Jon Henes: Bankruptcy Law for States: Rhetoric Vs. Reality

One thing is clear from the debate over whether a bankruptcy law should be enacted for states—bankruptcy as a concept and a process is misunderstood.

Importantly, Congress is digging into the issue as committees are beginning to hear testimony, which hopefully will create a greater public understanding of bankruptcy's virtues and tools.

Much education needs to be done.A New York Times editorial characterized the idea of a bankruptcy law for states as “pernicious,” stating that the purpose of such a law would be to tear up union contracts and negate pension obligations.

The editorial’s proposed solution for state governments? Threaten to “lay off workers” and remind both the public and union members that financial emergencies require sacrifice. This editorial - as well as others like it- demonstrates a wide-spread misconception of what a bankruptcy law for states would really mean.

The purpose of a state bankruptcy law would not be to tear up union contracts or eliminate pension obligations - although theoretically this could happen.

And the enactment of a state bankruptcy law would not roil the municipal bond market. Rather, the purpose of such a bankruptcy law would be to enable states to fix their fiscal issues through good-faith negotiations with their unions and other stakeholders, strengthen their fiscal foundation and enable them to emerge from the bankruptcy process stronger than when they went in, with the ability to attract municipal bond investors at a low cost.

Bankruptcy is not a “magic-bullet” for states, which will allow governors to simply snap their fingers to eliminate public pension and retire obligations.

Indeed, the elimination of these important obligations should not be seriously considered by anyone. What should and must be considered is how to modify these obligations so states responsibly can afford them over the long-term, while treating both taxpayers and public employees and retirees fairly.

"Bankruptcy is not a weapon provided to a financially distressed corporation or a municipality to eviscerate the rights of creditors - and it would not be a weapon for states."

The creation of a bankruptcy process for states can do this. It is no secret that a multitude of private companies - including companies in the automotive, airline, and steel industries - have filed for bankruptcy due to unaffordable pension and other retiree costs.

It is important to remember, however, that the Bankruptcy Code permits a company to terminate or modify its collective bargaining agreements with bankruptcy court approval only if it meets stringent requirements.

Consequently, in the vast majority of situations, rather than leaving the decision for a bankruptcy judge, a company and its union reach a consensual agreement on modifications to obligations under collective bargaining agreements.

Bankruptcy is not a weapon provided to a financially distressed corporation or a municipality to eviscerate the rights of creditors—and it would not be a weapon for states.

Bankruptcy is a process that permits a debtor and its stakeholders to negotiate in good faith in an attempt to reach consensus. Indeed, negotiated resolutions are preferred in bankruptcy. Bankruptcy also keeps a debtor and its stakeholders honest as the absence of a negotiated resolution leaves the decision in the hands of a bankruptcy judge.

For states in the throes of fiscal woes a bankruptcy law would not eliminate the need for hard work and government responsibility. What it would do is give states a process to once and for all negotiate a comprehensive and effective resolution to their fiscal problems.

Jon Henes is a partner in the Restructuring Group of the law firm of Kirkland & Ellis. Jon's practice involves representing debtors (including portfolio, privately-held and public companies), creditors' committees and distressed investors (including hedge funds, private equity funds and companies) in acquisitions, restructurings and bankruptcy cases.