By Joseph N. DiStefano

What happens when a town runs out of money?

In cities and townships around Pennsylvania, income, sales and property tax collections have fallen as the recession drags on.

But municipal expenses haven’t gone away. Roads need work. Crime and fires still need fighting. Health and pension costs keep rising.

So local governments, the biggest employers in many communities, cut services and jobs. “It becomes a really tough downward spiral,” said public-finance partner William Rhodes at law firm Ballard Spahrin Philadelphia.

A few towns see another way to ease costs. Westfall Township, in Pennsylvania’s northeast tip, cut millions from its debts last month as the first town in state history to successfully reorganize under Chapter 9 of the federal bankruptcy code.

In Harrisburg, City Controller Dan Miller calls bankruptcy “an option” to cut the state capital’s towering debt after the local authority failed to make payments on its bungled incinerator, deputy controller Bill Leinberger told me.

Chapter 9 leaves local officials in control of towns as they negotiate with creditors to delay or cut public debts. That’s in contrast with Chapter 11 bankruptcy, which gives creditors influence, and often control, over private companies that can’t pay what they owe.

Until now, it’s been a last resort. Westfall faced an unusual, crushing expense from a legal settlement. Harrisburg Mayor Linda D. Thompson and other officials are reviewing the sale of city property, and service and wage cuts recommended by state advisers, to avoid bankruptcy. Philadelphia hasn’t considered Chapter 9, says finance chief Rob Dubow.

Spending in Chester, Pittsburgh, Reading, Scranton and other financially troubled Pennsylvania cities is monitored by state advisers under Act 47, which gives distressed towns state financial support and flexibility from state rules in exchange for spending curbs. Philadelphia has a separate, similar fiscal-oversight board.

Fred Reddig, who heads the local-government office in the state Department of Community and Economic Development, calls Act 47 “a safety net to deal with a municipality that has fallen over the cliff. Hitting the bottom, that would be a Chapter 9 filing.”

A town’s bankruptcy “would affect the interest rates [nearby] municipalities have to pay” to borrow money between tax collections and for capital projects, said James Roberts, a partner at Eckert Seamans Cherin & Mellott L.L.C. in Pittsburgh, who’s been hired by the state to work with that city and has advised other distressed towns.

Reddig says towns including Chester and Wilkinsburg have used Act 47 powers to force cuts in public-worker wages and employee health spending.

So far, they haven’t used it to try to cut future municipal pensions, which towns have systematically underfunded across the state, making them potentially the biggest drain on public resources.

There’s no legal reason towns couldn’t use the act’s provisions, or even bankruptcy, to push for lower-cost pension programs for future retirees, Reddig told me.


Westfall’s problems were “unique,” says J. Gregg Miller of Pepper Hamilton L.L.P. in Philadelphia, who represented the township in its bankruptcy: The township owed developers $20 million, more than 10 times its yearly budget, from a court award in a long-running land-use dispute. When the developers tried to collect, Westfall filed for bankruptcy, with the state’s support.

The Chapter 9 plan shaved more than half off what Westfall owed and gave the township 20 years to pay, in installments. Even so, Westfall had to raise its real estate tax rate 25 percent.

Even when states don’t oppose a town’s declaring bankruptcy, Chapter 9 is expensive and time-consuming, because creditors typically fight it in court, forcing towns to spend extra on proving they’re broke, said Miller.

Still, “Westfall’s important” because it shows it can be done, said Rhodes, at Ballard Spahr.

“The reality is that state and local governments and their fiscal health will be the last thing to recover in this Great Recession,” he told me. “It’s hit them in so many ways,” from pension-investment losses to lower tax hauls.

If the economy stays slow for another three to five years, as bank analysts expect, municipal governments could be looking at a “lost decade” of relentless cuts, Rhodes said.

For the desperate, that could make Chapter 9 bankruptcy a less ugly choice.

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