Chapter 9 bankruptcy is no easy option
In the past few months, Chapter 9 — the form of bankruptcy for local governments — has been getting more attention as an option for local governments struggling to meet financial demands. Yet, because so few municipalities have filed for Chapter 9 in recent years, there is no clear road map outlining the process, including the potential consequences, experts say.
Cities and counties filing for Chapter 9 must meet eligibility requirements set by Section 109(c) of the federal Bankruptcy Code, such as proving that they are insolvent, receiving specific authorization to be a debtor under state law, and desiring to effect a plan to adjust its debt. If allowed to file, one consequence could be greater difficulty receiving financing upon emerging from bankruptcy. “In the municipal market, there’s been a belief that if a municipal entity files, it would have trouble accessing capital markets, with penalties like higher interest rates,” says David Dubrow, a partner with law firm Arent Fox and author of “The Treatment of Municipal Debt Under Chapter 9 of the Bankruptcy Code.” “That hasn’t been fully tested because of limited filings.”
The ability to receive financing and potential interest rates depend in large part on the reason the municipality enters bankruptcy and what it accomplishes before emerging. For instance, Orange County, Calif., the largest local government to enter Chapter 9, did so in 1994 because of risky financial investments. Its restructuring plan included making sure that debt holders were paid and issuing new debt. Before emerging from bankruptcy, the county had access to capital markets because of its specific situation, Dubrow says.
Merely discussing bankruptcy can affect the interest rates a municipality is able to receive. In January, New York-based Fitch Ratings released a two-page comment, “The Perils of Considering Municipal Bankruptcy,” warning that, “If bankruptcy is being actively considered, Fitch will assess whether the entity’s current rating should be maintained.”
Whether the risks are worth taking depends on a city’s or county’s specific situation. Some leaders of Harrisburg, Pa., have been considering Chapter 9 as a way to help the city financially restructure. Apart from the economy, the city has been struggling to make payments on nearly $300 million in debt accumulated by continually refinancing an incinerator.
City Controller Dan Miller believes bankruptcy would allow the city to reduce debt to what it can handle while also keeping its assets intact. He opposes the option of selling city assets because many of those assets, such as parking garages, generate income. “The bankruptcy approach is a much more sound long-term approach than the knee-jerk approach of selling assets, which is time consuming if done,” he says.
