California is running a projected deficit of more than $25 billion for 2011, and Illinois and New York are not far behind. Any corporation with a shortfall of that magnitude would face an almost certain bankruptcy filing, either voluntarily or at the hands of its creditors. States, however, are currently denied access to the protections of the Bankruptcy Code. Like the federal government, states are sovereigns under the U.S. Constitution and are imbued with the full power to raise funds to cover deficits by levying taxes on their citizens. Unlike the federal government, however, states cannot print money to cover their expenditures, and many of the states facing the most serious budget shortfalls have either come close to the limit of their practical taxing authority or face legal restrictions that prevent them from imposing new taxes or fees.

Municipalities may file for bankruptcy under Chapter 9, which offers a middle ground between the protections extended to corporations under Chapter 11 and the full denial of access of bankruptcy protection to the states. A bankruptcy court last year held that a nonprofit corporation established to undertake a public infrastructure project, and deemed an “instrumentality of the state” for tax purposes, was not a municipality under § 109(c) of the Bankruptcy Code and was therefore only eligible to file for bankruptcy under Chapter 11. In re Las Vegas Monorail Co., 49 B.R. 770, 795 (Bankr. D. Nev. 2010); see also In re Connector 2000 Assoc. Inc., No. 10-04467 (Bankr. D.S.C. 2010) (briefs citing extensively to Las Vegas Monorail).

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