Can Municipalities Go Through Bankruptcy?

Following disaster, a community is often required to bear substantial costs for both response and recovery. Even if a community does get financial aid but fails to meet all the requirements imposed by the State and FEMA; any assistance provided by FEMA can be de-obligated and create a substantial debt. Both of these situations could possibly lead down the road to municipal bankruptcy. Many people don’t necessarily understand that a municipality can go through bankruptcy like a corporation or individual. There are special provisions in the bankruptcy code for this very situation. We won’t delve too deep into the particulars, but below are some “wave tops” for consideration and understanding of the subject.

What Kind of Proceeding is it?

Municipal Bankruptcy proceedings are covered by Chapter 9 of the US Bankruptcy Code (11 USC § 901 et seq). This proceeding is similar to a Chapter 13 type of proceeding (see third question for explanation). [1]

Who Can Go Through Bankruptcy?

Though Chapter 9 is specifically titled “Adjustment of Debts of a Municipality”, the section is not limited to only Municipalities. Specifically, the Bankruptcy Code defines a “municipality” broadly to be any “political subdivision or public agency or instrumentality of State.” [2] Thus, in theory, any state agency can go into bankruptcy. However, it’s unclear as to how far reaching this “agency or instrumentality” definition can go. There is a concept of third party liability in debts; which could possibly still hold the larger governmental entity liable for the full debt. [3]

So Does That Mean the Municipality is Liquidated?

Not really. A Chapter 9 Bankruptcy is really an “organization of debt”. The municipality is required to put forth some collateral and develop a “feasible plan” for the repayment of debt. This makes a Chapter 9 akin to a Chapter 13 proceeding. [4] There are a lot of requirements though, especially when it comes to dealing with municipal bonds and where the revenue was coming from.

Does the Bankruptcy Judge Become the Mayor?

No. Specifically, the Bankruptcy code prohibits the court form impairing the municipal political or governmental powers or the State’s power over the municipality. [5]

Sources:

[1] Compare 11 USC §§ 941-944 with 11 USC §§1303, 1321-1328.

[2] 11 USC §101(40).

[3] Bankruptcy Rule 7014 (restatement and adoption of Rule 14 of the Federal Rules of Civil Procedure).

[4] Compare 11 USC §§ 901-944 with 11 USC §1303.

[5] See 11 USC §§903-904.