Municipal bankruptcies in the United States



FW moderates a discussion looking at municipal bankruptcies in the US between Doug Mintz at Cadwalader, Mark N. Berman at Nixon Peabody LLP, and John Wm. Butler, Jr. at Skadden, Arps, Slate, Meagher & Flom LLP.

FW: How would you describe the current plight of municipalities across the US? Will budget shortfalls and deepening financial losses prevent some from sustaining basic services?

Mintz: Municipalities remain deeply distressed. However, the crisis atmosphere of late 2010 and early 2011 has receded. The crisis was exacerbated by a comment from Meredith Whitney in late 2010 on the television program ‘60 Minutes’ stating that she estimated that 100 ‘significant’ municipal defaults reaching ‘hundreds of billions’ of dollars will occur in 2011 leading to a ‘wave’ of municipal bankruptcies. This has not materialised. In the first quarter of 2011 approximately 12 municipalities defaulted, representing $277m of debt, with just two municipalities filing for Chapter 9. By comparison, there were approximately 22 municipal defaults in the first quarter of 2010, representing more than $1bn of debt, and five municipalities filed for Chapter 9 during that time.

Butler: Many state, regional and local governments, agencies and authorities, which are broadly referred to as ‘municipalities’, remain financially distressed and are, or soon will, be facing unprecedented restructuring pressures. Income, property and sales tax revenues, which provide nearly 80 percent of municipal revenue, fell dramatically in recent years due to, among other things, high unemployment, depressed real property values and decreased consumer spending, although some traditional state revenue sources have begun to increase again as the US economy slowly recovers. At the same time, municipalities have been saddled with rising labour expenses, increasing demands for social services, unfunded federal mandates, and skyrocketing healthcare costs. As a result, municipalities have been forced to cut spending by any means necessary, including salary and wage reductions, employee layoffs, furloughs and early retirement and reducing or eliminating public services. Although they have largely reduced rather than eliminated basic services such as police and fire departments, municipalities ultimately could be forced to reduce basic services if they are not able to solve their financial problems.

Berman: US municipalities face both reduced revenues and increased expenses as a result of a confluence of factors. For example, revenues on investments may have declined in a lower interest rate environment. Sales tax revenue may have contracted in line with a decline in consumer spending. Real estate development fees may have declined as housing development has ground to a halt. Lower toll revenues may be experienced on toll roads and bridges due to higher gasoline prices. Lower real estate tax revenue looms as a result of the periodic re-assessment of real estate located within the municipality. Also, there has been a reduction in funding available from state governments as they struggle to balance their own budgets. When the decline in revenue is juxtaposed against increases in expenses, you have the prescription for financial trouble.

FW: Do you foresee a wave of bankruptcy filings by municipalities or not? Why?

Butler: No. Despite the financial problems facing municipalities in recent years, and contrary to some commentators who have predicted widespread failures, there has not been any material increase in municipal bankruptcy filings nor do we see that changing. First, federal bankruptcy protection is not available to many municipalities, which require state authorisation to file bankruptcy. Currently, fewer than 20 states unconditionally authorise municipal bankruptcies, and several of those states are taking steps to limit existing authorisation. Second, municipal bankruptcies are unpredictable, lengthy and costly endeavours, often involving significant litigation, due in part to limited precedent. Fewer than 600 municipal bankruptcy cases have been filed in the US since 1934, when such laws were first enacted. 

Berman: Not a wave, but there may be an increase from historical norms. One of the predictors of a wave of municipal bankruptcy filings was Meredith Whitney. Her prediction late last year got a lot of attention because she frequently appears on news shows on CNBC, Fox Business and Bloomberg News. While I do foresee a long period of financial difficulties for US municipalities, there are a number of reasons why I think her prediction is overblown. First, Whitney’s prediction focuses on a bankruptcy filing for the municipality, but it is not easy for a US municipality to initiate a bankruptcy case. Under Chapter 9 of the US Bankruptcy Code, the municipality must be specifically authorised by the state within which the municipality sits before it can file a Chapter 9 petition. Of the 50 states, only about 12 have authorised their municipalities to file Chapter 9 petitions without restrictions. Second, many of the municipalities are addressing their financial problems by reducing staffing and services – exactly what you would expect from a financially challenged borrower. Finally, those with the ability to do so have refinanced their troubled auction rate securities debt with new variable or fixed rate securities; or refinanced their troubled variable rate securities with fixed rate securities benefiting from the low interest rate environment.

