From March 2012 to March 2013, 76,467 bankruptcy petitions were filed in Florida under Chapters 7, 11 and 13. In contrast, since the Great Depression less than 500 municipalities have filed for Chapter 9 protection. In fact, only twelve municipalities filed for bankruptcy protection last year. Nevertheless, once Detroit became the largest city in U.S. history to file for federal bankruptcy protection, Chapter 9 has become a hot-button issue.

At its most basic, Chapter 9 provides for the reorganization of cities, towns and other municipalities. Unlike other chapters of the Bankruptcy Code, there is no provision for liquidation of debtor-municipality’s assets and distribution of the proceeds to creditors. Thus, reorganization is typically accomplished by extending debt maturities, reducing the amount of principal or interest, and/or refinancing debts by obtaining new loans.

The automatic stay of §362 applies equally to Chapter 9 cases. Indeed, additional automatic stay provisions are available which prohibit actions against officers and inhabitants of the debtor-municipality if the action seeks to enforce a claim against the debtor. Thus, the stay prohibits a creditor from bringing an action against an inhabitant of the debtor to enforce a lien on or arising out of taxes or assessments owed to the debtor.

The bankruptcy court may even extend the stay to state court suits challenging the legality of the Chapter 9 filing until the court has the ability to review the debtor’s petition. Such authority was exercised by Judge Steven Rhodes in the Detroit bankruptcy proceedings, when he halted three lawsuits filed by city workers, retirees and pensioners in Michigan state court.

The role of creditors is more limited in Chapter 9 proceedings than under other chapters. For example, there is no § 341 meeting of the creditors, nor may creditors propose competing plans. All is not lost, however, as Chapter 9 does provide for a creditors’ committee that has powers and duties very similar to the committee in a Chapter 11 case.

In order to be confirmed, a Chapter 9 plan must be in the “best interests of creditors”. Unlike the Chapter 11 “BIOC” test, in the Chapter 9 context, the test has generally been held to mean that the plan must be better than other alternatives available to the creditors. Because the alternative to Chapter 9 is generally the dismissal of the case, courts often only require a reasonable effort by the municipal debtor.

Because of the magnitude of the Detroit bankruptcy, the landscape of municipal insolvency is likely to be dramatically affected by the outcome of each aspect of the proceedings. Municipal bondholders and other creditors should pay special attention to what transpires, and we will post updates as the case moves forward.