Can a Municipality Declare Bankruptcy?

Can a Municipality Declare Bankruptcy?

  Monday, September 12, 2011    Julie Tappendorf

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Given the current economic climate, it is not surprising that local governments throughout the country are experiencing financial difficulties.  Lower property values, coupled with tax caps, have resulted in a reduction in the amount of real estate taxes collected by local governments.  Little or no new development also means less permit fees. Sales taxes have also decreased due to declines in consumer purchases. In an attempt to balance their budgets, many local governments have reduced the number of employees through attrition and layoffs and have implement salary freezes, and in some cases reductions.  Others have deferred capital improvement projects.  Most local governments are operating “leaner” than ever before.

But what happens when a municipality finds itself with more expenditures and obligations than revenue, and no more fat to be cut from the budget?  Can a municipality seek relief under federal bankruptcy laws? 

Chapter 9 of the Bankruptcy Code authorizes a municipality to file for bankruptcy subject to certain eligibility requirements.  In addition to requiring insolvency and a willingness to agree to a debt restructure plan, the municipality must be specifically authorized by state law to be a debtor under Chapter 9.  Not all states have enacted express statutory authority, however, including Illinois.  And, in fact, a federal bankruptcy court recently dismissed a Chapter 9 bankruptcy petition filed by Washington Park, Illinois for that very reason. 

Does that mean that an Illinois municipality in fiscal distress has no mechanism for relief?  Not entirely.  A municipality with a population under 25,000 may seek approval to file under Chapter 9 through the recommendation and approval of a financial planning and supervision commission under the Local Government Planning and Supervision Act, 50 ILCS 320/1 et seq.  Larger municipalities that do not qualify under this Act may find relief under the Financially Distressed City Law, 65 ILCS 5/8-12-1 et seq.  This law provides debt restructuring relief to financially distressed home rule municipalities who qualify under the eligibility requirements of the statute. 

While neither of these options will provide Illinois municipalities a direct path to a Chapter 9 bankruptcy proceeding, and both involve complex and lengthy procedures, they may provide local governments in severe economic distress with some option for relief.