The government enacted the initial municipal bankruptcy legislation in the early 1900s during the depression era. Ever since the formation of a governmental mechanism to settle local government debts, an estimated 500 local governments have filed bankruptcy claims under Chapter 9. Even though Chapter 9 bankruptcy cases don’t happen that often, a filing by a large government entity can involve many millions of dollars in debt.
Only a local government can submit a claim for debt relief under chapter 9. The term “local government” defined in the Bankruptcy Code means a political subdivision or public agency or instrumentality of a higher level State government entity. The definition is wide enough to include cities, counties, townships, school districts, and public improvement districts. It also includes revenue entities that provide services which are paid for by users such as bridge, highway, and gas authorities.
There are three additional eligibility requirements for chapter 9:
The government entity must be exclusively allowed to be a debtor by State law
The municipality must be "bankrupt"
The municipality must desire to implement a plan to adjust outstanding debts
The principle of Chapter 9 bankruptcy is to offer an economically-distressed local municipal protection from its creditors while it develops a plan for adjusting its debts. Reorganization of the debts of a municipality is normally done by lengthening the dates on which the debts are due, reducing the amount of interest on debts, or refinancing the debt with a new loan. Although similar to other chapters in some respects, chapter 9 is significantly different in that there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors.