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Chicago Public Schools Bankruptcy?

posted by Jason Kilborn

SchoolbankruptThe local press has been abuzz the last two days with talk of Illinois Republicans' plans to take over Chicago Public Schools (CPS) and allow/force it to file for municipal bankruptcy. I immediately wondered whether this was just political rhetoric, part of Governor Rauner's quite clear plan to undermine public union power, especially in the school system, or if bankruptcy was the right tool for what ails CPS. As my image here suggests, it seems to me ... not so much; that is, CPS isn't quite "bankrupt" in the sense that Chapter 9 might help.  Not yet, and maybe not ever.

I will never forget a phrase I first heard from Tom Moloney, a bankruptcy partner at New York law firm Cleary, Gottlieb, where I started my law career. He explained to a potential client that bankruptcy could help clean up balance-sheet problems, but it provided little help with cash-flow problems. So what kind of problem does CPS have? A bit of searching revealed that CPS has a bit of both, but I'm not convinced that debt relief would be the main goal of a CPS bankruptcy filing. Its 2015 audit report, released about a month ago, certainly does reflect nearly $7 billion in bond debt. But this is mainly long-term debt. CPS doesn't seem to be insolvent in the Chapter 9 sense--it has been managing to pay its bills (including debt service) as they come due by collecting larger property and replacement (business) tax revenues and accessing the bond market, despite its plummeting credit rating. CPS's ordinary debt service amounts to only about $500 million a year, a small fraction of its nearly $7 billion budget. CPS seems to have two main problems (no surprise): labor and pensions.

Back to where I started, it seems the main purpose of a Chapter 9 filing would be to provide leverage for CPS in union negotiations. "Instruction" understandably represents the largest budget line and about half of the CPS budget. The relationship between CPS and the teachers' union has been strained in recent years, to put it mildly, with the union threatening another imminent strike just recently. Public authorities like CPS have little to no leverage in negotiations with a public union, especially the massive and powerful teachers' union. This makes talk of the smallest of labor concessions (such as small contributions to health care costs, salary freezes, or reductions in planned raises, to say nothing of staffing reductions) either monumentally difficult or impossible. Chapter 9 bankruptcy seems to be about the only real leverage that CPS and other public employers have in dealing with public unions, though I wonder whether even that would be enough in light of the acrimony I've witnessed here in the city. Recall that the Detroit unions ultimately agreed to concessions in the "grand bargain" in that landmark case. I don't see an infusion of cash from foundations or the state to encourage teachers' union compromise with CPS, and I doubt that a crammed down Chapter 9 plan could avert a system-wide strike. A CPS bankruptcy would very likely put federal labor and bankruptcy laws on a collision course, and it does not seem certain that bankruptcy would win.

Another significant, and related, concern is CPS's rapidly expanding obligation to shore up a nearly 50% underfunding in its $9.5 billion pension fund (CPS is the only Illinois school district that has its own pension fund). A new law requires CPS to move toward 90% funding by mid-century, which requires an annual pension fund contribution of over $600 million and rising (this in light of an absolutely laughable assumed 7.75% rate of investment return!). Rulings in the Detroit and Stockton cases that pensions can be cut despite state constitutional protection demonstrate another area where only Chapter 9 can provide public employers the leverage to escape otherwise inviolate but practically unsustainable pension debts. Again, even though sections 1113 and 1114 do not apply in Chapter 9 cases, I would anticipate that the teachers' union would put up a much greater fight against CPS efforts to reduce pension debts and retiree health obligations, up to and including a strike.

This whole situation thus seems potentially much messier than I suspect Illinois Republicans have anticipated. While CPS does have a balance-sheet problem of sorts, especially with respect to pension debt, its main issues are inextricably linked to labor relations (cash flow). I'm not sure Chapter 9 will provide the bulldozer than Governor Rauner wants and expects it to be, and in any event, it will be some time before CPS is in the dire financial situation that Detroit was in (or that Chicago State University will be in as of March). In any event, for now, talk of a CPS (or Chicago) bankruptcy seems to be pure and possibly empty rhetoric.

Chalkboard image courtesy of Shutterstock


Ok, the cash flow vs balance sheet thing sounds like you didn't quite understand what Tom was saying. Bankruptcy can absolutely help cash flow issues, if those issues are the result of liabilities coming due.

If your cash flow issues are that you did a ton of borrowing, and can't pay it back, that is a balance sheet issue bleeding into cash flow.

If you have operations that don't have positive cashflow, bankruptcy won't help you. If you have massive debts (both pension obligations and bonds) that you are going to otherwise have to repay in the next 5 years, and your operations generate positive cash flow, just not enough to cover the debts coming due, that is exactly the kind of thing bankruptcy can help with.

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