Municipal Bankruptcy: Once “Once a Blue Moon,” but Now?

Back in September, Steven Schrayer posted “Municipal Bankruptcy Filings a Murky Proposition.”  He referenced a Wall Street Journal article, “Local Debts Defy Easy Solutions” by David Wessel.  In the article, Wessel stated that

[t]here is no obvious mechanism for state and local governments to resolve the coming collision between competing claims of taxpayers, retirees (both current and future) and bondholders.

One existing mechanism, though not one that any municipality would resort to unless it were truly necessary, is municipal bankruptcy under Chapter 9 of the federal bankruptcy code.  (Click HERE for a very helpful, non-technical discussion of municipal bankruptcy by Office of Administration of the U.S. Federal Courts.)

Wessel  noted that municipal bankruptcies are rare events:

[R]eneging on debts remains a rarity among U.S. state and municipal governments. Fewer than 250 of the nation’s 89,000 local governmental units have filed for bankruptcy since 1980.

Wessel goes on to state that

[r]ecent close calls in Harrisburg, Pa., and Central Falls, R.I., spark predictions that the next phase of the financial crisis will be a tsunami of municipal bankruptcies and defaults. Muni-bond experts at rating agencies and bankruptcy lawyers assure us that isn’t likely.

To characterize Harrisburg as a “close call” suggests that the risk to the state capital has passed, which appears far from certain at this point.   Harrisburg is currently awaiting a determination from the DCED on whether it will be permitted to enter Pennsylvania’s Act 47 recovery process for “distressed” municipalities.  Whether it will enter the Act 47 and/or whether it will file for bankruptcy under Chapter 9 remains to be seen.

Despite the suggestions – noted by Wessel – from municipal bond experts and rating agencies that a significant increase in municipal bankruptcy filings is unlikely, there is something less-than-reassuring about such assertions.  (These are the same rating agencies that did the ratings on the CDOs at the center of the housing meltdown.)  It also might have something to do with the conclusion of Wessel’s article:

[b]ankruptcy is a last resort. To avoid it, state and local governments need an alternative that is less unappealing. They don’t have one yet.

While the experts with whom Wessel spoke aren’t (publicly) predicting an increase in municipal bankruptcy filings, sentiment in the finance and legal community does not appear unanimous.  For example, after taking bids from a number of law firms of various sizes and from various locations, Harrisburg’s City Counsel selected the New York law firm of Cravath, Swain & Moore to advise the City on whether or not, and then how, to file for bankruptcy under Chapter 9.

The services that Cravath is providing to the City (free of charge) undoubtedly provide a public benefit to the City – namely access to high quality (and otherwise high cost) legal services.  However,  Cravath’s pro bono representation of Harrisburg also provides an opportunity for Cravath attorneys to gain additional experience (the firm does already have experience in municipal bankruptcy proceedings and in bankruptcy and reorganization work more generally) in a field where – because of the rarity of Chapter 9 filings – experience is harder then usual to come by.

While its pro bono representation of Harrisburg is assuredly driven by a desire to satisfy the ethical obligations of Cravath attorneys to provide pro bono legal services, it is also places the firm in the middle of what would be a highly publicized filing by the state’s capital city.  Such experience and publicity would likely make Cravath more competitive when bidding to represent other municipal entities across the country in possible future municipal bankruptcy filings.  Cravath’s Harrisburg work can be viewed – at least in part – as a bet against Wessel’s predictions, a bet that in the not-to-distant future, municipal bankruptcies may no longer be the blue-moon occurrences they are today.

Posted on December 11, 2010, in Municipal Government, Uncategorized. Bookmark the permalink. Leave a comment.

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