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Municipal Reorganization: Chapter 9 of the U.S. Bankruptcy Code

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Because municipalities are government entities, their economic problems have historically been addressed politically through state-based remedies, such as the creation of a financial control board, not through judicial intervention. Chapter 9 of the U.S. Bankruptcy Code, 11 U.S.C. Section 901 et seq., is entitled "Adjustments of Debts of a Municipality." Though rarely used, this chapter of the Code has important historic antecedents and may be a important tool for insolvent municipal entities. The term "bankruptcy," however, is a misnomer when it comes to chapter 9. For many reasons, chapter 9 differs from chapter 11, which governs the reorganization of private business. This report provides an overview of chapter 9.

The paramount feature of a municipal reorganization is the requirement that the municipal debtor and a majority of its creditors reach an agreement on a plan to readjust the municipality's debts. The outcome of any reorganization cannot be predicted with certainty. Several basic principles may provide guidance as one considers the likely course of a major municipal reorganization. First, the policy underlying chapter 9 is unlike that of other chapters: municipalities are not subject to liquidation or strict judicial control. Municipal authorities do not need judicial permission to exercise governmental functions. Second, development of the reorganization plan is largely the initiative of municipal authorities.

Even though the U.S. Bankruptcy Code is designed to give the cash-strapped municipal debtor "breathing room" and an opportunity to marshal its assets, nothing in the law relieves it from the requirements of applicable nonbankruptcy law. Filing bankruptcy does not lift from the municipality the burdens imposed upon it by myriad state and federal laws. Reorganization and, ultimately, repudiation of debt may be facilitated by a chapter 9. But the manner in which the municipal debtor reaches its goal for rehabilitation will still be shaped, in large part, by the constraints of the federal and state laws under which it operates.

On December 6, 1994, Orange County, California, filed under chapter 9, the largest municipal bankruptcy filing to date. The County reorganized successfully, and its case was closed in 2000. Though the underlying causes of the County's financial problems were arguably unique, chapter 9 proved to be sufficiently flexible to accommodate the needs of a large municipal debtor and its creditors.


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