Municipal Bankruptcy and Political Will…Tools for Stability in Municipal Government

Municipal Bankruptcy and Political Will…Tools for Stability in Municipal Government

Post ID: 445 | POSTED ON: Oct 10, 2011

Unfunded mandates, reduced funding by state and federal sources, long-term legacy obligations, collective bargaining agreements and over-taxed residents and businesses. Sound familiar? 

Financial pressures like these have increasingly confounded efforts by municipal governments and other political subdivisions to address their funding obligations for day-to-day operations as well as future commitments. And across the country, talk of bankruptcy permeates the news.

Municipal bankruptcy – or Chapter 9 of the U.S. Bankruptcy Code – has become a household phrase as a result of problems facing locales such as the Vallejo, CA,  about to exit bankruptcy with renegotiated public worker contracts after years in court and  unrecoverable millions spent on administrative costs; Central Falls, RI, which  recently filed for bankruptcy to effectuate a restructuring of its public employee union contracts and outstanding obligations to retirees; Harrisburg, PA, which may be on its way to Chapter 9 because of questionable decisions in connection with bonding for an incinerator project; and Jefferson County, AL, which recently threatened bankruptcy to force the final negotiations with holders of sewer project bonds about which many folks have scratched their heads and because of which others have gone to jail. 

But is bankruptcy the answer for governments looking to solve complex financial problems in 2012 and beyond? An understanding of what can and cannot be accomplished through a municipal bankruptcy is paramount to the effectiveness of Chapter 9 as a tool for political problem-solving.

What Is Chapter 9?

Chapter 9 is a long available, but seldom used, provision of federal bankruptcy law that allows municipalities to reorganize their financial affairs through an “adjustment of debts.”  While similar to the Chapter 11 bankruptcy provisions more commonly used for non-governmental businesses, Chapter 9 has some major differences. Among the issues that confront a municipality considering use of bankruptcy — but not a business in the same situation —  are enforceability of state law limits defining which municipalities can use Chapter 9 and whether and to what extent preliminary state law restructuring efforts must take place first. Chapter 9 also places severe restrictions on what the presiding bankruptcy judge can and cannot order in the event the municipality and its creditors and contractors cannot reach agreement on the primary terms for the fiscal restructuring. 

The most significant difference is the requirement that, unless the filing is necessary to avoid action by a creditor that will harm the interests of other stakeholders, preliminary efforts must be made by the municipality to obtain the agreement of creditors and contract counter parties to adjustment of financial obligations before bankruptcy can be utilized.  Other significant differences are that Chapter 9 has no provisions enabling liquidation of a municipal debtor, and there are many provisions that seek to affect the balance of power among debtors and creditors that are much different than Chapter 11’s provisions. Also, the U.S. Constitution’s 10th  Amendment places limitations on the involvement of bankruptcy courts that oversee the Chapter 9 debt adjustment process.

Political Will and the Effective Use of Chapter 

Chapter 9 is a tool for a municipality to restructure its finances in an orderly fashion — but it is not a substitute for political will, which is required to tackle the difficult fiscal problems surrounding us. No restructuring will take place without politicians recognizing the needs and proposingsolutions in an environment where no solution is going to please everyone with a stake in the outcome.  Everyone wants to pay less for government, but no one wants reduced services, benefits or entitlements.  Everyone wants to pay less for outstanding bond debt, but no one wants to cut the debt if it means future borrowing will be more expensive.  Currently, it is vogue to believe that public employees are paid too much for too little effort and have benefit packages far exceeding those in the private sector at much lower costs to the recipient. But who wants to suggest that years of promises be broken? 

Municipal bankruptcy will not eliminate any of the hard choices that must be made to restructure governmental obligations successfully.  Bankruptcy provides only the forum and the judge – a federal judge constrained by the Constitution and armed with little power to compel action by local government officials.   Indeed, successful adjustment of municipal debt — in or out of Chapter 9 — hinges on the political will of those making the municipality’s decisions.  Strong political will is required for a municipality to even take a step toward filing a Chapter 9 proceeding.  Ironically, if the decision makers have strong enough spines to file a Chapter 9, they also have the political will to make the hard decisions to address a municipality’s distress — without the need to file. Once in Chapter 9, a municipality most likely will need to do “unpopular” things such as raise taxes, cut services and renegotiate labor agreements in order to restructure its finances.  Such undertakings can also be done outside of bankruptcy and without the administrative costs of a filing.

Bankruptcy Is Not a Substitute for Political Will

Municipal officials need to muster the political strength to address the financial problems facing government today.  Politicians must make unpopular decisions and take the necessary steps required to “fix” the problems.  Until this is done, Chapter 9 will not and cannot be the answer that everyone is seeking. It is not the easy way out. Initially, a municipality in financial trouble does not need Chapter 9 — except perhaps to be used as a potential threat. As a threat, Chapter 9 can be very useful in forcing all sides to face, and make, tough political decisions. But first, the problems need to be acknowledged and understood and then the solutions need to be proposed.  Only after this occurs should debate be had as to whether Chapter 9 is the right tool to effectuate real, sustainable solutions to the financial problems facing local government today.

Michael Viscount is a partner in Fox Rothschild LLP’s Financial Restructuring and Bankruptcy practice group, resident in the Atlantic City, NJ office. Michael is a commercial lawyer whose practice focuses on the representation of public and private business owners and creditor groups in matters involving corporate debt restructuring, workouts, bankruptcies, banking and finance, dispute resolution, and other complex commercial matters. He is a seasoned practitioner who employs a practical approach to develop creative solutions to address the needs of financially distressed companies and their lenders, vendors, and owners. Michael Viscount can be reached at mviscount@foxrothschild.com or 609.572.2227.

Josh Klein is an attorney in Fox Rothschild LLP’s Financial Restructuring and Bankruptcy practice group, resident in the Philadelphia, PA office. Josh represents public and private companie, and creditor and equity groups on corporate debt restructurings, workouts, sales, bankruptcies and other complex insolvency matters. His experience and guidance have helped his clients develop solutions to address critical financial situations. Josh is also a Certified Mediator appointed to the Mediation Panel for the United States Bankruptcy Court for the Eastern District of Pennsylvania. Josh Klein can be reached at jklein@foxrothschild.com or 215.299.2723.

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