It's Time to Talk about the Pros and Cons of Chapter 9 Municipal Bankruptcy
As most of you already know, municipal bankruptcy is different from corporate bankruptcy. Since the inevitable outcome of gridlock in City Hall is bankruptcy, we should discuss whether or not it is a preferable outcome to emergency management.
Here are some of the Pros and Cons from attorney who has represented municipalities in bankruptcy court:
http://www.pennlive.com/editorials/i...ter_9_ban.html
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Bankruptcy ‘pros’
1. “Cram down” power of the judge. If the bankruptcy judge finds the settlement to be reasonable, the judge can impose the settlement against creditors’ will. This threat resulted in the favorable settlement in Westfall Twp.
2. Bankruptcy court interference is minimal. The bankruptcy court does not interfere with the running of a local government. There is no power to appoint a trustee to run the city or municipal government.
Unlike Chapter 11 corporate bankruptcies, in Chapter 9, the judge cannot force a city to sell assets. He or she cannot restrict the hiring of professionals such as accountants or lawyers or auditors, nor can he or she limit the city’s ability to go out in the market and try to issue more unsecured debt, although the judge must approve any issuance of secured debt.
3. No competing plans by creditors. The plan to solve the municipality’s debt problems can only come from the municipality. Creditors cannot submit their own plans. That said, under state law, the municipality must work in conjunction with the Department of Community and Economic Development during a Chapter 9 case.
4. Automatic stay. When Chapter 9 is filed, the municipality does not have to pay its debt obligations. It also stops all lawsuits, including mandamus, which is what the Westfall Twp. developer filed.
5. Executory contracts can be rejected or manipulated. Municipal contracts, including union contracts, can be rejected or changed. This provision has been used extensively in the bankruptcy filing of Vallejo, Calif., where the city claimed it could not meet its labor contract obligations.
6. “Preference.” If a creditor gets paid within 90 days before bankruptcy, it can be undone, although the payment of bonds isn’t considered a preference.
Bankruptcy ‘cons’
1. Expensive and time consuming. To give you an idea, it cost Westfall Twp. $600,000 for lawyers and accountants in the bankruptcy case, and Westfall’s Chapter 9 filing was about as straightforward a case as you can get.
2. Uncertain outcome. You can’t predict what a bankruptcy judge will do. We didn’t know how much the judge would allow us to reduce the debt. It’s not a given that the debt will even be able to be reduced. Everything depends upon the interpretation of what is a “reasonable” plan.
3. Difficult to get into Chapter 9. DCED must be consulted before filing for bankruptcy. Often it must approve the bankruptcy. We did an emergency filing, but we were in touch with DCED extensively in the months leading up to the filing.
The other key to filing is that a municipality must show that it has attempted substantial negotiations with creditors. When such negotiations run into a brick wall is when Chapter 9 might make sense, but you must prove that those negotiations took place and that the municipality is insolvent.
4. DCED is active in the case. In lieu of court supervision, DCED plays the role in overseeing the case. DCED appoints a “plan coordinator” — normally a consultant of some sort with experience in municipal finance — to develop a financial plan. The plan coordinator works in consultation with local government.
5. Need at least one class of “impaired” creditors voting to accept plan. This is a provision you do not hear much about. The judge cannot cram down a reasonable plan unless at least one class of creditors agrees to the plan.
In Westfall’s case, even though it was only one developer who was owed money, Westfall owed three other parties smaller sums. They all agreed to the plan even though the developer initially did not. Before Westfall filed for bankruptcy, we knew that at least one class of creditor would likely go along with the plan.
6. Credit market impact might be negative. The bond rating agencies have made it clear that they take a negative view of any city that files for bankruptcy, and that may impact credit ratings in an entire state. That said it is not clear what long-term impact this has. I have seen no studies on the matter.
The Westfall situation was unique because there was only one large creditor.Most times with a bond issue or union contracts [[as in the Vallejo situation), there are multiple parties involved making it far more complicated.
The key to Chapter 9 bankruptcy is that a judge must decide whether the plan the municipality presents is “reasonable.” The judge must ponder what can a city reasonably pay?
In the case of Westfall, it had no valuable assets to sell, but residents did end up with a 20 percent tax increase to meet even the reduced debt payment of $6 million.
It seems to me that Chapter 9 is best utilized only if you have what you believe is a reasonable plan and creditors will not agree.
