Deficit-ridden cities that don't dare declare bankruptcy can follow another route to recovery: operating under a court-appointed receiver.

Unlike bankruptcy with its federal code, receivership works under state laws. Forty-eight states have laws providing for municipal receivership in some form, according to James E. Spiotto, a bankruptcy expert at the Chicago-based law firm of Chapman and Cutler. Some states provide for receivership of municipal utilities, others for "virtually any type of municipality," Mr. Spiotto said.

But while a cash-starved city could seek to enter bankruptcy court to re-organize, it would probably not request the imposition of a receiver, and surrender the reins of government.

If a city came under such fiscal strain that it stopped making payments to workers, pension funds, and vendors, it could lead labor unions representing pension beneficiaries to file suit against the city. In 1986, just such a scenario led to a Michigan district court to appoint Louis H. Schimmel receiver for the city of Ecorse, a city of 14,000 south of Detroit. Mr. Schimmel is director of the Municipal Advisory Council of Michigan, a job he has held since 1967.

Combined with work as director of the council, the receiver's job proved brutal. "I ran the city for three years and nine months under court order, replacing the mayor and council," Mr. Schimmel recalled. "It was quite an experience."

Ecorse had run up a $6 million deficit when he took over, Mr. Schmimmel said. "The city never worried about finances, never understood about finances, and didn't know anything about Chapter 9, and didn't care if they ran out of money," Mr. Schimmel said.

As court-appointed receiver, Mr. Schimmel found he wielded absolute power that circumvented the city's elected officials. "They just were there, but they had no authority to do anything," he recalled. "It was definitely unique. I suspended their salary for six months."

Douglas C. Dahn, a labor lawyer at the Troy, Mich.-based firm of Cox & Hodgman who represented Mr. Schimmel, said that the receivership rested on case law in the state.

"There was a case on the books that did say that in certain circumstances a receivership over a public entity might be appropriate." And the only legal challenge to the court-imposed receivership failed on a technicality, Mr. Schimmel said.

From his perspective, receivership offers the best alternative to a city at the end of its fiscal rope. "We think the success of [Ecorse] is a good model to follow."

But what happened in Ecorse, Mich., could be difficult to duplicate in other states.

In Massachusetts, where the state's cities and towns have come under increasing pressure from local aid cuts and the state's Proposition 2 1/2 limit on property tax, bankruptcy and receivership have been bandied about by local officials as though they were interchangeable. But "they're two different things," said Jeffrey Sternklar, a partner in the Boston law firm of Burns & Levinson.

The firm is sponsoring a panel discussion Thursday in Boston to delve into "alternatives to municipal bankruptcy," including receivership.

But it is unclear whether receivership, in which a court appoints a financial overseer with broad powers, could even work in the Bay State.

In Massachusetts, no provisions exist that would allow imposition of a receiver by a court, according to James W. Segal, who is counsel at the law firm of Hale & Dorr. When the state's Department of Revenue appoints a finance board, "it's only done with the consent of the municipality," added Mr. Segal, who served as executive director of the Massachusetts Municipal Association.

Massachusetts has established boards for a number of fiscally troubled cities, beginning in 1931 with Fall River, Mr. Sternklar said. Recently, it set up a control board for the city of Brockton.

A financial control board, according to Mr. Spiotto, is "a variation" of the strictly defined receivership situation, in which the receiver "acts as the manager" of a municipal body.

Mr. Schimmel, for his part, takes a dim view of municipal bankruptcy. "I don't think municipalities lend themselves to bankruptcy at all," Mr. Schimmel said in a recent telephone interview. "Municipalities are not entities that are designed to go out of business if they don't break even," he said. "If you have bankruptcy in a corporation, you sell assets and pay everybody off at 50 cents on the dollar. In a city, you still have to provide services. It seems to take an outsider to come in and make the hard decisions," Mr. Schimmel said.

Not everyone shares his enthusiasm for receivership, however.

"I can't believe it would be a preferred method of reorganizing a city's problems," said Jeffrey Cohen, a specialist in municipal bankruptcy at the Denver-based firm of Cohen & Associates.

Any receiver without Mr. Schimmel's level of experience, and especially overseeing a city larger than Ecorse, would encounter extreme difficulty.

"You will have an independent person judging or making decisions for the city. The quality of decisions that are made may leave a whole lot to be desired. It would require quite a learning curve, that's the first problem."

Another problem would arise on legal grounds. "In municipal situations," Mr. Cohen said, receivership "would seem to be very unwieldy, since almost anybody would have standing to object to what this receiver would do."

Receivership could work only in a small city like Ecorse. "When you have a major city, you're going to have some major interests fighting" the receiver, Mr. Cohen said. "How can a state court run an executive and legislative branch? It would run into so many problems when you get into a medium-sized Northeast city, the issues are so numerous that it would not be feasible."

Or, as Mr. Spiotto of Chapman & Cutler puts it, for a large and complicated city, "Chapter 9 may be a better alternative, because it allows elected municipal officials to continue operations, while still having to come up with their own plan."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.