Beyond the Great Divide: Federalism Concerns in Municipal Insolvency

Source: Andrew Dawson, University of Miami Legal Studies Research Paper No. 16-15, March 3, 2016

From the abstract:
A growing number of municipalities suffer extreme financial distress, a problem which states may seek to address either under local law or with the aid of federal bankruptcy relief. There is an unresolved tension in how these two options interact. If a state chooses the bankruptcy option, do state laws nonetheless operate to protect the interests of certain classes of creditors? If a state does not use bankruptcy, might bankruptcy law nonetheless limit the state’s ability to adjust the municipality’s debts?

These questions raise important federalism concerns that have thus far been analyzed under what this article calls the Great Divide Model of municipal bankruptcy federalism: Congress has the exclusive power to adjust debts (i.e., financial restructuring), while states have the exclusive power to address local governance (i.e., operational restructuring).

This article challenges this model as inconsistent with the practical realities of municipal financial distress and its resolutions. Debt and governance go hand in hand, both in causing and resolving financial distress. The federalism questions in municipal insolvency are better framed within a cooperative model of municipal bankruptcy, which involves analyzing the limits of the bankruptcy power in this realm and the state interests in local governance.