Posted July 29, 2013 1:29 am by Comments (3)

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July 29, 2013

 

Perhaps you’ve started wondering whether the Bankruptcy Code could offer a fresh start to Illinois, Cook County, Chicago, or other units of the state. Through bankruptcy, maybe they could cut some debt, renegotiate labor contracts, reduce pension liabilities, reschedule obligations, cancel bad contracts — all things that happen in the private sector?  Bankruptcy occasionally works for people and companies so why not for government?

 

Don’t count on it.

 

Most bankruptcies you know about are under Chapters 7, 11, and 13 of the Federal Bankruptcy Code. They’re for liquidations, reorganizations and personal bankruptcies in the private sector but not units of government. Only Chapter 9 is for government, like the case Detroit just filed.

 

Chapter 9 is not for Illinois itself, however, where the answer is clear: No bankruptcy proceeding can be filed by or against states themselves.

 

How about Chicago, Cook County or other troubled units of the state? Chapter 9 is for local units like those only in states where Chapter 9 is allowed, and Illinois doesn’t allow it (except for very small units under narrow circumstances). Pew Charitable Trusts this month delivered a nice study of different state approaches to what they allow. In Illinois, Chapter 9 filings generally are not authorized. Instead, for cities over 25,000 population, the state has only the Financially Distressed City Law, which provides for a sort of receivership proceeding only for very, very distressed cities which the state labels as such by joint resolution of the legislature.  Illinois has only one “financially distressed” city, East St. Louis, which has struggled under that status for 23 years. Chicago, Cook County and most other municipalities would not meet the requirements of the statute.

 

Couldn’t Chapter 9 be amended to allow states to file or to make it work properly for all cities and municipalities?  Or couldn’t the Financially Distressed City Law or other statutes be changed by the state to allow for a smart reorganizaton? Yes, theoretically, but be careful what you wish for. If those laws are amended by the same forces that broke us, those powers will only write themselves into still stronger positions.  Pension obligations, for example, could get a first priority. Public unions have already figured this game out, which is why they want those “guaranty” provisions written into pension reform legislation assuring that pension contributions get made ahead of other payments.

 

Even if Illinois allowed Chapter 9 proceedings for its local units of government, a mess could result because Chapter 9 itself is vague and untested.  The Federal Bankruptcy Code became law in 1982 and extensive case law since then now makes private sector proceedings quite predictable, rational and fair.  Chapter 9 government proceedings, however, have been rare, so nobody really knows how Chapter 9 cases like Detroit’s will turn out.

 

In short, the concept of a “fresh start” — which is the ancient legal precept of bankruptcy law — doesn’t exist for government in Illinois, and only a dramatic turnover in Springfield could change things.

 

None of this is to say that the state or any of its cities other units aren’t broke or “bankrupt” in a figurative sense.  It just means no orderly process for reorganization exists, which will make things extraordinarily messy eventually.

 

Mark Glennon

 

 

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Tia Goss Sawhney

Lack of an orderly process of managing insolvency (aka bankruptcy) is not protection against insolvency. Furthermore governments have a long history of insolvency — insolvencies accompanied by chaos and tremendous human costs. There is no reason to believe our governments are different. See “This Time Is Different: Eight Centuries of Financial Folly” by Carmen M. Reinhart, Kenneth Rogoff, 2009. Orderly processes now are much better than digging from chaos later.

Anono- Great question, and the short answer is “chaos,” I’m afraid. Maybe I need to do a Part 2 on this elaborating on the scary eventuality.

So what happens when a unit of government starts not paying, getting sued, judgements on it etc?

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