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Tuesday, April 5, 2011

Chapter 9 of the U.S. Bankruptcy Code: “Municipal Bankruptcy”

Carol A. Pettit
Legislative Attorney

As cities and states have experienced varying degrees of financial difficulties in recent years, “municipal bankruptcy” has been mentioned relatively often in the popular press. The term is somewhat misleading, both in the word “municipal” and in the word “bankruptcy.”

Many people think only of cities when they hear the word “municipal.” Upon learning that in the context of the U.S. Bankruptcy Code the term means more than just cities, some think that states may use the provisions of the Bankruptcy Code for municipal debtors: chapter 9. However, states are currently not eligible to be debtors under the Bankruptcy Code. The Code’s definition of “debtor” includes only persons and municipalities. Its definition of “municipality” includes cities and counties as well as other political subdivisions, public agencies, and instrumentalities of a state. However, a municipality may not file under chapter 9 unless specifically authorized to do so by its state. To be eligible for chapter 9, a municipality must be insolvent.

Chapter 9 is titled “Adjustment of Debts of a Municipality.” The Bankruptcy Code does not provide for the liquidation of a municipality’s assets and distribution thereof to the creditors. Instead, it provides a legal mechanism through which municipalities may be protected from the claims of their creditors as they attempt to develop and negotiate a plan to adjust their debts. In this way, chapter 9 has similarities to chapter 11 reorganizations. However, a municipality retains more control in a chapter 9 case than does the debtor in a chapter 11. The oversight and involvement of the bankruptcy court is quite limited. The court cannot interfere with the municipality’s political or governmental powers, its property or revenues, or its use or enjoyment of its income-producing property.

There are only a few sections of the Bankruptcy Code that were specifically written in chapter 9; however, many other sections of the Code are explicitly made applicable to a chapter 9 case. Among these is § 365, which allows executory contracts to be assumed or rejected in a bankruptcy proceeding. Collective bargaining agreements (CBAs) are executory contracts. The expense incurred in meeting the obligations of CBAs may be a substantial budget consideration for many municipalities. While chapter 11 includes a section that specifically addresses the standards that must be met before a court can allow rejection of a CBA, no such section exists in chapter 9. Instead, based on two chapter 9 cases (In re County of Orange, California and In re City of Vallejo, California) it appears that municipalities may reject CBAs if they meet the less stringent standards established in National Labor Relations Board v. Bildisco and Bildisco. 

Although of current interest, chapter 9 is a provision of the Bankruptcy Code that is rarely used. Since 1979, the number of chapter 9 filings per year has averaged less than 10. Most of those have been by small government agencies such as municipal utilities, school districts, or singlepurpose entities.

Although chapter 9 has provided significant relief in the two major cases named above, it is not a panacea for a municipality’s financial problems. It can be a lengthy and expensive procedure. Additionally, the debtor’s ability to adjust debts, particularly pension or general obligation debt, may be limited by the state’s constitutional or statutory restrictions since a plan of adjustment cannot require the municipality to take an action that is not lawful.

Date of Report: March 31, 2011
Number of Pages: 16
Order Number: R41738
Price: $29.95

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