changing payment terms such that the municipality is left with debt payments that it can make given its financial situation.
The Bankruptcy Code definition of a municipality includes towns, cities, counties, tax districts, school districts, and other governmental bodies. Since Congress codified Chapter 9 bankruptcy in 1937, there have been approximately 650 municipal bankruptcies.
Starting in 2009, the number of municipal bankruptcies filed each year has increased from perhaps a half dozen per year up to more than twice that per year. The size of these bankruptcies has increase as well.
City and county bankruptcies in the 1990s were generally in the $100s of millions of dollars. In the 2000s, municipal bankruptcies began to commonly exceed $1 billion dollars. The year 2013 saw the largest municipal bankruptcy to date in the United States with Detroit filing a Chapter 9 bankruptcy estimated at just shy of $20 billion.
Cause of Rise in Municipality Bankruptcies
As noted above, there can be a myriad of causes for a municipality going bankrupt. However, the most common of these appears to be related to pensions.
As with Detroit, San Bernardino, and several other high-profile municipal bankruptcies, the cities’ pension funds have significant shortfalls and. Leadership of the city claims the shortfall that may be as high as 50 percent of the pension value is in large part because of mismanagement by the trustees of the fund. City leaders are looking to Chapter 9 as a way to release the city from the unfunded portion of the pension.
Chapter 9 vs. Chapter 7 and 13
Although a Chapter 9 bankruptcy is for municipalities, whereas Chapter 7 and 13 are for individuals, the bankruptcies have many similarities. Chapter 9 bankruptcy is much more similar to Chapter 13 than Chapter 7, in that it allows the municipality to reorganize its debt rather than typically eliminate debts entirely. However, the power of Chapter 9 concerning municipalities is more limited than is the case with Chapter 7 and 13 for individuals.
The way Congress enacted Chapter 9, they made sure the power given to the bankruptcy court did not violate the Tenth Amendment. The Tenth Amendment limits the authority the federal government has to interfere with decisions made by state government. As bankruptcy courts are federal in nature, their power is therefore limited.
A bankruptcy court can oversee a municipal bankruptcy, approving a municipality’s debt reorganization plan and making sure the municipality executes that plan. However, the bankruptcy court cannot force the municipality to sell assets to satisfy creditors or prevent the municipality from obtaining new loans during a bankruptcy in order to continue to operate.
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