Municipal Bankruptcy Should Be a Last Resort

February 27, 2011 – In The News
The Courier Post/The Daily Bankruptcy News

With numerous states and municipalities facing budget crises and in financial distress across the country, talk of bankruptcy permeates the news of late. Municipal bankruptcy -- or chapter 9 of the U.S. Bankruptcy Code -- has in fact become a household name as a result of the problems facing such locales as the city of Vallejo, Calif., (already in chapter 9) and the city of Harrisburg, Pa., (not in chapter 9).

Close to home, talk of a chapter 9 filing for the city of Camden, which recently laid off a number of its police and firefighters, has been percolating. Chapter 9 allows municipalities to reorganize their financial affairs through an "adjustment of debts." While similar to chapter 11 for nongovernmental businesses, it has some major differences.

However, the intricacies and workings of chapter 9 is not my focus here. I am instead addressing what I view as misconceptions regarding the use and value of chapter 9 for municipalities and what is needed -- from a political perspective -- to utilize (or not utilize) chapter 9.

Chapter 9 is a tool. It is a tool for a municipality to restructure its finances in an orderly fashion, and it also permits the municipality to attempt certain things involuntarily, such as the rejection and termination of collective bargaining agreements.

While voluntary action on all sides is necessary for a municipality to successfully adjust its debts under chapter 9, success really 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.

Yet ironically, if the decision-makers have the political will 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 chapter 9. 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 be done outside of bankruptcy and without the administrative costs of a bankruptcy filing.

Municipalities need to muster the strength to address their financial problems. Until they make decisions and take the necessary unpopular political steps to mitigate their financial situations, chapter 9 should not be an option.

Initially, a municipality like Camden really does not need chapter 9 -- except to be used as a potential threat to force the decision making process on all sides -- if they can address their problems up front. Only after this occurs should debate be had as to whether chapter 9 is the right tool to implement thedecisions that are made for the city of Camden and other distressed municipalities.

Joshua Klein’s article was also picked up by The Daily Bankruptcy News .