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This page contains a single entry from the blog posted on February 20, 2009 4:49 AM. The previous post in this blog was Krugman for economic czar!. The next post in this blog is "Everything from tamale husks to broken hockey sticks". Many more can be found on the main index page or by looking through the archives.

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Friday, February 20, 2009

If it comes time for bankruptcy, can Portland go?

In discussing the fiscal calamity that the City of Portland's massive debt load seems likely to cause eventually, we have been referring to it in a shorthand way as a "municipal bankruptcy." Our thought has been that when the monthly payments on the city's debts become too great for it to pay -- and with huge pension obligations on top of too many bonds outstanding, that day will almost certainly come -- the city would do what Vallejo, California is doing, declare bankruptcy under the federal bankruptcy laws. There is a chapter of the bankruptcy code specifically designed for local governments -- Chapter 9 -- and we have surmised that the city will eventually wind up in a Chapter 9 proceeding.

Bankruptcy can be a good thing for a troubled debtor -- just ask the Pacific Northwest religious order of Jesuit priests, who this week invoked bankruptcy to dissuade priestly sex abuse victims from pursuing down to the last dollar their damage claims against the order. In a bankruptcy, the people who are owed money get paid something, but the payout is usually a day late and many dollars short. An honest debtor gets to walk away from part of what it owes, and quite often it gets to continue operations. Some or all of the creditors wind up grinding their teeth -- just ask the pilots of an airline that went bankrupt how they made out on the pensions they had earned before the bankruptcy.

Anyway, a legal-beagle reader out there has been pestering us for a little while now to stop talking about Portland declaring bankruptcy, because, he says, Oregon municipalities aren't allowed to invoke bankruptcy protection. The other day, he wrote us and said:

Last time I looked, Oregon cities were not eligible for Chapter 9. Bankruptcy law says that if state courts can't adjust the debts of cities, neither can federal courts. An Oregon Supreme Court case from the last big depression said state courts can't adjust city debts; it violates separation of powers.

But who knows what the current Supreme Court would say?

We have never considered the prospect of an insolvent debtor not being able to declare bankruptcy and rearrange its debts. Bankruptcy has always been explained to us as a necessary evil, because without it various creditors would be foreclosing and seizing assets left and right, making it impossible for the debtor to continue operating and ever get back on its feet. The ensuing chaos would be unfair to the creditors as a whole as well as to the debtor and its owners. There are no debtor's prisons in the United States, but without bankruptcy, it has been suggested, bad things can happen to everyone surrounding an insolvent borrower.

If our reader's right and Oregon cities can't go bankrupt, what will happen if Portland's obligations to pay pensions and bonds make it impossible to run basic services at even a minimal level? With the state's constitutional property tax limitations in place, the city can't raise property taxes above a certain level to keep everything going. Will it simply shut down current operations, and use all property tax collections to pay police retirements and debt service on bonds? Which of those creditors would have priority? And if people aren't getting municipal services, how long will they keep paying their property taxes?

It would be an interesting scenario, to be sure.

So, is the reader correct about this? To our eye, untrained in bankruptcy law and not all that expert on the Oregon Constitution, he may or may not be. The case to which he is probably referring is Enterprise v. State, a 1937 decision involving that picturesque city in the northeastern corner of Oregon. The 1933 Legislature had set up a system whereby a city in default on its debts had to submit to court appointment of an "administrator," who would have broad powers over the defaulting city's operations with the goal of getting the creditors paid off. The state's high court ruled that it would be unconstitutional to force a city's elected governing body to subject itself to that level of interference with its authority. The Supreme Court wrote:

While the administrator's duties are confined to management of the fiscal affairs of the city, his power is, nevertheless, great. He possesses the sole authority to sign its checks, warrants, etc. He possesses a veto power over its contracts. While he has no authority to discharge an elective official, he, nevertheless, has the power to fix the salary of such individual as well as authority to hire, discharge and fix the salaries of all other city employees....

