What a great question posed in this recent article by the Third Branch News!  I read an article this morning: http://news.uscourts.gov/when-cities-go-bankrupt and thought it gave GREAT insight as to where we as a country are headed. 

The City of Detroit filed for relief under Chapter 9 of the United States Bankruptcy Code on July 1, 2013, recording the largest, most significant municipal bankruptcy filing in history.  The statistic in the above referenced article that most astonished me was, “Chapter 9 filings are not common. From 1991-2012 there were 217 Chapter 9 bankruptcies filed nationwide, with 20 filed in [Fiscal Year] 2012.”  The 2012 filings were twice the number of filings under Chapter 9 than the average in the past 20 years and more than 3 times the average since Congress enacted the law in 1934 allowing municipalities to file for bankruptcy relief.  Our cities are increasingly becoming more and more poor as time goes on.

The Washington Post says that Detroit lost over a million residents over the past 60 years, one-quarter of which left from 2000 to 2012, and with them went their tax dollars.  Loss of tax revenue coupled with decreased state aid and a huge economic hit to the auto industry – the city’s major export, have left the city’s finances crippled. 

So what happens with a city files bankruptcy?  It can use its property to raise revenue, raise taxes, and “adjust” debt (i.e. not pay).  They can even reject retiree benefit plans – cut the pensions and retirement benefits for our senior citizens!

As I research the issues surrounding Chapter 9 filings, I’ve found that a municipality seeking relief under Chapter 9 is allowed more freedom to operate its “business” without court imposed restrictions and does not have to seek court approval for many acts as a Chapter 11 debtor normally would.  The municipality still has to file a feasible plan for reorganization.  Here is where we assess the “best interests of the creditor test,” but it’s held to a different standard under a Chapter 9 filing than it ever would in a Chapter 11 filing.  That’s because the best interest of the creditors is far different when you evaluate creditor options collecting against a normal entity vs. a municipality.

If a normal business filed Chapter 11, proposed reorganization and then either (1) didn’t get the plan confirmed or (2) defaulted on the confirmed plan, a creditor could attempt to collect its debt through normal state court actions.  Creditor gets a Judgment and then executes on said Judgment, typically either by garnishment, lien or levy.  A Chapter 9 case is different … because – how do you collect from a municipality?  Can you imagine the pandemonium if Judgment creditors started going down to City Hall with the Sherriff and asking the City Clerk to empty out the cash drawer?????

The practical application of this Chapter basically tells general creditors that they can either agree to whatever ludicrous plan the municipality proposes or the municipality can simply put its feet on its desk and say, “Come get me – go ahead, try to collect.”  Then creditors can start suing municipalities one by one, getting Judgments that aren’t even worth the piece of paper they’re printed on.

For more information on bankruptcy, please visit www.abankruptcyfirm.com/ or contact your local Kansas City Bankruptcy Lawyer, Betsy Lynch, at 816.434.6616.

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