Illinois Governor Rauner presented his turnaround agenda in his “State of the State” address last week and called for, among other things, the state “to extend to municipalities bankruptcy protections.”  Mirroring the proposed legislation introduced by Representative Ron Sandack in January, and reported on in an earlier post, Illinois seems positioned to provide municipalities with clear and direct access to Chapter 9 bankruptcy and, in so doing, provide them with more leverage in negotiating with creditors, including employees and retirees.

The move toward bankruptcy may best be viewed as recognition that bankruptcy is a tool that, if used properly, could help cities restructure their liabilities in an organized way using the court supervised bankruptcy process to provide structure.  It also provides the only way for cities to impair contracts, including collective bargaining agreements and pension contracts. The legal right to impair such contracts has been confirmed in various rulings in the Chapter 9 cases of Vallejo, Stockton and Detroit.

While Illinois state pension reform makes its way through the appellate process and a much anticipated ruling by the Illinois Supreme Court, by providing access to Chapter 9, Illinois would permit pension reform on a city-by-city basis.  Cities would have the opportunity to reduce their pension liabilities through bankruptcy based on their need to balance the costs of delivery of essential services to residents against their ability to pay creditor claims and employment and pension obligations.

Allowing access to Chapter 9 is a pragmatic solution particularly in a state where financial difficulties at the state level all but preclude financial assistance to distressed municipalities. Should the state go further (and we hope it does) and provide for oversight and supervision prior to the actual bankruptcy filing, it has the opportunity to be one of the first states to develop a pre-packaged business approach to municipal bankruptcy. By utilizing lessons learned (sometimes painfully) in Stockton, Detroit and San Bernardino, Illinois could advance the Chapter 9 process simply by providing oversight and supervision to the municipality before permitting a filing. In the absence of financial support, providing assistance designed to make the bankruptcy process as efficient and cost effective as possible and to ensure meaningful compliance with the Bankruptcy Code’s eligibility requirements should be an additional consideration that goes hand in hand with allowing access to Chapter 9.

What remains to be seen as the Illinois legislature moves its Chapter 9 proposal through the legislative process is how this will affect capital market access and pricing for Illinois municipalities.  On some level, providing access to Chapter 9 in the absence of state supervision and support may be viewed by bondholders as the least attractive option.  This is likely because the absence of supervision and oversight leaves creditors at risk of the free fall that San Bernardino illustrates.  With no state intervention in the process, San Bernardino asserted a fiscal emergency, skipped the pre-filing neutral evaluation process, and landed in a Chapter 9 bankruptcy with no preparation and no idea about how to get out.  Over two years after the filing, the Court had to order a deadline for San Bernardino to file a plan.

As for Chicago, Mayor Emanuel’s office told the Chicago Times that the Governor’s proposal was not part of Chicago’s plans, noting that cost cutting and budget management efforts would continue. So at least for now, no bankruptcy plans are in the making for Chicago. That could change if the benefit of a bankruptcy filing, bringing with it the ability to impair collective bargaining agreements and pension contracts, would make current cost cutting and budget management more efficient and arguably more cost effective.

In the absence of any pre-filing supervision or oversight, creditors in Illinois would be left with Chapter 9′s eligibility requirements and the hope that any Illinois municipality seeking to use Chapter 9 to restructure its contracts will present, prior to filing, a well thought out restructuring plan and conduct fulsome negotiations with creditors. Chapter 9 provides its own gatekeeping process requiring negotiations with creditors before filing, but experience shows that the quality of compliance varies greatly, leaving one to wonder whether more state involvement could improve efficiency and effectiveness for soon to be municipal debtors. Capital market creditors, for the most part, have demonstrated a greater willingness to negotiate as they have moved through Vallejo, Stockton, and Detroit. State oversight of the pre-filing process has the potential to produce better results for everyone involved.

For those of you who wrote in response to our recent blog noting that the current Illinois statute which provides that only the Illinois Power Agency can file bankruptcy and is not the Agency that approves access to bankruptcy, thank you. We value our engaged readers and the dialogue that has followed many of our blog posts. Stay tuned as we navigate, along with our clients and blog readers, the challenges of municipal restructuring and bankruptcy.