Mintz: The ‘wave’ of bankruptcies has not materialised and will not materialise for a number of political, business and legal reasons. First, the economy has improved in 2011, reducing the pressure on municipalities’ tax base. More fundamentally, a number of legal and procedural hurdles limit sharply the types and numbers of entities that may file for Chapter 9 bankruptcy. The harms to a municipality likely outweigh the benefits. Harms include limiting a municipality’s ability to tap the capital markets for further bond offerings – the lifeblood of municipal finance – or at least raising the cost of a municipality’s borrowing for the future. Additionally, the political risks for elected officials in filing for bankruptcy relief loom large over any potential Chapter 9 filing. It is difficult to imagine elected officials choosing to file for Chapter 9, except in dire circumstances.

FW: To what extent does Chapter 9 of the Bankruptcy Code provide a solution to struggling municipalities? What hurdles, such as eligibility and pre-filing requirements, apply?

Berman: Chapter 9 provides a limited solution to a struggling municipality. Eligibility requirements like state authorisation to file presents a serious obstacle. Another eligibility requirement, that of establishing insolvency, is also a problem as, unlike a Chapter 11 debtor in the commercial restructuring arena, a municipality has the burden of proving that it is insolvent, a hotly contested issue in most Chapter 9 contexts. While the City of Vallejo in California appears to be getting ready to exit Chapter 9, the experience there has been gruelling in terms of the time the process has taken and the costs incurred. While the benefits obtained are precisely what the City needed, the political context of the reorganisation makes most politicians reluctant to initiate the process. Most would rather use the threat of a Chapter 9 filing to negotiate an acceptable out of court solution.

Mintz: There are significant legal hurdles preventing Chapter 9 filings. To qualify for Chapter 9 bankruptcy protection, an entity must qualify as a municipality, have specific state authorisation to file, be insolvent, desire to affect a plan to adjust its debts, and negotiate with its creditors in good faith. These standards filter out many entities. All of these factors pose hurdles, particularly the first two. An entity is a ‘municipality’ only if it is a “political subdivision or public agency or instrumentality of a State”. One court recently held that the Las Vegas Monorail, though funded in part through a municipal bond offering, did not constitute a municipality eligible to file for Chapter 9 because it did not engage in traditional government functions, like police or schools, and lacked sufficient government control to meet the threshold. Additionally, any Chapter 9 filing requires express state law authorisation. Twenty-three states have no authorising statute and Georgia explicitly prohibits municipalities from filing for Chapter 9. Thus, nearly half of all potential entities could not file even if they wanted to – at least not without further state action. These hurdles limit significantly the number of entities eligible to file for Chapter 9.

Butler: Generally, municipalities should consider Chapter 9 only as last resort because it is not a comprehensive restructuring solution for their financial problems. Chapter 9 ‘stays’ creditor enforcement actions and efforts, allows debtors to reject burdensome contracts, and provides a process to propose, approve and consummate a plan to restructure certain financial obligations. However, various legal and practical restrictions limit the effectiveness of such tools, including the stringent eligibility standards that are inevitably litigated at the outset of most Chapter 9 cases. Only a municipality defined as “a political subdivision or public agency or instrumentality of a state” but not a state itself, may file Chapter 9. The municipality must also have state authorisation to file, be unable to pay its current obligations, and satisfy certain statutory requirements relating to the municipality’s prior negotiations with its creditors. In a number of recent cases, establishing eligibility to obtain an order for relief in a Chapter 9 case has been a time consuming and highly contentious process. Indeed, most reported judicial decisions relate to eligibility disputes.

FW: Are employment issues, including pensions and labour contracts, easier to tackle in a Chapter 9 setting?

Mintz: Chapter 9 facilitates the termination, or renegotiation, of a burdensome collective bargaining agreement (CBA). To reject a union contract, a corporate debtor must meet an elevated standard for rejection. However, the elevated standard does not apply in Chapter 9. By contrast a municipality need only show that the CBA burdens its ability to reorganise, that the equities balance in favour of rejecting the contract, and that the municipality made reasonable efforts to negotiate a voluntary modification and further efforts are not likely to produce a prompt and satisfactory solution. While the law may give municipalities increased leverage to negotiate with unions, politics may render this advantage less meaningful. Unions often represent powerful political interests and few politicians seek to anger unions by unilaterally rejecting collective bargaining agreements. Likely the only elected officials that can take advantage of this aspect of the Bankruptcy Code are those that are either out of viable alternatives or willing and able to take on the unions directly.

