October 13, 2011
Muni Bankruptcy. It's not just for OC anymore....
Posted by David Groshoff

Although I’m a native Midwesterner, for a little over a year as a faculty member at Western State I’ve been settling into life as a resident of Orange County, California (the "OC"), famed for its post-suburban life, real housewives, and, of course, its high profile mid-1990s bankruptcy filing

Yesterday, Pennsylvania’s state capital city, Harrisburg, agreed by a 4-3 vote (and opposed by Mayor Linda Thompson) [more on that squabble later] to join the fun and file for bankruptcy protection.

The public nature of Harrisburg's financial distress has been festering for some time and should not be a surprise to many of Harrisburg’s creditors.  As a result, the muni market didn’t move much in response to yesterday’s news, but buying CDS protection on Pennsylvania's state’s bonds, rose following the event.

While my practical experience involved a number of creditor claims on business entities on the verge of, in, or immediately post-Chapter 11 bankruptcy, municipal bankruptcies -- governed by Chapter 9 of the Bankruptcy Code -- are rare, with apparently fewer than 700 Chapter 9 filings since the late 1930s

[Given that rarity, how many profs even cover Chapter 9 in a general bankruptcy course that often teach the typical Chapters 7, 11, and 13?  Or for schools with curricula containing specialized courses that separate consumer bankruptcy from corporate bankruptcy, does Chapter 9 get mentioned anywhere in these courses, or is Chapter 9 simply just one of those things often learned in practice because of its rarity?]

Chapter 9 is generally referred to as “municipal bankruptcy,” although 11 U.S.C. §101 presents a broader definition of what constitutes a “municipality” than just a city, so entities such as counties are included as well.  Section 109(c)(2) requires the municipality’s relevant state government to permit the municipality to become a Chapter 9 debtor entity.  In OC’s bankruptcy, the state of California refused to intervene on the county’s behalf, and in Pennsylvania, “Act 47” (of 1987) (53 P.S. § 11701.101 et seq. (2011), the “Municipalities Financial Recovery Act”) exists for municipal bankruptcies.

While these laws may seem facially transparent and dry, a number of potentially fascinating issues may occur in Harrisburg and be worth watching, such as: (1) whether the filing itself is procedurally valid and legally authorized; (2) lawyers for the mayor apparently indicated to the court that they plan to represent the mayor and the municipality, but the 4-member city council majority who voted for the bankruptcy have hired different legal counsel for the municipality, and, prior to this split, Cravath was reported as having advised Harrisburg on both Act 47 and Chapter 9; (3) [perhaps redundant] the acting city solicitor indicated that the 4-3 vote was invalid because his office did not review the decision prior to a vote; (4) how much drama actually plays out in an anticipated pitting of firefighters and police officers against muni bondholders; (5) whether this move (or ultimate success) by Harrisburg encourages a wave of other troubled municipalities to file for Chapter 9 protection; and (6) if so, how would those additional filings impact the CDS and muni bond markets?

Who knew all of the fun and drama that Chapter 9 bankruptcies could bring?

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