What is the Municipal Bankruptcy Act?
Purpose of Municipal Bankruptcy Act
- The Municipal Bankruptcy Act, chapter 9, allows municipalities to reorganize their debts by extending the maturity dates of their debts, reducing the amount of principal and/or interest that is owed, or refinancing the debt by obtaining a new loan. These municipalities include cities and towns as well as villages, counties, taxing districts, municipal utilities and school districts.
Bondholders Are Main Beneficiaries
- The act is specifically structured to provide financially distressed municipalities protection from their creditors while they develop and negotiate plans to pay their debts. Those creditors usually include investors who have loaned money to the governments through bonds.
Issuers of bonds are required to make debt service payments to bondholders until the bonds mature. Bonds typically mature over the course of 20 to 30 years. If the issuer declares bankruptcy, the act provides that bondholders are one of the first in line to be paid back.
Bondholders generally do not have to worry about the threat of preference liability with respect to a bankrupt municipality, according to the Administrative Office of the U.S. Courts. It is a part of the Federal Judiciary
Rarely Used Act
- Since the act first became law, few municipalities have had to use it. In fact, there have been fewer than 500 municipal bankruptcy petitions filed since the Municipal Bankruptcy Act was established, according to the Administrative Office of the U.S. Courts. Orange County, Calif. was the last municipality to go bankrupt, and that was in 1994. Although chapter 9 cases are rare, the significance of a filing by a large municipality would be eye-catching because of the amount of bonds that could be involved.
- While municipalities can file for bankruptcy, state governments cannot. This is creating a major problem in 2011 with so many states experiencing some of their worst budget crises in decades.
Considering municipalities receive a large about of revenue from their states, there is concern that the recession could cripple that revenue stream, according to financial analyst Meredeth Whitney. She recently authored a report about the ensuing bankruptcies of several states. The report has prompted members of Congress to consider legislation that would create a law similar to the Municipality Bankruptcy Act that could help states facing bankruptcy.