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Attorney: Judge would put Chicago Public Schools' bankruptcy on 'short leash'

By Amanda Robert | May 23, 2016

CHICAGO - Should the historic budget cuts being planned by Chicago Public Schools not prevent it from going bust, the idea of bankruptcy looms as a possibility.


And should that occur, the judge to whom the case is assigned will play a key role, observers say. His or her role in administering the case would differ from a Chapter 11 corporate reorganization.

In CPS’ case, legislators could consider a bill that would authorize a district bankruptcy, as well as procedures designed to foster negotiation and provide outside oversight of its pre-filing and post-filing activities.

This could include appointing an emergency manager or control board that would work with CPS to develop a restructuring plan and lead negotiations with its creditors.

Bankruptcy attorney David Christian, who heads his own practice in Chicago and Kansas City, Mo., explains that if Illinois passed a bill that has been introduced and CPS opted to file for bankruptcy, a federal bankruptcy judge would rule on motions that govern how the case should proceed and possibly require that CPS engage in the mediation process to move toward a quicker conclusion.

“I think the bankruptcy judge would want to have the case on a very short leash, given the public importance,” Christian said.

Saqib Bhatti, a fellow at the Roosevelt Institute and director of the ReFund America Project in New York, explains that the judge would also collect all of CPS’ bills at the beginning of the case and decide what should and shouldn’t be paid in the short term.

Bhatti says that once CPS – or its emergency manager or control board – introduces a restructuring plan in a Chapter 9 bankruptcy, the district will share it with creditors, who then may file objections with the judge.

Unlike in a Chapter 11 bankruptcy, he says, the judge can only decide whether to accept or reject the restructuring plan.

“In a corporate bankruptcy, the corporation comes up with a plan, people object to that plan and a judge might come up with a whole new plan,” Bhatti said. “In Chapter 9, the idea is that the judge in deciding what to do doesn’t impose his or her plan on the taxpayers. The judge can simply give a thumbs up or thumbs down.”

If the judge rejects the plan, the parties restart the process and develop a new plan.

“It can go back and forth as many times as needed to get a plan passed,” Bhatti said.

In the past few months, Chicago Public Schools have asked principals to help eliminate $85 million from school budgets and required teachers and other employees to take multiple furlough days in an effort to close its imminent $1.1 billion deficit.

CPS has also rallied against Gov. Bruce Rauner’s recent proposal to cut its funding by $74 million a year. According to CPS, the nation’s third-largest school district, its students already receive just 15 percent of Illinois’ education funding even though they make up 20 percent of the state’s enrollment.

Rather than direct more money to financially-strapped CPS, Rauner has publicly supported a legislative measure, introduced by Rep. Ron Sandack, that would allow any local unit of government in Illinois – including school districts – access to Chapter 9 of the federal bankruptcy code.

While arguably not the most popular option, Christian contends that Chapter 9 bankruptcy could serve as a last resort for CPS if the district is unable to sort out its finances.

“When circumstances are dire, and you’re running out of options, or you have no options left, it’s that process that brings everyone together, imposes discipline and creates a requirement as a practical matter, if not as a strict legal matter, that you get something done that solves the problem,” he said.

Christian points out that in some cases, legislation that provides for Chapter 9 bankruptcy also outlines what the municipality can expect during the process. As an example, he refers to Michigan, where state law required that an emergency manager oversee the Detroit bankruptcy and provide a report to the governor before he or she filed the case.

Christian cites other significant differences between Chapter 9 and Chapter 11 bankruptcy, including the inability of the bankruptcy court in a Chapter 9 case to appoint a trustee to take control of the operations of a municipality.

He adds that the same level of permissions and transparency doesn’t exist in Chapter 9 as would be required in Chapter 11. For example, he says, a municipality in a Chapter 9 case can continue its regular operations and expenditures without court approval, unlike a business that obtains debtor-in-possession financing in a Chapter 11 case.

“This all arises out of the nature of the entity as one that exists by virtue of the sovereignty of the state and its relationship to the federal government and the fact that it is financed by the taxpayers, not by private capital,” he said.

Despite their differences, Mark Glennon, managing director at Ninth Street Advisors, a financial planning and consulting firm in Chicago, contends that Chapter 9 and Chapter 11 bankruptcy share an important similarity – improving the debtor’s ability to raise money in the future.

“It is the oldest trick in the book that lenders play in bankruptcy,” Glennon said. “They threaten people and tell them their credit rating will be forever-ruined if they go into bankruptcy. But it’s not like individual bankruptcy.

“Municipality bankruptcy is like corporate bankruptcy. Bankers are quite anxious to lend to companies after bankruptcy or even while they’re in bankruptcy.”

However, like Christian, Glennon contends that bankruptcy isn’t the best option for any particular municipality. He says the question is whether it’s unavoidable, and if so, the municipality should be prepared to face it quickly and efficiently.

Glennon adds that CPS needs to analyze its contracts, assets, liabilities, secured and unsecured debt and pension obligations before the district can answer that question.

“It’s the duty of any officer of a company or a municipality that is in severe trouble to go through the analysis to determine whether a bankruptcy would be a sensible option for all stakeholders,” Glennon said. “That’s not getting done by CPS or anyone else.”

He also points out that since Detroit exited bankruptcy in 2014, the city discovered that it underestimated its pension liability and failed to make needed cuts during the restructuring process.

“That’s why it’s critical that you get this right when you’re in bankruptcy,” Glennon said. “Otherwise you’re locking into a severe problem that’s going to continue.”

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