Experts disagree on extending bankruptcy option to troubled states

UHLC’s Houston Law Review hosts 17th Annual Frankel Lecture

David Skeel, S. Samuel Arsht Professor of Corporate Law at the University of Pennsylvania Law School Panelists Claton P. Gillette, Anna Gelpern, and David Skeel answer questions from the audience during the 17th Annual Frankel Lecture.
David Skeel, S. Samuel Arsht Professor of Corporate Law at the University of Pennsylvania Law School Panelists Claton P. Gillette, Anna Gelpern, and David Skeel answer questions from the audience during the 17th Annual Frankel Lecture.

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Nov. 2, 2012 -- A panel of financial and government law experts agreed Friday that excessive debt has proved ruinous for states such as California and Illinois, but differed on whether extending Chapter 9 bankruptcy filing to include states is the solution to their troubles.

Currently, Chapter 9 restructuring is available only to municipalities such as cities, counties, and various other government entities.

Three renowned law school professors explored the pros and cons of extending Chapter 9 to include states during the 17th Annual Frankel Lecture hosted by the Houston Law Review of the University of Houston Law Center. Professor Jim Hawkins served as moderator.

“States are an awful lot like consumers, they borrow too much,” said David Skeel, a professor of corporate law at the University of Pennsylvania Law School. “State politicians are a little bit like teen-agers with a credit card,” added the keynote speaker, a strong proponent of extending bankruptcy to states.

The option of state bankruptcy might encourage creditors to negotiate on outstanding debts, Skeel said, and rein in lawmakers who tend not to worry about paying off debts down the road. It also might make lenders more wary, he said, and allow for debt restructuring, including a small amount of pension underfunding. Bankruptcy would require all creditors to be treated equally, including taxpayers in terms of service cutbacks and public employees, both of whom are generally hit hardest in a tight economy. State bankruptcy, Skeel said, would allow a more orderly restructuring of debt and state finances as an alternative to a massive federal bailout or insolvency.

Skeel also said the U.S. Supreme Court’s decision striking down the extension of Medicaid as interference in state sovereignty might lend new impetus to the issue of state bankruptcy. He also noted the ongoing financial crisis in Europe is “surprisingly relevant” to the U.S. debate in that members of the European Union are somewhat comparable to states here. The bottom line solution, he said, is for the EU to exert greater control over member countries, which he said would meet too much resistance. Bankruptcy is the much more attractive option for beleaguered countries such as Greece, Italy, and Spain, he said.

“I do agree that the case for state bankruptcy is not a slam dunk,” he concluded, adding that there are valid arguments on both sides.

But, the first commentator Anna Gelpern, professor at American University of Washington College of Law, agreed with Skeel, in part. “I’m the first to admit that there are many things wrong with sovereign debt restructuring today,” she said. “Governments have too much debt. Too much debt is inefficient, (and) takes away the debtor’s autonomy.” She said, however, she fears the spillover effect of how bankruptcy might affect the bond market and concern that debt restructuring would not be enforceable because of sovereign immunity. Bankruptcy does not automatically mean justice for public employees and others, she said, because fragmentation and inequality would remain real problems. 

“I don’t disagree that state bankruptcy might have benefits,” said the second commentator, Clayton P. Gillette, professor at New York University School of Law. “I’m very skeptical.” His concerns, he said, are the unintended consequences that might occur in the bond market and the possibility that the option of filing for bankruptcy might actually encourage irresponsible or reckless behavior by lawmakers. “My concern is that we can’t foresee everything that might happen,” he concluded.

In his closing comment, Skeel said, “I agree with their bottom line that we don’t know if state bankruptcy is a good idea or a bad idea.” But, he said, “They seem to feel we can ‘muddle through,’ while I feel we need a more structured rule of law.”

Click here to watch a video of the event.

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