Chapter 9 Eligibility: The Test for Insolvency (Part 1 of 3)

The Bankruptcy Code places limitations on the use of Chapter 9.  The largest limitation, mandated by the Tenth Amendment to the Constitution, is whether a state permits municipal bankruptcy filings. Once that hurdle is overcome, a municipality must prove its eligibility to file for Chapter 9 protection. As MuniBK has previously reported, the entity must meet the definition of a “municipality.” The requirements, however, do not stop there. The municipality must also be insolvent. In a series of three posts, MuniBK will examine what is meant by “insolvency.” 

Chapter 11, the section of the Bankruptcy Code that addresses non-municipal reorganizations, does not require that an entity seeking protection be insolvent. In contrast, insolvency is a threshold issue in Chapter 9. As will be discussed later in this series, this definition also includes prospective insolvency, so that municipalities need not wait until the eleventh hour before availing themselves of Chapter 9’s flexibility to adjust debts.

In the context of Chapter 9, a municipality is insolvent if it is “(i) generally not paying its debts as they become due unless such debts are subject to a bona fide dispute; or (ii) unable to pay its debts as they become due.”  Under Chapter 9, municipal insolvency is not simply a balance sheet inquiry or an exercise in mathematics, but rather an inquiry into whether the municipality is actually paying or able to pay its obligations. The relevant date for a determination of insolvency is the date on which the Chapter 9 petition is filed.

In the next post, we will examine the first prong of the insolvency test: when is a municipality considered to be “generally not paying its debts as they become due”?

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