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By: Mark Glennon*

Since the ‘B’ word is now being spoken in Chicago and other Illinois cities, here are some key things to keep in mind as the debate about bankruptcy for Illinois municipalities emerges:

• First, Springfield has not yet authorized its towns, cities, counties and other local units to file bankruptcy, though a bill has been introduced to do that by Reps. Sandack and Ives. Only municipalities in states that have authorized bankruptcy can file under the Federal Bankruptcy Code. Chapter 9 of the Code is for those municipalities. (Our primer on that from two years ago is linked here.)

• Expect the topic of “conditions” to become part of the debate about authorization from the state. The state may attach important conditions to municipal bankruptcy, such as appointment of a trustee or emergency manager, as Michigan did with Detroit. Also, Springfield’s authorization could be granted on a city by city basis.  The only express limitation on permissible conditions is that they not “undercut the efficacy” of Chapter 9. A good article on permissible conditions is linked here.

• That bill pending in the Illinois legislature is condition-free — short and simple — but it may be amended as it progresses.

• It’s now generally assumed that pensions can be cut in bankruptcy, despite constitutional pension protections like Illinois has.  In other words, the Federal Bankruptcy Code trumps state constitutions, which is what the court ruled in Detroit’s bankruptcy (though it was never appealed). The judge in the Stockton California bankruptcy said, effectively, the same thing.

• In addition to whatever conditions the state imposes, eligibility for a municipality to file for bankruptcy is strict, and is deliberately designed to discourage filings when out-of-court alternatives are available. First, the municipality must prove it’s insolvent, which is not the case for corporations. Second, it must, essentially exhaust out-of-court settlement negotiations with creditors, unless it has obtained the prior consent to filing from a majority of each class of those creditors, or show that negotiations aren’t feasible. Those are fact-intensive issues a judge must decide. It’s why the eligibility ruling was so widely followed and critical in Detroit’s case.

• There’s no such thing as an involuntary Chapter 9 bankruptcy — creditors cannot push a municipality into bankruptcy, as they can with companies.

• Chapter 9 is far more vague and unpredictable than business reorganizations under Chapter 11, which you may be familiar with. Countless reported decisions have interpreted Chapter 11 since the Bankruptcy Code was enacted by Congress in 1982, but Chapter 9 cases have been few and far between, and Chapter 11 is more detailed on its face than Chapter 9. So, the outcome of municipal bankruptcy is much less certain than for business bankruptcies.

• Pensioners are understandably fearful of bankruptcy but, in the right circumstances, they might embrace it. In Detroit, pensions were cut no more than 4.5%, but unsecured general obligation bonds were cut at least 25%. The prospect of getting more than their share compared to other unsecured creditors, over whom they have no explicit legal priority, may become appealing. Many pensioners might be wise to take a 4.5% cut and run — if Detroit is really indicative of things to come.

• Politicians and voters, too, may warm up to bankruptcy, again if they think the Detroit precedent of cutting bondholders hardest will hold up. They might see bankruptcy as a means of exporting losses since bondholders would be mostly outsiders.

• But we don’t really know if the loss shares in Detroit would be replicated in Illinois. Chicago and many other Illinois cities have unfunded pension ratios far worse than Detroit’s before its bankruptcy. Chicago’s pensions are only 34% funded (according to S&P last week); Detroit’s were roughly 59% to 77%, depending on whose numbers you used  (though the “official” numbers claimed 91%). Moreover, all bankruptcy reorganizations become “let’s make a deal,” to some extent, as a reorganization plan is drafted. Detroit’s plan was a negotiated deal that a judge blessed, but did not design. Aside from Chapter 9’s vagueness, there’s also the reality that law tends to get thrown aside in major cases of any kind. The General Motors and Chrysler bankruptcies were prime examples of where established law was simply ignored.

• A prime rule known by turnaround and reorganization specialists of any kind is “go big, go strong, go fast, go early,” which is the way Gov. Rauner described it to the Wall Street Journal recently. We stated the rule as “do it big, do it fast and do it decisively” when we wrote about it back in 2012. But in Chicago and most cities in Illinois, it’s been “deny, delay, extend and pretend.” If that approach continues into bankruptcy, the result is a failed reorganization with the likelihood of re-filing, and years upon years in bankruptcy court.

• As for the state itself, Chapter 9 is not available to states, but maybe not forever. It can be amended, and there is already plenty of reported discussion of that in Washington. Just this past Saturday I heard that discussion described by Richard Porter, a GOP National Committeeman, in an appearance here in suburban Chicago. If the pension protection clause in the Illinois Constitution is ruled by the Illinois Supreme Court to be sacrosanct, thereby invalidating pension reform, one option is for Washington to amend the Bankruptcy Code to allow states to use bankruptcy to override their pension protection clauses.

• At the end of the day, the biggest issue is who gets how much on their claims. Get it right, and a bankrupt gets a fresh start while treating its pensioners and other creditors fairly. Get it wrong, and a particular class of creditors, favored for one reason or another, owns the store. In the Chrysler bankruptcy, United Auto Workers got vastly preferential treatment than other creditors, contrary to the law, and ended up owning 55% of the restructured company.  If that were replicated in a municipal bankruptcy, as public unions and their political friends would no doubt seek, pensioners could still emerge from bankruptcy holding obligations that would leave a municipality crippled.

Obviously, there are plenty of unknowns in Chapter 9, which is part of why it’s rightly described as a last resort, and one reason why I don’t yet have an opinion about which cities it might be right for. But I’m certain of this: If I was still practicing law, I’d be learning all I could about Chapter 9 and getting ready for years of hard work.

*Mark Glennon is founder of WirePoints. He earlier practiced law and his work included corporate bankruptcy and turnarounds.

Updated 4/22/15.








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Well said and Yes I agree things are getting out of hand. It seems like most people stopped caring but I have hopes that we will get things back soon.

Awesome article and I will be following you on FB

God Bless

Kathy Berg

Thanks for summing up this issue and for the links. Of course, you’re right that “it’s been “deny, delay, extend and pretend.” Those all too common tactics have only made things worse and drastic turnarounds necessary.
What’s amazing is that municipalities busy themselves decrying loss of money from the LGDF rather than scurrying to cut spending. These taxing bodies refuse to acknowledge reality and change their ways. Taxpayers who will only suffer all the more should be screaming! .


LGDF = Local Government Distributive Fund.

The unions will do everything they can to drag out even 1 penny of pension reduction.

There is an influential faction in the unions, for which this is as much an ideological, political, and voter mind share battle as a common sense or monetary battle.

The little guy against the rich 1 percenters.

Socialism vs capitalism.

They lose a penny, they believe that’s the start of a landslide.

You will never win a common sense logical debate with these types.