It has been held too many times to require the citation of authority that the power of taxation is a legislative power -- not a function of the judiciary. Likewise, the power to fix the salaries of municipal officers, and to effect municipal contracts is entirely foreign to the judicial branch of our government. Yet this statute undertakes to clothe an officer of the courts with power to be subtracted from municipal officers and to install him in an office which may very truthfully be termed municipal dictator. By appeal from his rulings all of the quarrels of the council chamber concerning legislative and administrative affairs would be transferred to the courtroom. It would become the city hall....

We are firmly convinced that since this act contemplates that the judicial branch of our government shall exercise the above-mentioned legislative and executive functions, it is invalid.
Does Chapter 9 bankruptcy step over the line that the court drew in the Enterprise case?

Perhaps not. An official description of Chapter 9 indicates that the power of the bankruptcy trustee may be sufficiently limited in a municipal case to avoid the separation-of-powers problem that the 1933 Oregon law encountered. The description notes:

Section 904 limits the power of the bankruptcy court to "interfere with – (1) any of the political or governmental powers of the debtor; (2) any of the property or revenues of the debtor; or (3) the debtor's use or enjoyment of any income-producing property" unless the debtor consents or the plan so provides. The provision makes it clear that the debtor's day-to-day activities are not subject to court approval and that the debtor may borrow money without court authority. In addition, the court cannot appoint a trustee (except for limited purposes specified in 11 U.S.C. § 926(a)) and cannot convert the case to a liquidation proceeding.

The court also cannot interfere with the operations of the debtor or with the debtor's use of its property and revenues. This is due, at least in part, to the fact that in a chapter 9 case, there is no property of the estate and thus no estate to administer. 11 U.S.C. § 902(1). Moreover, a chapter 9 debtor may employ professionals without court approval, and the only court review of fees is in the context of plan confirmation, when the court determines the reasonableness of the fees.

The restrictions imposed by 11 U.S.C. § 904 are necessary to ensure the constitutionality of chapter 9 and to avoid the possibility that the court might substitute its control over the political or governmental affairs or property of the debtor for that of the state and the elected officials of the municipality.

Similarly, 11 U.S.C. § 903 states that "chapter [9] does not limit or impair the power of a State to control, by legislation or otherwise, a municipality of or in such State in the exercise of the political or governmental powers of the municipality, including expenditures for such exercise," with two exceptions – a state law prescribing a method of composition of municipal debt does not bind any non-consenting creditor, nor does any judgment entered under such state law bind a nonconsenting creditor.

The description goes on to note that only the local government may commence a Chapter 9 case; it can't be dragged into bankruptcy court by creditors, the way private debtors can. That, too, may distinguish the old Enterprise case -- although courts probably wouldn't allow themselves to become mini-city halls, even if the city council members wanted them to. The key seems to be what level of powers the bankruptcy trustee could exercise.

Anyway, if Portland does find itself in a serious cash flow bind when its various chickens come home to roost, surely folks will be casting an eye on Chapter 9 bankruptcy. Whether that route will actually be available, however, does not seem to be entirely settled. Let's hope the question never comes up -- but we wouldn't bet on that.

Comments (2)

Out of curiosity, do you think it ever dawns on Sam/Randy/Dan (they've been there the longest) that this is an issue with them? I know Randy's fix (at least with PFDR) is to just keep raising taxes.

I think Mr Fish probably understands and I don't even know if Fritz can balance her checkbook or if she just believes touching the hem of Sam's coat will cure all.

Chapter 9 sounds like a good way out.

Selling a lot of bonds to institutional investors with few ties to Oregon would minimize the local impact of chapter 9. If chaper 9 is coming, it would be nice if our noble leaders would find a tactful way to tell local buyers to bid a click too high to win, and to quietly sell bonds not already sold to far-away investors.

Better to have the Swedes pay for our streetcars and soccer stadium than all the grannies in Hillsboro.


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