[Jeondaegyu's 7 Attempts and 8 Failures] Bankruptcy of Local Governments

Jeon Dae-gyu, Chief Judge of Seoul Bankruptcy Court

Last April, the International Monetary Fund (IMF) projected that South Korea's national debt-to-GDP ratio would reach 69.7% by 2026, five years from now. This represents a sharp increase of 21 percentage points from last year's 48.7%. It is a warning that among advanced industrialized countries, South Korea's debt growth rate is effectively the fastest. Not only the central government but also local governments' debts are increasing rapidly. According to the Ministry of Economy and Finance, the total debt of local governments is expected to exceed 30 trillion won in 2021. This is analyzed as a result of reduced revenues such as tax income due to the COVID-19 pandemic and competitively increased expenditures such as disaster relief funds. Next year, with the presidential election and nationwide local elections scheduled, local governments' expenditures are expected to increase further.

What should be done if local government finances deteriorate? Occasionally, foreign news reports mention mass layoffs of public officials in the United States due to decreased tax revenues. It is entirely possible for local governments in South Korea to lay off public officials citing financial difficulties.

If a local government faces bankruptcy, is court-supervised restructuring possible? Like companies, can local governments apply for rehabilitation procedures in court to limit creditors' rights and reduce debts to reorganize their financial structure? The U.S. Federal Bankruptcy Code provides regulations on municipal rehabilitation procedures under Chapter 9. The main reason for introducing this is to protect financially bankrupt local governments from creditors' collection efforts while adjusting debts under court supervision. The focus of the municipal rehabilitation system is to allow local governments to continue their governmental functions while restructuring their debts.

In fact, there have been cases in the U.S. where municipal rehabilitation procedures were carried out under the Federal Bankruptcy Code. Detroit, which rapidly grew in the early 1900s due to the automobile industry, faced a financial crisis in the 1980s and 1990s due to the decline of the automobile industry. In response, Detroit filed for rehabilitation proceedings in court in 2013. The court deemed the filing proper and proceeded with the rehabilitation process, and in November 2014, the rehabilitation plan was approved. Instead of repaying debts immediately, Detroit used funds for necessary city functions, which reportedly led to a decrease in crime rates and improvements in the city's employment indicators, thereby improving the economic situation.

Although the U.S. Federal Bankruptcy Code regulates rehabilitation procedures for local governments, unlike other bankruptcy procedures, the court's authority is significantly limited to respect the autonomy of local governments. For example, without the consent of the debtor local government, the court cannot interfere with the local government's political or administrative authority, property or revenue, or the use or benefits of property.

Can South Korea also allow local governments to apply for rehabilitation procedures in court if they face financial difficulties? Since rehabilitation procedures aim at rebuilding local governments and can guarantee stable livelihoods for public officials, there is room to consider their recognition. However, local governments have governing functions, and it may be inappropriate for courts to perform these functions. Nevertheless, the worsening financial condition of local governments cannot be ignored. Legislative solutions are needed to recognize municipal rehabilitation procedures while limiting court authority to some extent, as in the U.S.

Jeon Dae-gyu, Chief Judge, Seoul Bankruptcy Court