Critique of Allen Skillicorn’s Proposal to Allow Cities to Enter Bankruptcy

Bond analyst Steve Willson critiques State Rep. Allen Skillicorn’s legislation to allow municipalities to go through bankruptcy:

With due respect to Mr. Skillicorn, this legislation will provide virtually no relief to Illinois taxpayers.

The purpose of municipal bankruptcy is to allow municipalities to adjust their debts when they can’t raise the revenue needed to pay their debts, or paying their debts would leave them with insufficient revenue to pay for critical municipal services such as police and fire protection.

So the key focus in bankruptcy would be if granting relief would increase revenue available for such services.

Would that work for Illinois municipalities?

Let’s look at the facts.

First, Illinois home rule municipalities (e.g., Chicago, Crystal Lake) have the legal authority to raise property taxes without limit for operating purposes.

How does a city with the legal authority to increase revenue go to court and claim it doesn’t have enough revenue?

“Yes, your honor, we COULD raise more revenue — we just don’t wanna. Please grant us relief.”

Good luck with THAT argument in court!

Second, almost all debt issued by municipalities is protected from municipal bankruptcy.

Allow me to explain.

The vast majority of Illinois municipalities’ debt is called “general obligation bonds”, and those bonds are payable from a tax levy legally segregated from the operating funds.

In other words, reducing debt would NOT increase funds available for operating purposes, like police or fire protection.

The second largest type of debt of Illinois municipalities is bonds issued for water and sewer systems are payable from revenues of that system and the municipalities have the legal authority to set rates for their utilities at whatever level they want.

This means, again, that using bankruptcy to reduce utility debt would not increase funds available for regular municipal operations such as police and fire protection.

“Yes, your honor, we filed bankruptcy claiming we didn’t have enough revenue for critical municipal services and, yes, cramming the debt won’t give us a penny for those services, but please reduce the debt anyway.”

Good luck with that argument in court!

Bankruptcy MIGHT provide relief from debt payable solely from the General Fund of the municipality, but there’s very little of that debt in Illinois.

Third, revenue for pensions is also from separate, legally dedicated tax levies unlimited as to rate or amount, so asking for relief from pension payments will also be denied in bankruptcy court because

(a) the municipality can raise the revenue needed to pay the pensions and

(b) reducing the levy doesn’t increase money available for operating purposes.

“Yes, your honor, we went bankrupt claiming we didn’t have enough revenue for critical municipal services such as police and fire protection, and, yes, cutting the pensions won’t increase revenue for police and fire protection, but please cut the pensions of widows and retirees anyway.”

Good luck with THAT argument in court!

The fact is that Illinois municipalities (and I include schools in this category) do not have a revenue problem.

They have a SPENDING problem or, more correctly, a lack-of-guts problem.

They COULD fix the problem — they just don’t want to.

Bankruptcy won’t fix that problem.


Critique of Allen Skillicorn’s Proposal to Allow Cities to Enter Bankruptcy — 3 Comments

  1. Re: First argument that judge will make the municipality raise taxes.

    When we talk about whether a bankruptcy is viable, we talk about two things: whether the debtor is eligible for bankruptcy, and if so, whether (outside of Chapter 7, the liquidation chapter) the debtor can propose a plan to restructure its debts.

    Eligibility for Chapter 9 bankruptcy (which is a reorganization chapter, not a liquidation chapter) is governed by 11 U.S.C. § 109(c).

    Section 109(c) of the Bankruptcy Code imposes five requirements to be eligible for relief under Chapter 9:

    (1) debtor has to be a municipality,

    (2) state law must specifically authorize the municipality to file bankruptcy (what Skillicorn is trying to do),

    (3) it has to be insolvent (I’ll explain what this means below),

    (4) it has to desire to adjust its debts with a plan, and

    (5) it has to obtain agreement from its creditors to file bankruptcy (good luck) or it must have tried in good faith to negotiate a repayment plan with its creditors but have failed (not onerously difficult).

