The purpose of Chapter 9 is to provide a financially distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts. Reorganization of the debts of a municipality is typically accomplished either by extending debt maturities, reducing the amount of principal or interest, or refinancing the debt.
To file for Chapter 9, municipalities must be insolvent, have made a good faith attempt to negotiate a settlement with their creditors and be willing to devise a plan to resolve their debts. Chapter 9 differs from other sections of the bankruptcy code, such as Chapter 11 and Chapter 13, which generally provide court relief to cash-strapped businesses and individuals, respectively.
When a municipality files for Chapter 9, its finances move into the jurisdiction of the courts. Municipalities seldom pursue bankruptcy, and only as a last resort. Filing for bankruptcy gives policy makers some breathing room by changing a political process into a judicial one, and it can halt potential lawsuits resulting from debt defaults.
Marc A. Levinson, John H. Knox, and Shayne C. Kavanagh remind GFOA members that there are a number of good reasons why municipalities should avoid bankruptcy if at all possible. On the other hand, Marcy Boggs notes that the new reality of post-coronavirus finances means that bankruptcy might be something more governmental entities will be forced to consider.