Butler: Some have suggested that municipalities should file Chapter 9 cases to modify their labour contracts and costs because Chapter 9 debtors have been allowed to reject burdensome CBAs and retiree insurance benefits. However, unlike Chapter 11 of the Bankruptcy Code, which also has mechanics for modifying or rejecting CBAs, Chapter 9 has no mechanics for a court to mandate or implement new CBAs. Thus, municipalities could remain obligated to negotiate new CBAs with employees who are under no binding contract. Moreover, modifying CBAs does not resolve the larger issues regarding legacy obligations such as underfunded pensions. As problems regarding municipal pension and retirement funding are revealed and the amounts paid for municipal labour compensation and benefits are scrutinised, it has become increasingly clear that municipalities must address the long-term structural obligations. Chapter 9 provides no special tools or magical formula for addressing these problems.

Berman: With the benefit of a ruling in the Vallejo, California Chapter 9 case, there is now precedent for the rejection of CBAs using the relatively easy to meet standard of whether the agreement is burdensome to the municipality. The ruling will also allow the municipality to proceed by motion to seek authority to reject the agreement, rather than proceed by way of the more onerous standard and lengthy procedure required by Section 1113 of the Bankruptcy Code applicable to commercial business reorganisations under Chapter 11. However, pensions are a different story. Section 1114 of the US Bankruptcy Code covers the modification of retiree benefits under Chapter 11. Based upon the Vallejo decision mentioned above, Section 1114 appears not to apply to a Chapter 9 proceeding. But there are several states that have statues or state constitutions that limit the ability of a municipality to reduce vested pension benefits.

FW: What negotiating leverage do municipalities have in the context of a filing? What counter-leverage do lenders have at their disposal?

Butler: Chapter 9 provides a centralised forum, presided over by a judge, in which all stakeholders are required to present their claims, complaints or other objections, and a mechanism to force restructured debt terms on recalcitrant creditors who refuse to voluntarily restructure their debt claims. Even so, the primary leverage a municipality is afforded by Chapter 9 arguably is simply the threat of actually filing a case, which may be unpredictable, lengthy and costly for all parties involved, and which likely will result in a negotiated resolution that could have been achieved by the parties outside bankruptcy. Unlike private business restructurings, which ultimately move forward to avoid a business failure, municipalities will not liquidate if stakeholders cannot agree on a global solution in a meaningful time. Creditors retain leverage in a Chapter 9 case because, among other things, the Chapter 11 ‘absolute priority rule’ applies, and a municipality cannot confirm a plan unless at least one class of impaired creditors votes to accept the plan and claims in creditor classes rejecting the plan are treated fairly and equitably. 

Berman: The municipality, assuming state authorisation exists for a Chapter 9 filing in the first instance, can use the threat of a Chapter 9 filing to try to negotiate a restructuring with its creditors that might approach the solution a Chapter 9 case would be expected to produce. The municipality might also point out to creditors the difficulties, costs, and delays associated with obtaining and enforcing a judgment against the municipality. The bond insurers and indenture trustee active in negotiations over the Jefferson County, Alabama sewer warrants have been involved in lengthy litigation over the enforceability of a rate covenant placed in the indentures, and while the plaintiffs succeeded in having the state court appoint a receiver, there is the further step of the receiver putting in place a higher rate that will surely occasion further litigation, costs and delays. Add to that the inability for creditors to file an involuntary Chapter 9 case against the municipality, the inability to liquidate a municipality under Chapter 9 or the inability to appoint a trustee to assume management of the municipality, and you have rather limited actions that the creditors can take.

Mintz: While municipalities have little incentive to file for Chapter 9, lenders have even less leverage in Chapter 9 than they do in Chapter 11 for several reasons. First, constitutional concerns about a federal bankruptcy court interfering with the day-to-day operations of local governments limit bankruptcy court oversight of Chapter 9 debtors – far more than in Chapter 11. Second, Chapter 9 has no exclusivity and thus no fixed time by which a debtor must try to emerge from bankruptcy. Thus, cases may linger in Chapter 9 much longer than in Chapter 11, with little leverage for a lender, or judge, to advance the process. For example, the City of Vallejo has been in Chapter 9 for over three years. Finally, the standards for cram-down on municipal debtors in a non-consensual plan of debt adjustment are even less fixed than the cram-down standards in Chapter 11. Thus, lenders have a significant incentive to work with municipalities to avoid a Chapter 9 filing. 

FW: What options outside Chapter 9 are available to struggling municipalities?

