In this era of economic uncertainty, many communities are struggling to meet their financial obligations and find it necessary to consider extreme measures. The city of Vallejo, California filed for bankruptcy two years ago. The cities of Harrisburg, Pennsylvania’s capital, and Hamtramck, Michigan, have considered filing bankruptcy within the last 6 months. Wisconsin local governments, however, cannot file for bankruptcy. Wisconsin has never granted bankruptcy authorization. Chapter 9 of the Federal Bankruptcy Law allows bankruptcy relief only for municipalities in states where state law explicitly authorizes municipalities to file for bankruptcy. While Wisconsin law frequently considers cities and villages a “municipality,” the Bankruptcy Code considers any political subdivision, public agency or instrumentality of a state a “municipality.”
Bankruptcy is a specialized area of law often susceptible to misconception. It is useful to begin with some background on basic bankruptcy law so readers have a common understanding. Congress enacted the Bankruptcy Code under Article I, Section 8 of the U.S. Constitution, which authorizes Congress to create uniform bankruptcy procedures for the entire country. Bankruptcy is a form of legal relief granted in appropriate cases by federal bankruptcy courts. A stay on collecting debts while the case is being considered by the court is imposed when a petition for bankruptcy is filed. At the end of the case a debtor is granted a discharge, which prohibits existing creditors from making any attempt to collect from the discharged debtor. The goal is to give an unfortunate debtor a “fresh start” from burdensome debts.
Municipal Chapter 9 bankruptcies are not like other bankruptcy proceedings. Bankruptcy relief generally is either in the form of liquidation of non-exempt assets of the debtor, or reorganization of debt in accordance with the code and a plan that is proposed by the debtor or creditors, and approved by the court. Exemptions are determined under federal or state law. Typically a set amount of individual debtor’s home equity is one example of an exempt asset. Debts are prioritized by the code, with unsecured, non-priority creditors being the least protected. Liens, such as home mortgages, survive the bankruptcy.
Municipal Chapter 9 bankruptcies differ in that a “discharge” is not granted as in Chapter 7 or 11. A municipal bankruptcy under Chapter 9 would give a municipality a breathing spell while it tries to reorganize its debts in a plan that is acceptable to a majority of its creditors. It would not involve liquidation of the municipality’s assets. Mercifully, you will never see parks, fire stations, schools and streets being sold to pay creditors. Chapter 9 also allows certain executory contracts to be avoided, such as certain employment contracts.
The main difference is that each state controls whether its local governments can seek bankruptcy relief. It is how Congress reconciled it sole authority to enact bankruptcy laws with the 10th Amendment of the Constitution that reserves to the states those powers not otherwise provided in the national Constitution. Arguably municipal bankruptcy could permit a federal court to set policy as to municipal debts within a state. Congress resolved this by not does not imposing Chapter 9 on the states unless they opt to accept its provisions. That acceptance cannot be implied, it must be explicitly given. Some states, such as New Jersey, authorize a state agency that reviews if a city may seek bankruptcy relief.
If you want to read more about municipal bankruptcy, there is an excellent article in the Bloomberg Law Reports: “Chapter 9 Bankruptcy – A Tool for Municipalities When Raising Taxes Is No Longer an Option.” There is also information at the United States Courts website on Chapter 9, and other bankruptcy chapters. Special thanks are given to Attorney William Wallo, Judicial Clerk for the Wisconsin Federal Bankruptcy Court, Western District – Eau Claire, for his guidance and advice.