During the Great Depression, the bankruptcy code was altered so that local governments could seek protection from creditors in bankruptcy. Since the creation of Chapter 9 bankruptcy, only 623 municipalities have filed bankruptcy. But some states are terrified that the number could increase. Because of this fear, 25 states have made moves to either restrict or completely stop local governments from filing Chapter 9 bankruptcy. Others have required municipalities to solve their debt troubles outside of bankruptcy. Why the moves to restrict bankruptcy for cities and towns Many states are mistakenly afraid that even one Chapter 9 bankruptcy filing in their state could have negative impacts on other cities' ability to borrow.
But there are a few major flaws with the logic used by state governments:
- Cities that are bringing in less revenue and can't pay their bills are already facing difficulties borrowing. Those cities in the same state who have not filed bankruptcy should not have too much trouble finding lenders if they are doing well enough.
- It can be nearly impossible for municipalities to effectively work out debt settlements with creditors outside of bankruptcy. There simply are too many creditors and too many demands. With bankruptcy, they can at least force a restructuring agreement.
- By failing to allow cities and towns to file Chapter 9 bankruptcy, states could inevitably harm the municipality's financial future and the well-being of its citizens. Many cities are unable to meet their obligations to workers, retirees and others are failing to properly fund their police force so that public safety is at risk. If these troubled municipalities file Chapter 9 bankruptcy, they will be able to free up future revenue for essentials.