Chapter 9 has historically been a rarely used and specialized chapter of the Bankruptcy Code providing for reorganization of municipalities. In today’s economic climate, the filing of Chapter 9 and the issues involved in municipal insolvency have become much more prevalent. The term “municipalities” is defined broadly to include many different types of “political subdivision or public agency or instrumentality of a state” which could include cities, towns, counties, taxing districts, special districts, municipal utilities, school districts, and hospital districts. 

Chapter 9 was originally enacted in 1934 in response to hundreds of municipal bond defaults in the 1930’s. The last 3 years have seen a significant increase in the number of Chapter 9 filings. Municipal debt defaults are only one reason for current filings, many of which have been caused by other reasons including large judgments, labor costs, pension obligations, lower general revenues, and hospital bonds or operating expenses of a health system. 

Kentucky is one of 26 states that permit a Chapter 9 filing. KRS 66.400 provides that any taxing agency or instrumentality as defined in Chapter 9 of the Bankruptcy Code may file a petition. A “county” cannot file a petition unless its proposed plan is first approved by the state local debt officer (although not defined within the statute, this should currently be the Governor’s Department for Local Government). Thus, for a county to file Chapter 9, more significant state government oversight will be required than for a non-county entity. 

There are some similarities but many differences between Chapter 9 and Chapter 11. If a Kentucky municipality or instrumentality were to file Chapter 9, the Chief Circuit Judge of the Sixth Circuit would name the bankruptcy judge to handle the case, and it is not required to be the bankruptcy judge sitting in the same district as the debtor. Likewise, it is possible that a Kentucky bankruptcy judge could be appointed to handle a municipal bankruptcy in another state. Often, bankruptcy judges have been appointed from neighboring states to avoid appearances of political persuasion, since the Chapter 9 process is fraught with highly-charged political issues. Other common issues include disputes over eligibility to file, proving insolvency, and the municipality’s “good faith” efforts to first negotiate with its creditors prior to filing, a requirement that is not present in other chapters of the Bankruptcy Code. Open records and public scrutiny are heightened in the Chapter 9 setting. 

DelCotto Law Group anticipates the issues in Chapter 9 will hit the Commonwealth sooner rather than later. As with all of our financial distress clients, we believe analyzing the issues involved in a possible Chapter 9 filing is a required step in making a fully informed decision. Certainly, no municipal governing body wishes to rush out and file Chapter 9. However, it is an option that must be understood and explored. With the added requirements in Chapter 9 of good faith negotiation before filing, making a record of these efforts with qualified counsel is a must. As with our complex Chapter 11 business debtors, we work with our client representatives to understand their unique issues and players, including discussions of pros and cons of filing; how to best work with other constituents to avoid a filing or after a filing; the added unknowns of numerous issues that will arise in a Chapter 9 filing (in comparison and contrast to Chapter 11 cases); and the importance of the negotiation process before, during, and after such a filing. 

DelCotto Law Group is prepared to assist those involved in a municipality fiscal crisis to balance the interests of all parties concerned in order to best maximize the situation in a fair, balanced, informed, and considerate manner.

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