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States in Bankruptcy? Not So Much

The Rarely Used Chapter 9 is Reviewed during Pandemic

By: Laura Day DelCotto

Mitch McConnell has received much press over a comment he knows to be impossible. States lack the ability to file bankruptcy under the Bankruptcy Code absent a Congressional amendment. 

However, in Kentucky, every other type of local and quasi-governmental entity is permitted to file bankruptcy, and we may begin to see an uptick in filings.  Municipalities, cities, counties, local water, sewer, hospital districts—all eligible to file as a “political subdivision or agency or instrumentality of a State.”  The Bankruptcy Code does not define exactly whether a specific entity is a “public agency or instrumentality” but the analysis lies in whether the entity is funded by taxes along with the oversight and control details of its governance mechanisms.

Municipal filings are made under a rarely used chapter of the Bankruptcy Code, Chapter 9. There are many quirks and differences from the other types of filings that most attorneys and the public are familiar with, due to constitutional protections arising between federal courts and state sovereignty. 

Chapter 9 Background and History

Chapter 9 was substantially changed in 1937, after the prior act was declared unconstitutional. The Great Depression saw many filings as local governments were hit hard with precipitous drops in revenues from taxpayers. The fact that Chapter 9 has been sparingly used doesn’t mean that it’s not ready for use when needed, like now. Just like all types of bankruptcy filings, cash flow is king. When cash stops coming in, expenses don’t stop on a dime. Furthermore, local governments can’t be forced to “liquidate” and continue to have their primary goal of acting to protect the health, safety and welfare of the public they serve.   

The small city of Fairfield, Alabama filed for Chapter 9 on May 19, 2020. We are watching. Just like we have been watching the other cases over the years, and providing legal counsel in the few chapter 9’s to date in the Commonwealth of Kentucky.  We will write more about bond debt issues, since the bond lawyers pontificate that a filing will mean never having access to credit markets again. This has proven untrue.

“The city has faced a substantial decline in revenues in recent years due to economic forces beyond its control,” stated a portion of the resolution authorizing the filing. Fairfield is a small town of 11,000 residents south of Birmingham. There are at least 20% of residents living below the poverty line.   Sounds very familiar. Filing bankruptcy is not a moral failure. It is the start of a process to bring all the competing interests into a central forum. It encourages them to work together, under Court oversight, to determine an equitable outcome. 

About DelCotto Law Group

DelCotto Law Group is Kentucky’s asset protection law firm known for its commitment to the lifetime success of its clients. With offices located in Lexington, Louisville and Danville, DLG serves Kentuckians with complicated financial matters, especially in the areas of bankruptcy and complex litigation. For more information please call (859) 231-5800, email info@dlgfirm.com or reach us on our contact page.

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