The effects of the recent fi nancial crisis and the ensuing recession continue to take their toll on municipalities in the United States, which are struggling with reduced revenues at the same time their residents have an increased need for government services. It has been reported that Atwater, California is considering Chapter 9 bankruptcy, and Atwater is not likely to be the last municipality to be faced with such a decision.1 Many cities and counties will have to address extraordinary budgetary shortfalls as they face increasing operating and legacy costs (and in some cases, the consequences of bad investment decisions) in the distressed economic environment left by the real estate boom and bust, deteriorating local industries, declining tax revenues and reduced state aid.

Municipal credit ratings face reviews and downgrades, as demonstrated most recently by Moody’s largely negative statewide action in California.2 Many bond insurers have left the market since the 2008 fi nancial crisis. Amid all this, states and municipalities facing fi scal discipline are understandably leery of adding to their debt burdens at increasing costs. In states where municipalities are permitted to use Chapter 9 of the U.S. Bankruptcy Code, they may elect to undertake a Chapter 9 restructuring. But for all municipalities, even those not specifi cally authorized by state law to pursue Chapter 9 restructurings, public-private partnerships may off er untapped revenue streams and alleviate municipal distress.

Chapter 9 Municipal Bankruptcies

Chapter 9 of the U.S. Bankruptcy Code was designed specifi cally to assist insolvent municipalities. A Chapter 9 bankruptcy is generally similar to a bankruptcy under Chapter 11, commonly used for corporate reorganizations. As Chapter 11 does for business debtors, Chapter 9 permits municipal debtors to continue operating, protected from creditors’ debt-collection eff orts, while in bankruptcy. With court approval, the municipality can “reject” burdensome contracts, replacing them (if necessary) with new contracts at market terms. With respect to rejection of labor contracts in particular, the municipal debtor may use the normal standard that is applicable to all other kinds of contracts, rather than the heightened standard for labor contracts required in Chapter 11 cases. To replace ordinary debt-collection mechanisms, Chapter 9 provides for the formulation, court approval and implementation of a “plan of adjustment” that specifi es the classifi cation and treatment of creditors’ claims.

A Chapter 9 plan of adjustment can provide for the discharge of debt and rejection of certain contracts, allowing the municipality to eff ect a fi nancial restructuring that reduces its past and going-forward obligations. Of course, uneconomical labor contracts and unmanageable debt burdens sometimes may be addressed outside of court with the consent of the aff ected unions and creditors, but Chapter 9 provides a mechanism for relief when consensual renegotiation of such contracts and obligations is not possible. As a result, in states permitting Chapter 9 restructurings, the mere threat of a Chapter 9 fi ling may make unions and unsecured creditors more willing to negotiate.

Statutory and Credit Risk Limitations

While some municipalities may effectively wield Chapter 9 to restructure their financial affairs, either by threatening to file or actually filing a bankruptcy case, Chapter 9 is not a magic bullet. First, constitutional and statutory limitations prevent Chapter 9 from being as powerful, and hence as useful, as it might otherwise be. In particular, a bankruptcy court cannot require a municipality to take certain actions that may be critical to addressing a municipality’s insolvency, such as raising taxes, cutting services, selling assets or changing municipal organizational structures, so unless the municipality elects to take these politically difficult revenue-generating or cost-saving measures on its own, a Chapter 9 proceeding may not effect a full restructuring of the municipality’s finances. Municipalities that can benefit from taking such actions, however, might pursue them under state law while concurrently using Chapter 9 to restructure unsecured debts and labor contracts. Indeed some states, including Massachusetts, North Carolina, New York, Connecticut and New Jersey, have enacted legislation or taken case-bycase measures to facilitate this complementary use of state and federal law.

A second limitation on Chapter 9’s usefulness is the perception that it may result in further damage to a municipality’s credit rating, thereby making it harder and more expensive for that municipality to access the bond market for years. In part because of this perception, nearly half of all states currently do not authorize municipalities to use the federal bankruptcy statute.3 Fear of a potential downgrade, not just for the debtor but for similarly situated municipalities (and possibly the state), can delay a municipality’s decision to file for Chapter 9 and generally has the effect of forcing state intervention. Ironically, this delay can result in a deeper fiscal crisis for the municipality to address in Chapter 9.

Asset Privatization With or Without Chapter 9

Whether or not eligible to pursue a Chapter 9 restructuring, some municipalities may wish to pursue privatization of public assets and services as an alternative to filing Chapter 9. The concept of privatization may seem socially and politically untenable; nevertheless, finding creative ways to partner public and private interests in order to invest in the maintenance or redevelopment of municipal resources offers opportunities for both savvy investors and distressed municipalities (and their citizens). No doubt some municipalities have assets that may now be more efficiently utilized in private hands. Under the right circumstances and terms, underemployed assets and all but the most essential services (i.e., waste disposal, water treatment, utilities, hospitals, transportation, education, etc., but not police and fire) could be privatized, outsourced or entrusted to public-private partnerships, thereby relieving municipalities of financial burdens, stimulating the local economy and possibly even generating some positive cash flow for those municipalities. Unlike the restrictive statutes regarding Chapter 9, many states already have enabling legislation to permit or promote public-private partnerships.

Furthermore, for those municipalities that are legally permitted to pursue a Chapter 9 restructuring, doing so does not preclude also privatizing assets and services through public-private partnerships. If, however, a municipality intends to elect both Chapter 9 and infrastructure development and privatization, then the timing of each should be considered. On one hand, if the economic environment is sufficiently conducive to private investment at the time a municipality begins to consider its options, it may wish to pursue such investment prior to filing Chapter 9, in the hope that the investment will obviate the need for Chapter 9 or, at the very least, that the advantages of such investment may be realized prior to any chilling effect Chapter 9 may have on the local economic climate. On the other hand, if the investment climate is crippled, a municipality may wish to seek private investment after a Chapter 9 proceeding, so that such investors may be able to take advantage of the concessions and efficiencies that are realized through the restructuring process.

The restructuring of troubled municipalities, with or without Chapter 9, is not an overnight process. Often, the absence or neglect of real estate and infrastructure development is symptomatic of the problem. In ordinary times, few municipalities would choose to leverage public assets and services, but challenging times call for unconventional and even speculative solutions. For some municipalities, public-private partnerships may be worth considering as an element in the plan for getting back to a stable, long-term footing.