Berman: Several states have statutes that do not allow their municipalities to file a Chapter 9 proceeding without first going through a process that provides some financial oversight. For example, in the Commonwealth of Pennsylvania, the specific authorisation is found in the Financially Distressed Municipalities Act (53 P.S. §§11701.101 et seq.), commonly referred to as Act 47. Harrisburg, PA, saddled with dealing with financial obligations associated with an incinerator, has recently entered the Act 47 process. To date, 26 Pennsylvania municipalities, including the City of Pittsburgh in 1993, have entered the Act 47 process, but only six have succeeded in completing it. Another example is Rhode Island where, in reaction to the financial plight of the town of Central Falls, specific authorisation for a Chapter 9 filing was passed and can be found in §45-97. Like Pennsylvania, the Rhode Island statute only allows a receiver appointed by the state to file a Chapter 9 petition and then only after the imposition of a process of financial oversight and discipline. It is possible that a state authorised process will allow sufficient steps to be taken to solve the financial problem. It is also possible, either as part of that process or apart from it, that the state’s financial resources, probably in the form of a loan, might be made available to assist. Unfortunately, the financial problems being experienced at state levels may limit the availability of that solution.

Mintz: The best option for struggling municipalities, and their lenders, is consensual restructuring of debt. Because neither side is likely to embrace a Chapter 9 filing, both parties should work together to negotiate new terms. However, because a Chapter 9 filing could harm both sides, the perceived threat of Chapter 9 may be viewed as distant, making negotiations more difficult. For municipalities with significant union or litigation obligations Chapter 9, if available, may make more sense. A municipality can, as previously discussed, terminate collective bargaining obligations in Chapter 9 with greater ease than in other contexts. Moreover, litigation and other unsecured obligations can be resolved efficiently, as in Chapter 11. 

Butler: Many states are taking action to provide municipalities with additional restructuring options beyond state bailouts and Chapter 9. Michigan enacted a law enabling its governor to appoint emergency financial managers (EFMs) to run troubled cities. The EFMs can be granted broad powers, including amending budgets, changing staffing levels, rejecting, modifying, or terminating contracts, including union contracts, and consolidating or eliminating departments. Other states, including Indiana and California, have been attempting to implement similar emergency manager or consultant concepts. In New York and other states, comparable powers have been granted to receivers and oversight boards. Nassau County New York, for example, has been put under the control of a state-appointed six-member oversight board. Certain municipalities are taking similar steps on their own. In Detroit, Mayor Dave Bing in May 2009 formed a ‘crisis turnaround team’ of over 50 professionals who volunteered to create an extensive report of recommendations for restructuring the city. Mayor Bing also created the ‘Detroit Works Project’ which focuses on consolidating residents in the city’s most viable areas to improve the efficiency of the city’s services.

FW: How can municipalities deal with restructuring subdivisions of their organisation?

Berman: The key will be to look at how the subdivision was organised and the type of debt that needs to be addressed. For example, if the subdivision was created as a separate municipality for Chapter 9 purposes, is located in a state that has authorised a Chapter 9 filing, and the municipality has not guaranteed the subdivision’s obligations, then the subdivision alone can consider the filing of a Chapter 9 case without causing the entire municipality to take that step. This may be common with various districts established for specific purposes, including housing, hospital, water, sewer and similar districts. On the debt side, if the debt is backed by a pledge of special revenues but is otherwise non-recourse to the municipality, then the possibility exists of leaving the subdivision and its creditors to the reality that the system can only produce so much revenue to address its debt obligations. If the municipality is going to lend its resources to solving the problem, either by raising additional non-system revenues or other attributes attractive to creditors, for instance a separate state sponsored authority to issue refinancing bonds, the creditors might be expected to provide some quid pro quo to reduce the overall costs to the subdivision. 

FW: Are prospective buyers such as hedge funds demonstrating a strong appetite for distressed assets? Are more municipalities selling off assets to improve their financial position?

Mintz: Hedge funds have looked closely at a number of distressed assets in recent months. In particular, there are some assets such as bridges, parking lots and other revenue-producing projects on the market. However, for the most part they have not found valuations distressed sufficiently to warrant significant investments. This may be, in part, because for the reasons discussed, the pressure on municipalities has lifted in the last few months. Had the market continued to crater, as appeared to be the case in late 2010 and early 2011, municipalities may have been forced to take more extreme actions to fend off their creditors – such as the sale of hard assets at a deep discount – a step recently undertaken by the Greek government with respect to its sovereign debt.

