Issue Summary (Updated January 2011)

Municipal Bankruptcy

The Issue:

Chapter 9 of the U.S. Bankruptcy Code permits municipalities to file for bankruptcy as a way to reorganize their debts. 

What We Know:

Though in place since the late 1930s, bankruptcy filings by municipal governments are quite rare-only around 500 or so have taken place.  The U.S. Constitution gives Congress the power to write uniform bankruptcy laws, and Chapter 9 specifies that municipalities (defined broadly enough to include cities, counties, authorities, etc.) may file for bankruptcy if several conditions are met.  The municipality must be insolvent, must have trouble securing agreement from creditors, and, under amendments made to the law in 1994, specifically authorized by its state to file.  As of 2010 nineteen states, including Pennsylvania, permit municipal bankruptcy and those that have are free to attach as many conditions as they wish.  In Pennsylvania the proceedings for bankruptcy flow through Act 47, the fiscal distress law, and authorities are prohibited from filing for Chapter 9.

That being said, bankruptcy may not be as harsh or draconian as one might think.  A municipality cannot be forced to liquidate assets to satisfy creditors, and a judge is prohibited from interfering with the day-to-day business of the municipality. 

Municipal bankruptcy may be a vehicle through which municipalities begin to deal with pension obligations and other legacy costs that have become too burdensome.  The Pennsylvania Constitution prohibits the revocation of pension benefits through laws or ordinances, but this likely would not apply to proceedings before a bankruptcy judge.  A recent high profile case in Vallejo, CA dealt with the issue of whether collective bargaining agreements and constitutional provisions on contracts would hold in a bankruptcy proceeding.  The court held that they would not, noting that when a state permits municipal filings it is valuing the benefits of bankruptcy for its municipalities greater than its state laws.

Recommendations:

Given the fact that public sector unions have demonstrated their resistance to pension reform in the recent effort to make incremental changes to municipal pension, municipalities in Pennsylvania may be advised to explore Chapter 9 as a way to get contractual changes in post-employment benefits. 

Whether Pittsburgh's enormous legacy cost price tag would force the City into bankruptcy remains a very big question.  Under terms of the oversight board law, the Governor would have to approve a filing, and the enormous political pressure and public sector union opposition would be a lot to overcome.  Things would have to hit the absolute rock bottom for the City to pursue Chapter 9. 

What changes could the state make in regards to municipal bankruptcy?  The process, currently embedded in Act 47, could be streamlined, permission to file could be extended to school districts and authorities, a quasi-judicial board could be created to review filings based on objective criteria and be a check on misuse of bankruptcy filings.  Above all, the state's role in ensuring that the local government carries out the recommendations of the court must be spelled out.