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Why Bankruptcy is not an option

Why Bankruptcy is not an option

Government Finance Officers Association recommends that municipalities make every effort to avoid bankruptcy. Bankruptcy will cause a serious cost on the community’s reputation and the government’s creditworthiness. The harm to the community’s reputation could sap its economic vitality and will increase the government’s cost of borrowing which will deter industrial investment. Besides these costs, the cash outlays required to go through the court proceedings are significant. Legal, consulting fees and staff time preparing for hearings and responding to requests for information could easily reach into the millions of dollars. Finally, bankruptcy is not a cure-all. As a practical matter, a judge is unlikely to completely void any of the municipality’s obligations (so debts and bondholders will still need to be paid). As a matter of law, a judge cannot override provisions of state law that may be contributing to the municipality’s financial distress, such as public employee pension benefits that are bankruptcy.

Although bankruptcy may provide some additional latitude to local government officials, in the end, it's the municipality’s management and elected officials who still must make the hard choices required to reach financial health. Lower bond ratings will increase borrowing costs for those entities at a time when many of them are struggling financially because of a steep drop in tax revenue. When all else fails in the recovery process, local government may have the ability to file for protection under chapter 9 of the United States Bankruptcy Code. If bankruptcy becomes a serious option, then the local government should first engage stakeholders on the possibility of renegotiating obligations in order to avoid bankruptcy. Labor unions may prefer to renegotiate rather than submit to the possibility of having their contract voided in court. Creditors may be willing to restructure debts. Governments need to consider all the possibilities to resolve their fiscal distress and gain a clear understanding of what bankruptcy can and can't do before moving forward.