Goals and Governance in Municipal Bankruptcy

Abstract

The years from 2011 to 2013 were remarkable in municipal bankruptcy terms. During those years, several cities and counties took the rare step of filing for bankruptcy under Chapter 9 of the Bankruptcy Code. When Detroit filed for bankruptcy in July, 2013, it became the largest city measured by both population and outstanding debt to file for Chapter 9.

The recent filings challenge the conventional wisdom that Chapter 9 is poorly tailored to the rehabilitation needs of larger cities and counties. Those who have written about Chapter 9 in the past twenty years have treated Chapter 9 and state intervention in municipal financial affairs as freestanding alternatives rather than as complementary components of a comprehensive municipal financial recovery plan. These authors compare municipal bankruptcy to corporate bankruptcy and conclude that because Chapter 9 does not incorporate all of the Chapter 11 checks on debtor behavior, it cannot adequately promote the financial rehabilitation of a sizable general-purpose municipality. This approach ignores the original goal of Congress in enacting a municipal bankruptcy law in the aftermath of the Great Depression, which was to bring together two sovereigns, the state and the federal government, to accomplish something that neither could accomplish alone – the imposition of a plan to adjust municipal debts that would be binding on all creditors, wherever located.

This article refocuses the discussion about the limitations of the municipal bankruptcy process by examining the goals of Chapter 9 and relating its governance provisions to those goals. A refocused discussion is particularly timely, because the deteriorating financial condition of many cities has led states to reexamine their programs for resolving municipal financial distress and the conditions under which they permit their municipalities to file for bankruptcy. Chapter 9 may only be as effective as the state governance that accompanies it. Therefore, policy makers on the state and federal levels need an understanding of the role of Chapter 9 in an integrated scheme for municipal financial recovery in order to decide whether and how to assist municipalities on the state level and to decide whether reforms to Chapter 9 are necessary.

Keywords: Municipal Bankruptcy, Chapter 9, Bankruptcy, Municipal Finance

JEL Classification: H74, H77