Involuntary Bankruptcy for American States

Abstract:     
Recently, in light of fiscal challenges faced by numerous American states, a number of legal scholars and policymakers have explored the possibility of extending bankruptcy law to the states, which, unlike municipalities, cannot file for bankruptcy under existing law. These discussions have thus far been limited to a voluntary state bankruptcy option. This essay proposes that, if bankruptcy law is extended to states, the federal government be authorized to initiate bankruptcy for a state when the state is likely to need financial assistance from the federal government or when it is likely to impose significant financial costs or harms on the rest of the nation. It proposes that no other involuntary consequences need follow from an involuntary initiation. For example, a state bankruptcy regime could be designed to give a state forced into bankruptcy an option to exit bankruptcy at its discretion after a short period. The regime could also be designed to give a state that remained under bankruptcy protection the opportunity to propose a restructuring plan that could in turn provide for adjusting its obligations without violating the Contract Clause of the U.S. Constitution. An involuntary procedure would not assure that states obtain relief sooner than they would absent the regime. The federal government might itself delay invoking the procedure, perhaps for reasons similar to those that would deter the state from voluntarily seeking relief in bankruptcy. Furthermore, a state forced into bankruptcy might choose to exit without submitting a plan for restructuring if the option to exit were available. Nonetheless, the inclusion of an involuntary procedure in any state bankruptcy regime should increase the chances that a state in financial distress would obtain bankruptcy relief and would do so somewhat earlier than if there was no chance of an involuntary initiation.

The commentary on extending bankruptcy protection to states assumes, often without inquiry, that an involuntary bankruptcy provision for states would be impermissible under the U.S. Constitution. But constitutional impediments to a state bankruptcy regime with an involuntary component are much less robust than courts, commentators, and scholars assume. A narrowly drawn bankruptcy regime for states that could be triggered by the federal government only if a state were likely to need financial assistance or threatened domestic financial stability should be able to navigate constitutional doctrines of state sovereignty. American states are not unqualifiedly sovereign, and their sovereignty is not so expansive that it can prevent the federal government from protecting fundamental national economic and financial interests when a state faces financial crisis.

Number of Pages in PDF File: 35

Accepted Paper Series