Pennsylvania State Law aka Act 47

I read this article in the Pittsburgh Tribune Review:(http://www.pittsburghlive.com/x/pittsburghtrib/news/s_672744.html) and it got me thinking about state oversight of financially distressed municipalities. Under Pennsylvania state law (commonly referred to as Act 47), municipalities in the Commonwealth are not eligible to file for federal bankruptcy protection without first implementing a financial recovery plan overseen by a state appointed board.

This approach to municipal reorganization stands in stark contrast to the federal bankruptcy code. Under the state law, a distressed municipality attempts to cut expenses and increase revenue in an effort to pay off its debts. The result is often a myriad of political “quick-fixes,” such as new taxes, elimination of social programs, and the sale or lease of municipal assets, such as parking garages.

The state system lacks two significant components that the bankruptcy code provides to distressed companies or municipalities to assist in reorganization. First, Act 47 does not allow for the discharge of debts. Instead, Act 47 requires that the municipality attempt to restructure certain debts or pay them off with a lump sum. Of course, financially distressed municipalities usually lack the cash flow to make lump sum payments on large debts. Similarly, Act 47 does not allow municipalities to cancel unfavorable contracts. The inability to discharge debts and cancel unprofitable contracts would have proven fatal to several big companies that have emerged from Chapter 11 Bankruptcy over the past two decades; GM, US Airways, and the Pittsburgh Penguins, just to name a few.

Second, the Bankruptcy Code gives corporate debtors the ability to “cram down” union contracts for the best interest of all creditors. In other words, the Bankruptcy Code allows union contracts to be reasonably restructured so that the company’s employees do not sap all of the company’s future revenue, leaving nothing for creditors. Act 47 system has no such provision and, in fact, relies exclusively on the political leaders of the municipality – often unions’ closest allies – to enact changes in applicable collective bargaining agreements. Such a system is destined to fail and has done so, repeatedly.

The Tribune Review reports that 25 municipalities have entered Act 47 oversight but only 6 have escaped. Proof of Act 47’s shortcomings can be seen right here in Pittsburgh, which was forced into this state form of receivership in 2004 and has spent nearly 6 years attempting to right its financial ship, but to no avail. As of this writing, Pittsburgh’s employee pensions have only 30% of the money necessary to fund future payouts. Unions have refused to agree to reduce their benefits and the politicians responsible for forcing such concessions lack the political backbone to press for change. In short, politics has taken over and, 6 years later, the City is still on the verge of bankruptcy. How has Act 47 helped the City of Pittsburgh? It hasn’t.

With the economic downturn and lack of revenue, more and more municipalities in Pennsylvania are at risk of falling into Act 47 protection. Those municipalities are staring at five to ten years of financial purgatory, during which no meaningful changes take place and bankruptcy continues to loom on the horizon. I say let Pennsylvania municipalities file bankruptcy.