The Difference Between Chapter 9 and Other Types of Bankruptcy

Detroit is activating a specific section of the U.S. bankruptcy code that applies to municipalities.

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Reuters

On Thursday afternoon, Detroit became the largest municipality in American history to file for bankruptcy. After teetering on the brink for several months, the city, under the leadership of state-appointed emergency manager Kevyn Orr, has officially entered Chapter 9 bankruptcy proceedings.

In the U.S., there are six main types of bankruptcy. The most common form, Chapter 7, applies to individuals, while the often-in-the-news Chapter 11 is used for corporate rehabilitation. Detroit is activating the much more rarely used Chapter 9, a specific section of the U.S. bankruptcy code that applies to municipalities, and which can include tax districts, municipal utilities, and school districts as well as cities and towns. 

Twenty-four states, including Michigan, have provisions to authorize or offer conditional authorization for municipal bankruptcy, while another three states offer limited forms of authorization for municipal bankruptcy, according to State Budget Solutions. (A full map of individual state prohibitions can be found here). In this case, Republican governor Rick Snyder wrote a letter accompanying the filing, explaining "it is clear that the financial emergency in Detroit cannot be successfully addressed outside of such a filing, and it is the only reasonable alternative that is available."

There are several distinctions that set Chapter 9 bankruptcy apart, many of which will be particularly relevant for Detroit in the months and years to come. Significantly for a city once thought to be ruled by the UAW, Chapter 9 gives cities a wider range of discretion in modifying existing collective bargaining agreements. Most importantly, under municipal bankruptcy, there's no provision that forces a city to liquidate its assets in order to provide quick paybacks to creditors (potentially good news for the billions of dollars of art housed in the Detroit Institute of Art). This type of forced sell-off would violate states' abilities to govern their own affairs under the 10th Amendment. Instead, the bankruptcy court's role in Chapter 9 proceedings are more limited, and focused on approving a plan of debt reduction and overseeing its execution.

Detroit is beginning the Chapter 9 process carrying the largest municipal debt ever to be considered by the courts. The next largest to date include Orange County, California, in 1994, at around $1.7 billion, and Jefferson County, Alabama, which filed in 2011 with about $4 billion of debt. Detroit's estimated debt is at least $18.5 billion.

Top image: Kevyn Orr addresses the media after being named Detroit's emergency manager in March (Rebecca Cook/Reuters).

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