Chapter 9 Bankruptcy, reserved for municipalities, is a relatively rare and murky area of bankruptcy law. The concept of an entire city or municipality filing for bankruptcy seems strange to most, and in the area of bankruptcy law, pales in comparison to the amount of filings under other chapters in the bankruptcy code. Chapter 9 bankruptcy has its roots in the economic collapse of the Great Depression, and until recently, was barely used except for the 1994 filing by Orange County, California.
Now, with the approval by a bankruptcy court in California, the municipality of Stockton, California, a city with a population of roughly 300,000, will have the opportunity to seek reorganization under Chapter 9. One of the reasons Chapter 9 is so rare is the massive amount of debt that a municipality that would potentially seek relief under Chapter 9 would have. In this situation, Stockton has $900 million in debt to the California Public Employees' Retirement System alone.
The sheer magnitude of this case has potentially precedent setting implications across the country. For most bankruptcy situations, a Chapter 7 liquidation or Chapter 13 individual reorganization is the predominant form of filing. In those cases, the chance that issues arise that will lead to precedent being set are rare. But here, with the ramifications of the outcome of Stockton's bankruptcy so large, the effect could be felt across the country. If their reorganization works, who's to say that it wouldn't lead to larger cities in the future deciding to file under Chapter 9 instead of seeking to borrow money or raise taxes to make up for any shortfall?
Although it likely will not have any major effect on the primary forms of consumer bankruptcy under Chapters 7 & 13 of the Bankruptcy Code, the Stockton bankruptcy is novel in bankruptcy law. For that reason alone it bears watching, as well as for the impact it could have on cities across the country.