Panel Urges Bankruptcy Law Changes

Wall Street bond specialists, citing concerns that arose when Orange County filed the largest municipal bankruptcy in U.S. history, called Tuesday for reforms to the municipal bankruptcy law.

The reforms are designed to give bondholders a stronger voice in bankruptcy proceedings. As part of the reforms, a municipality would be required to give notice to the state before it filed bankruptcy, and a municipality in bankruptcy would have to pay bondholders if it had the resources.

“This would generally strengthen the rights of municipal bondholders versus a troubled municipality,” said Bruce Bennett, lawyer for bankrupt Orange County, who did not help draft the recommendations. “It would make it more difficult for a troubled municipality to continue to provide services at a time when it’s in default on debt.”

Under current Chapter 9 bankruptcy code, which governs municipal bankruptcies, debtors such as a county retain most authority in a bankruptcy. In corporate bankruptcies, however, a judge and creditors have more power than a company to determine policy.

The municipal section of the bankruptcy code was written in the 1930s and most recently updated in the 1970s.

Orange County filed for bankruptcy on Dec. 6, 1994, a move that sent shock waves through the entire municipal bond market and made it more costly for other local governments there to borrow money. It even temporarily hampered the U.S. Treasury market.

The proposed reforms were prompted by concerns that Orange County unfairly penalized bond investors by declaring bankruptcy when it had the ability to raise taxes to pay its debts.

The reforms would help keep intact the workings of the municipal bond market and allow local governments to continue selling low-cost debt by reassuring bondholders.

Charles Forest, an investment banker with A.G. Edwards & Sons, Orange County’s underwriting firm and a committee member, said it was time to amend the law.

“So many things bought and sold in the municipal market today are very different than what was in the market even 20 years ago,” Forest said.

The Ad Hoc Committee on Municipal Bankruptcy Law Reform, which issued the recommendations, will complete a final study in May and is talking to legislators who might sponsor new legislation that would include the reforms.