See Timothy Hippa 2009:
In difficult economic times, the demands for municipal services increase while revenues from declining property values or decreasing sales tax diminish. For some municipalities or units of local government, the lack of adequate revenues may create a financial disaster. In such a case, a municipality may imitate the private sector and seek protection through a bankruptcy filing. The federal Bankruptcy Code provides a method for a local government to file for bankruptcy; however, state law makes the actual filing exceedingly difficult, if not impossible. (Emphasis added)
Many people are familiar with the three most common types of bankruptcy filed under Chapters 7, 11, and 13, especially in light of recent high profile bankruptcy filings such as General Motors. However, municipalities cannot seek protection under the traditional bankruptcy chapters because those chapters are reserved exclusively for private individuals and corporations. Instead, a municipality must seek relief under the lesser-known Chapter 9. Although similar to reorganization under Chapter 11, Chapter 9 contains several significant and noteworthy differences. First, and perhaps most importantly, the municipal government must have a specific grant of authority by the state legislature to be a debtor in bankruptcy. This grant of authority cannot be general in nature, but must specifically mention and reference the bankruptcy code. (County of Orange, 183 B.R. 594 (C.D.Cal 1995)) Secondly, the municipality must: (1) have the agreement of its creditors; (2) fail to obtain an agreement with its creditors after good faith negotiations; (3) show that negotiations would be impractical; or (4) reasonably believe that a creditor will attempt to obtain a preference as the term is defined by the Bankruptcy Code.
Until July 6, 2009, only one Illinois local government — Slocum Lake Drainage District of Lake County — had filed for bankruptcy in Illinois in the previous twenty years. (Slocum Lake Drainage District of Lake County, 336 B.R. 387 (N.D.Ill. 2006)) However, on the creditors’ motion, the bankruptcy court dismissed Slocum Lake’s bankruptcy petition thereby denying Slocum Lake the protections provided by the Bankruptcy Code. The Slocum Lake case is extremely instructive for an Illinois local government currently experiencing severe financial distress. In finding that Slocum Lake (and indeed, any Illinois municipality) could not directly file for bankruptcy, the court held:
The Debtor has the burden of proof to establish that it is eligible to be a debtor under Chapter 9. The court finds that the Debtor has not met that burden. … [T]he Court finds that the general authority contained in [Illinois statutes] is insufficient to meet the “specifically authorized” requirement…Had the Illinois General Assembly intended to specifically authorize this Debtor or other municipalities to seek relief under Chapter 9, it could have easily drafted appropriate legislation, but has not done so.
However, this long history of unsuccessful municipal bankruptcies in Illinois ended when the Village of Washington Park filed for Chapter 9 bankruptcy on July 6, 2009. While this case is in its earliest stages, as of publication of this article no creditor has made an objection to the Village of Washington Park’s eligibility to be a debtor in bankruptcy. As the only municipal bankruptcy filing in Illinois in the last twenty years or more, the negotiations and outcome of the Village of Washington Park’s bankruptcy filing are sure to become a roadmap for any future Chapter 9 filings in Illinois.
Perhaps the only state subdivision with a specific grant of authority for bankruptcy in Illinois is the Illinois Research Park Authority, a division of the state executive branch. All other municipal governments must follow the procedures required by the Local Government Financial Planning and Supervision Act (the “Act”) (50 ILCS 320/1 et seq.). The Act provides a means by which an Illinois municipal government undergoing a financial emergency may seek relief. The Act creates a special financial planning and supervision commission to manage insolvent municipal governments. To obtain relief, the Act requires that an insolvent municipal government petition the financial planning and supervision commission and essentially enter into receivership under the control of the commission. Under this process, the commission or its appointed financial planner has broad powers to restore solvency to the municipal government. One of the powers afforded the commission is to recommend that the municipality seek relief under Chapter 9. Only upon the commission’s recommendation can Illinois local governments seek relief under the Bankruptcy Code. (Slocum Lake Drainage District of Lake County, 336 B.R. 387 (N.D.Ill. 2006))