When Mayor Mary C. Moran of Bridgeport, Conn., filed a petition in the U.S. Bankrutpcy Court last month, she vowed to protect owners of her city's bonds.
Municipal market participants are relying on that pledge, as well as a belief that the city's bankruptcy bid will fail because of legal challenges from the state.
Connecticut has said Bridgeport's filing violates laws at all levels: the city's own charter, state statute, and Chapter 9 of the federal Bankruptcy Code, the chapter under which Bridgeport filed its petition.
"We're taking the state's word for it that Bridgeport does not have the authority to go out and do what they're trying to do," said one municipal bond analyst at a major Wall Street securities firm. "However, we do not pretend to be lawyers."
Such trust, according to one source, recently led a bottom-fishing brokerage firm to buy a small quantity of Bridgeport bonds, which offered a handsome 8.50% yield shortly after the bankruptcy filing.
But the market's trust may be misplaced, according to rating agencies and legal experts. Moody's Investors Service, for one, downplayed the city's promises of loyalty to bondholders.
"We place no reliance on the city's assertion in the bankruptcy filing that it intends to protect bondholders rights," the agency said in a statement dated June 18. "To the contrary, given the nature of the city's filing and the city's previous positions regarding the review board and threatened bankruptcy, further unanticipated actions by the city may occur."
And entering bankruptcy court may not prove as difficult as Wall Street and state officials hope. Even Attorney General Richard Blumenthal, leader of the state's efforts to derail the city's petition, has admitted that some existing case law favors Bridgeport's position.
"There is authority from around the country on both sides," the attorney general said late last month in the first public hearings concerning the city's petition.
If the city does gain entrance to the court, owners of the city's $71 million of uninsured bonds may have nothing to rely on but the pledge of Bridgeport officials.
Mahesh Reddy, the city's budget chief, reiterated the pledge this week. "In our reorganization plan, we will show that bond indebtedness is not one of the options," he vowed.
If Bridgeport is allowed to enter Chapter 9 bankruptcy, vows to bondholders may not figure into the plan approved by the court. James E. Spiotto, a lawyer with the Chicago-based law firm of Chapman & Cutler and the nation's leading authority on municipal bankruptcy, said the city's promise could evaporate "if it becomes an obstacle to the judge apporving the plan."
Jeffrey Cohen, a lawyer at the Denver-based firm of Cohen & Associates, said that if the city gains access to bankruptcy court, bondholders could be forced to surrender their most-favored creditor status.
"Someone is going to have to take a haircut," Mr. Cohen said. "If the city pledges that the bondholders will not be touched, then other people in the case will have to take the haircut. You're going to have to get the labor unions to vote in favor of any plan."
In bankruptcy proceedings, a court segregates creditors into classes. In each class, creditors with two-thirds of the total value of claims and half the number must vote in favor of a plan for its approval.
If at least one class of aggrived creditors approves a reorganization plan, then the judge can "cram it down each dissenting class," said Jeffrey D. Sternklar, a lawyer with the Boston-based firm Burns & Levinson. "In municipal bankruptcy," he said, "creditors must get pretty much all they can be expected to get under the circumstances. That means the municipality must have exercised its taxing power to the fullest."
Another simple risk in the Bridgeport case, according to Mr. Spiotto, stems from the very conditions that drove the city to seek bankruptcy court protection in the first place. If "cash flow from taxes decreases, and they just don't have the cash available," Bridgeport officials might renege on promises to bondholders.
On the other hand, according to Mr. Spiotto, Chapter 9 cases have shown that municipalities usually keep promises for fear of being banished from the credit market.
"The cities that have said they would continue to pay have honored that," Mr. Spiotto said, referring to cases including the 1983 San Jose [California] Unified School District bankruptcy filing.
In that case, the fiscally ailing district also felt a need to inform the credit markets of good intentions.
"Even as the school district filed, it became immediately evident that the district had to make clear to the system's bondholders that the action would not in any way impair their rights," said Iola Williams, then a San Jose city council member testifying in Washington on behalf of of 1988 ammendments to the code.
The district, according to Ms. Williams's testimony, "did not treat its pledge to its bondholders as terminated because of the filing, but rather, continued to collect taxes which were made available to the district in order to continue to make payments, as pledged, to the bondholders."
Bridgeport bondholders can likewise take comfort from that city's self-interest. "You need access to the credit markets," Mr. Spiotto said. Borrowing for infrastructure as well as cash flow has become essential to cities of Bridgeport's size.
"If they say at first they will honor their debts [to bondholders] and then fail to do so," Mr. Spiotto predicted, "it will certainly have an effect on the credit market's view of their willingness to pay."
So far, the city has made good on its promises to protect bondholders. On July 1, it paid $26,121 in interest.
But will the promises be enough to ensure that the $27 million in debt service Bridgeport owes between now and mid-June 1992 will be paid?
"Absent some collateral, that's all they are -- promises," Mr. Cohen said. "I think that's still far from clear."
Bondholders may take some comfort in the city's intercept mechanism, which was imposed as part of the 1988 legislation that established a state review board for the city's finances.
The intercept takes all city "taxes interest, penalties, and other charges" and sets it aside for debt service first. How that protective device would function in the context of a bankruptcy is unclear.
James H. Lloyd 3d, an attorney at Bridgeport's bond counsel, the Hartford-based Updike, Kelly & Spellacy, would not speculate.
"That kind of comment would have to be premised on very thorough evaluation," he said. "We have not been retained by Bridgeport in connection with the bankruptcy. We have not been asked to evaluate the effect that the filing might have on bondholders."
