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While focus remains on Detroit’s attempt to exit bankruptcy, state legislatures outside of Michigan are experimenting with new tools to ensure that distressed municipalities address their debt issues. One such state, Pennsylvania, is hoping to reform its Municipalities Financial Recovery Act to prevent municipalities from remaining in the state-run program in perpetuity.

Since 1987, 26 Pennsylvania cities have voluntarily entered the program, which is meant to facilitate the adjustment of municipal debt by negotiated agreement with creditors. Only six have successfully exited, while the other municipalities – including Pittsburgh, Harrisburg and Scranton – remain. Some cities have been operating in the program for more than 20 years. Why? The MFRA provides cities operating under its program access to tax revenue that other municipalities aren’t provided. Thus, the MFRA has turned into a glorified subsidy for distressed municipalities, without providing them any true incentive to complete negotiations with their creditors.

In order to stop this free-ride, the Pennsylvania Senate recently passed an amendment to MFRA limiting a municipality to spending five years in the program. If the municipality cannot turn around its finances in that time, a receiver – much like the emergency manager in Detroit – could be put into place. The receiver would then have the power to put the municipality into a bankruptcy under chapter
nine of the Bankruptcy Code. The amendment needs to be approved by the Pennsylvania House of Representatives and the Governor, but, if ratified, the amendment could be a major incentive for Pennsylvania municipalities to get their finances in order.

If Detroit’s bankruptcy proves successful, look for more states to try to force their distressed municipalities to solve their financial problems. Chapter nine of the Bankruptcy Code does not allow a municipality to declare bankruptcy unless it is authorized to do so under state law. As Detroit and Pennsylvania show, states are becoming willing to “authorize by force” and put distressed municipalities into bankruptcy against their will.

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