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.