    Insolvency under the Bankruptcy Code, as applied to municipalities, means that the municipality either generally is not paying its bills as they come due or cannot pay its bills as they come due. 11 U.S.C. § 101(32)(c).

    So, your concern about a judge saying “Why can’t you just raise taxes?” is unfounded.

    If the municipality is not paying its bills on time, if it is authorized by state law to file bankruptcy, and if it meets the three other requirements, it is eligible to file. No judicial discretion is involved.

    But, just because a municipality can file bankruptcy does not mean that it will be granted relief in the bankruptcy case.

    In order to be granted relief, it has to have a plan to restructure its debts confirmed by the bankruptcy court. Plan confirmation standards for vanilla bankruptcies are obtuse, and for a Chapter 9 bankruptcy they are completely Byzantine.

    If you want to try to parse the Bankruptcy Code, look at 11 U.S.C. § 943(b) and the portions of 11 U.S.C. § 1129 that 11 U.S.C. § 901(a) makes applicable to Chapter 9 cases.

    Here’s my quick-and-dirty summary of plan confirmation in Chapter 9.

    Although there are lots of hoops to jump through, the most important one is imposed by the requirement that the repayment plan be in the “best interests of the creditors.”

    This means something specific in Chapter 9 (i.e. in comparison to Chapter 11, which calls for a comparison of what creditors would get if a company were liquidated vs. what they get under a repayment plan–because a municipality cannot be forced by creditors to liquidate, the Chapter 11 standard doesn’t apply here).

    In a Chapter 9, the courts have basically said that “best interests of the creditors” is something akin to “are creditors going to be better off with the debt restructuring plan in comparison to how they would do if they were left to fend for themselves?”

    No creditor can force a municipality to increase its tax levy to repay its debts.

    Secured creditors can repo collateral.

    General obligation bondholders, even though a condition of the bonds was that the municipality would levy taxes to pay them, can’t actually force a municipality to increase its levy.

    So, again, your concerns about a judge asking “Why can’t you just raise taxes?” does not come into the calculation.

    Re: your second point about general obligation bonds.

    You’re right that funds to operate police and fire would not be freed up by reorganizing them in Chapter 9.

    That ignores the fact, however, that it would provide relief to taxpayers.

    Re: your third point about pension obligations.

    I’ve spent more time on this response than I should have, so you’re either going to have to take my word for it or do the research yourself.

    While I am unsure whether Chapter 9 can restructure vested retirement obligations, I am sure that Chapter 9 allows a municipality to reject crummy collective bargaining agreements and retiree benefit plans prospectively.

    So, there’s room here for relief.

    And see my response above about how your concerns about a judge saying “Why don’t you just raise taxes?” are unfounded.


  2. I would like to make clear I am not criticizing Mr. Skillicorn for his efforts, merely commenting that the actual result is likely to be immaterial.

  3. Publius: You are correct that my comments are not directed at the ability of a municipality to file under Chapter 9, but rather whether they would be granted relief if they filed.

    Dillon’s rule makes clear that when the choice is between the “good of the commonwealth” and creditors, creditors lose.

    However, where that is NOT the choice, creditors win.

    That’s not only black letter law, it’s the overwhelming precedent, including numerous bankruptcy cases involving special districts in Colorado and Texas that issued unlimited tax general obligation bonds.

    So your arguments that judges would not ask if a government could raise taxes is incorrect both with regard to the statute and with regard to virtually all case law.

    With regard to providing relief to taxpayers, that is not a valid reason to grant relief under Chapter 9.

    With regard to pension obligations, these are, like bonds, legally segregated revenue streams not available for operating purposes.

    Reducing pension obligations would not increase revenue available to a municipality to pay bills or fund such services as police and fire.

    Therefore under Chapter 9 there is no reason for a judge to rule that pensions should be reduced.

    And, by the way, there isn’t a single case in this nation’s history where a municipal government has gone bankrupt and a judge has cut pension obligations, but there is case law where municipalities (in California) sought and received bankruptcy protection because of their pension obligations and other creditors were compromised — but not the pensions.

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