Dispossessing Residents: Municipal Bankruptcy and the Public Trust

Juliet Moringiello, Associate Dean for Research and Faculty Development, Widener University Commonwealth Law School, Harrisburg, PA 

Municipal bankruptcy occupies an obscure corner of bankruptcy law. Although the federal law for resolving municipal financial distress is located in chapter 9 of the Bankruptcy Code, there are significant differences between the bankruptcy processes used for municipal bankruptcy and the bankruptcy processes used by individuals and business entities. Constitutional constraints imposed by the balance between federal and state power enshrined in the Tenth Amendment dictate much of the structure of chapter 9. As a result, chapter 9 lacks some of the governance controls that exist in the other bankruptcy chapters.

Another significant difference between municipal bankruptcy and other types of bankruptcy is the role of bankruptcy in distributing the debtor’s property. A liquidation bankruptcy under chapter 7 distributes all of a debtor’s property to its creditors, which  is the floor for distributions in a reorganization bankruptcy. According to the public trust doctrine, a municipality has no property that can be forcibly distributed to its creditors. Municipal property belongs to all of the municipality’s residents and is thus held in trust by the municipality, immune from seizure by creditors.

So why talk about bankruptcy in a symposium about dispossessing Detroit? One of the most contentious issues in municipal bankruptcy is the treatment of pensions, and indeed bankruptcy can result in reduced pension payouts. But all residents stand to lose something in bankruptcy that is not property and is not always entitled to constitutional protection: voice.

Some criticize the municipal bankruptcy process because it leaves control of the bankruptcy in the hands of the municipality and therefore effects no change in the conditions that led to the bankruptcy in the first place. If a dysfunctional city government played a role in the distress that led to bankruptcy, there is nothing in the Bankruptcy Code to dislodge that government. While true, that’s only one half of the story. Chapter 9 of the Bankruptcy Code was designed to work with state financial intervention schemes. We saw that in Detroit, where the Emergency Manager had the primary role of guiding the city through the bankruptcy.

Back to dispossession and the public trust. There are several types of intervention – in Michigan, the Emergency Manager displaces city government as a bankruptcy decisionmaker. In Pennsylvania, a municipal receiver does not displace city government. The receiver takes the lead in making the decisions necessary to resolve municipal financial distress but must work with the elected officials to implement a recovery plan. Any municipal recovery plan can involve the sale of municipal property because the public trust doctrine means only that such property is immune from a forced sale, not a voluntary sale. Outside of the property context, public trust can mean trust in the process, and if the state insolvency scheme is viewed as a takeover, the citizens will feel dispossessed of their voice. In fashioning an intervention process, states should consider the impact of that process on the voice of the residents who are so critical to a city’s ongoing recovery.