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What has happened when a city goes bankrupt? Is the "municipal corporation" dissolved? What stands in its place? Do the creditors take over City Hall and the city's streets and alleys? Can the creditors obtain a lien on the city's primary source of income: taxes? Can the bankruptcy court override the decisions of elected officials regarding taxation and spending? How high must taxes go, how low must services get, and who decides? Who are the residual stakeholders? Can we pierce the municipal "corporate veil?" If we do, who is behind it? What is the role of the state?
As these questions suggest, the bankruptcy of a municipal corporation raises fundamental issues regarding the nature of the city, and a study of municipal bankruptcy promises to shed considerable light on the scholarly debate over its legal status. Yet the subject of municipal bankruptcy has received little attention in the legal literature.1. The subject is apparently of too little practical financial importance to attract the attention of bankruptcy scholars (there are, after all, few municipal bankruptcies), but of such daunting technical complexity that it has discouraged serious in investigation by local government specialists.2. It is our intention to bridge these two fields of legal scholarship by exploring the meaning of bankruptcy in the context of municipal corporations and what this has to say about the legal structure of cities and their relation to their citizens, their states, their creditors, and the courts.
The perennial problem of bankruptcy is twofold. At the front end, cities and other borrowers need to be able to make credible, legally-enforceable promises to repay--or no one would be willing to lend to them. This requires a legal regime strong enough to overcome the "moral hazard" problem--the tendency of debtors to prefer to devote their resources to their own interests instead of repaying their debts. At the back end, it is not always possible to pay, and it is in the interest of all (creditors as well as debtors) to reach an accommodation when this eventuality occurs. This may require coercion of unwilling parties, since individual creditors may find it in their interest to resist a solution even when it is in the interest of the creditors as a whole. This is the...