Viewpoint: Don’t close the book on Chapter 9

By Patrick Shea and Emanuel Grillo

Ask any lawyer when most tough legal disputes get resolved, and he or she inevitably will tell you, “On the courthouse steps.” Why? Because even the most intractable problems become solvable once parties realize that they must settle their differences themselves or surrender decision-making authority to a judge.

Today’s deteriorating financial condition in many of our states, cities and towns present seemingly intractable financial concerns. Whether the problems arise from failed projects that cost too much, or legacy entitlements that cannot be sustained, the scope of municipal financial problems today appears to be broader and deeper than ever before.

Politicians, residents and others know hard choices must be made and compromises must come from all sectors to restore fiscal order. But, even when faced with life-threatening consequences, the difficulty of achieving overall consensus in a municipal restructuring usually results in a glacial tempo and only very limited success.

Chapter 9 of the federal Bankruptcy Code is the only vehicle specifically created to resolve all municipal financial distress issues in a single forum before a single judge at the same time. Yet, it has to date been rarely used.

Some political and special interests fear municipal bankruptcy so much that a number of states have recently passed legislation to limit, or even ban, its municipalities from filing for bankruptcy. Their argument is that having municipalities march into bankruptcy court will not restore financial order, but will wreak havoc on employee contracts, public services, retirement claims, municipal bonds and vendors. In the view of some, municipal bankruptcy will lead to a financial and governmental apocalypse: municipalities will no longer be able to raise money in the public markets and the bankruptcy epidemic will spread like a contagion to neighboring cities, towns and counties.

Indeed, that is essentially what California wrote into the preamble of the legislation it enacted into law on October 9 that limited the rights of municipalities to file for bankruptcy. Pennsylvania enacted similar, but arguably even tougher, legislation earlier this year forcing the Harrisburg City Council to file its bankruptcy petition without the support of the mayor or the state. Now, instead of having its elected officials fix its problems, Harrisburg must endure a fight for control between the city council, the mayor and the state. The jockeying for control comes to a head in November when the bankruptcy court considers whether Harrisburg should remain in bankruptcy.

The alleged fears of municipal bankruptcy are overblown. As the Harrisburg case suggests, those stoking the flames of fear in such debates are either elected officials who fear the prospect of losing financial control (and being compelled to make financial disclosures under oath) or special interests unwilling to give up any rights or benefits.

For all of the talk of Harrisburg’s problems over the last year, no material compromises have been reached, and no financial solutions have been implemented. That is what regularly happens outside of Chapter 9.

Indeed, the bankruptcy of Jefferson County, Ala., filed this week also shows how difficult it is to get a significant municipal restructuring done outside of bankruptcy. After reaching a deal that would have reduced its debt by over $1 billion, Jefferson County could not get all the approvals it needed to close that deal and now finds itself in Chapter 9.

Past experience suggests that bankruptcy is the better way to go for a number of municipalities. Outside of the recent Chapter 9 filing of Jefferson County, Ala., Orange County, Calif., remains the largest municipal bankruptcy of all time. It filed for bankruptcy on Dec. 6, 1994, having sustained a more than $2 billion investment loss. It emerged in June 1996, just 18 months later, through a confirmed, consensus plan that bound all parties and interests, and included over $1 billion of debt reduction. The county’s credit rating was quickly restored. Existing bond commitments were honored, and more than $800 million in new bonds were quickly sold because the county had again become solvent. Could that have happened outside Chapter 9? No.

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Patrick Shea is a lawyer and strategic advisor in private and public sector financial structures. He was the federal court-appointed lawyer for the 175+ municipal agencies with deposit investments of over $5 billion in the Orange County, Calif., bankruptcy. He can be reached at [email protected]. Emanuel Grillo is a partner at Goodwin Procter LLP, a national law firm, and the chair of the firm’s Financial Restructuring Practice. He can be reached at [email protected].