By Nick Brown
(Reuters) - You might think the capital city of a U.S. state would tap a high-powered, national law firm to handle its bankruptcy case. But when Harrisburg, Pennsylvania filed for bankruptcy last week, it hired a one-lawyer, local shop with no bankruptcy experience.
That's because complex political issues at the heart of most municipal bankruptcies can create obstacles that even the savviest corporate bankruptcy guru can't always solve.
So Harrisburg and other cities facing tough budget decisions often turn to lawyers with a better understanding of local politicians, and the various agendas trying to influence them.
"Asking any politician to put a gun to his head and make a decision that will have political ramifications is naive," said Bill Brandt, president and chief executive of turnaround firm Development Specialists Inc. "Your first order is to decide what in fact is accomplishable in that arena, which differs from a corporate bankruptcy."
There's also the issue of money: struggling municipalities can rarely afford the high fees a big firm can charge a large corporate client.
"Most municipalities that get into trouble are fairly small," said Richard Levin, a partner at Cravath Swaine & Moore. "They're not going to hire New York law firms or firms that charge those prices."
Harrisburg's City Council hired Cravath, one of the biggest U.S. law firms, on a pro bono basis in November 2010 to advise the debt-laden city as it lurched toward bankruptcy. Cravath said at the time it planned to "also represent the city in any Chapter 9 filing," touting its broad bankruptcy experience.
But the relationship did not last. Facing debt approaching $400 million related to an expensive revamp of its incinerator, and a raging battle with the mayor, governor and bondholders, the council turned to lawyer Mark Schwartz instead of Cravath to get it through bankruptcy proceedings.
A solo practitioner based in nearby Bryn Mawr, Pennsylvania, who was trained as a bond lawyer, Schwartz believes politics got in the way of Cravath getting the job.
"I said to, 'I bet you guys ran into a political buzz saw, right?' And they said 'That's right, we didn't really think about what the local politics were,'" he told Reuters. "Certain council members wanted them to go one way, the mayor wanted them to go another."
Levin, who led the Cravath team in Harrisburg, declined to comment on Schwartz's remarks as well as specifics of why Cravath was not retained for the city's bankruptcy.
Lawyers who get hired for municipal bankruptcies typically have a deep understanding of politics.
Schwartz worked as a legislative assistant in the Pennsylvania House of Representatives where he helped direct the House Rules Committee, and said the experience helped prepare him for municipal restructuring.
The handful of big firms that do municipal restructuring work have lawyers with similar backgrounds.
Cravath's Levin once worked for the House Judiciary Committee and helped draft the 1978 Bankruptcy Code. He has since represented the city of Gardena, California, the New York City Off-Track Betting Corp and several small municipalities in financial turnarounds. Cravath hired him from Skadden Arps Slate Meagher & Flom in 2007.
Other top lawyers known for municipal bankruptcy work include Kenneth Klee, whose firm, Klee Tuchin Bogdanoff & Stern, was hired by Jefferson County, Alabama, during a financial crisis earlier this year, and James Spiotto of Chapman and Cutler, which represented bondholders in the 2009 Sierra Kings Health Care District bankruptcy in California.
Klee, like Levin, helped draft the bankruptcy code for the House Judiciary Committee, while Spiotto advised Congress on amendments to Chapter 9 in the 1980s.
Law firm Dewey & LeBoeuf earlier this year hired Bruce Bennett, who in the 1990s represented Orange County, California in the largest-ever Chapter 9 bankruptcy.
But Bennett, whose high-profile corporate cases include counseling the bankrupt Los Angeles Dodgers, said Chapter 9 is simply too rare for a significant industry to grow around it.
"I don't think one could call municipal restructuring and bankruptcy a separate practice area or that there will ever be enough cases to justify classification as a separate practice," he said.
Only 630 Chapter 9 cases have been filed since 1937, according to data from Spiotto. That compares to more than 13,000 cases in 2010 alone filed under Chapter 11, which governs debt restructuring, usually for corporations, he said.
When municipalities are in dire financial straits, work is also available for financial advisers and turnaround consultants. Novak Consulting Group, founded in 2009, was tapped to file a rescue plan for Harrisburg that was ultimately rejected by the City Council.
Larger turnaround specialists have generally been less active in Chapter 9 cases. Alvarez & Marsal, best known for handling the wind-down of Lehman Brothers after its 2008 bankruptcy, has explored Chapter 9, assisting Cravath with pre-bankruptcy advising for Harrisburg.
But many struggling cities are reluctant to ask for turnaround help, said Alan Holtz, a managing director at restructuring firm AlixPartners.
"There's a difference between a market need and a demand," Holtz said. "There may be a need in the municipal market right now, but we just haven't seen the demand."
(Reporting by Nick Brown in New York; Editing by Martha Graybow and Edward Tobin)