Butler: Distressed asset investors are certainly active in the current marketplace, including the municipal sector, but no more so than other sectors.  However, there are an increasing number of privatisation transactions and municipalities exploring options for such transactions. Arizona, for example, generated $735m in a sale-leaseback transaction involving various state owned buildings. Chicago, Illinois sold the rights to its parking meters to generate revenue to fill a budget deficit. Harrisburg, Pennsylvania has also received proposals for the sale or lease of its troubled trash incinerator which has been unable to generate sufficient revenue to service the bonds issued to finance the incinerator. However, privatisation transactions can be complex and difficult to execute.

Berman: I believe that several hedge funds were buyers of municipal debt when pricing took a dive after Meredith Whitney’s comments late last year. They have done well as her dire predictions proved not to be realised. As for selling assets, certain municipalities have taken that step, but it’s not an attractive alternative from a political standpoint and not a good time to be selling.

FW: Is the outlook for US municipalities bleak? How can those battling with financial difficulties avoid Chapter 9 scenarios?

Butler: Municipalities are facing unprecedented challenges resulting from changing population and business demographics, skyrocketing labour, healthcare and other costs, as well their own poor financial planning, mismanagement of investments, reduced federal or state funding and overall general economic uncertainty. 

Most municipalities have been able to weather the storm so far by engaging in ‘belt-tightening’ measures designed to address short-term cash flow issues until economic conditions improve. However, the historical exploitation of municipal pensions has resulted in perhaps trillions of dollars of unfunded pension obligations, at a time when the cost of other post-employment benefits, which are also unfunded, is escalating and record numbers of employees are poised to retire and seek to access their pensions and benefits. States, municipalities, employees, and retirees must find the political will to meaningfully restructure those obligations in a fair and reasonable manner to prevent catastrophic municipal financial problems in the years to come.

Berman: Not surprisingly, the problem for US municipalities will likely be tied to the speed of the recovery of the economy as a whole. Recent increases in tax revenues in some states have provided a sense that there is some light at the end of the tunnel. Also, reductions in wages and staffing as well as refinancing of some debt issuances, often with state assistance, appear to have allowed some municipal entities to avoid having to resort to more drastic remedies. At its end, the present problem<> may have provided a benefit to all. Politicians have had to recognise that there are consequences for promising things that they may not be able to deliver in the future and voters are more focused that I can ever remember on the levels of debt being carried by federal, state and municipal governments. After all, the way to avoid a Chapter 9 proceeding is to never take on more debt than you can afford. Of course, whether the voters are prepared to accept a lower level of services than they have come to expect is yet to be seen.

Mintz: Like any entity, municipalities dealing with financial difficulties face stark choices. They need to increase their income, reduce their expenses, or both. However, because of the unique political and legal circumstances attendant to a municipal bankruptcy, unless the economy craters completely, municipalities are likely to avoid Chapter 9 filings in the foreseeable future. 


Doug Mintz is special counsel at Cadwalader. Working in the firm’s Financial Restructuring Department, he has experience in all aspects of bankruptcy and restructuring, representing secured lenders, debtors and official and ad hoc creditors’ committees. Mr Mintz has consulted with both funds and municipalities regarding Chapter 9 and distressed municipal obligations. He can be contacted on +1 (202) 862 2475 or by email:

Mark N. Berman is a partner at Nixon Peabody LLP, and a member of the firm’s Financial Restructuring & Bankruptcy Practice Group. Mr Berman is a fellow of the American College of Bankruptcy and has been listed in The Best Lawyers in America since 1989 as well as in Chambers USA since 2004. His efforts have included work on the financing of sports stadiums, toll roads, military housing, tobacco securitisations, wind energy projects and real estate developments as well as the out of court or in court restructuring of tolls roads and municipal debt. He can be contacted on +1 (212) 940 3168 or by email:

John Wm. Butler, Jr. is a partner at Skadden, Arps, Slate, Meagher & Flom LLP. His practice focuses principally on advising companies and their stakeholders with respect to complex business reorganisations, troubled-company M&A, debt restructurings and financing matters, including advising directors and officers on corporate governance, fiduciary duty and strategic matters. He has assisted many global businesses in restructurings outside the US, executing cross-border financing and privatisation transactions, and divesting various business lines and entities. He was named one of the decade’s most influential lawyers by The National Law Journal. Mr Butler can be contacted on +1 (312) 407 0730 or by email:

© Financier Worldwide



Doug Mintz



Mark N. Berman

Nixon Peabody LLP


John Wm. Butler, Jr.

Skadden, Arps, Slate, Meagher & Flom LLP

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