As we begin 2015, reflecting on the main lessons for capital markets participants from the Chapter 9 proceedings over the past few years seems appropriate.

Set forth below are highlights:

State Policy is the Critical Determining Factor in a Municipality's Approach to Bondholders
If state policy seeks to maximize access by municipalities in the state to the capital markets at reasonable interest rates, then bonds will be treated well. Rhode Island is the best positive example of this approach. A new state law was passed to provide all general obligation bonds with a statutory lien. The result was that in the Central Falls bankruptcy bonds were unimpaired and labor, pensions and other post-employment benefits were severely cut. 2014 continued the trend in Rhode Island subsequent to the Central Falls bankruptcy. No other filings have occurred in the state. Instead, labor and retirees have agreed to voluntary and material cuts to avoid a bankruptcy filing. Bondholders have continued not to be negatively affected by municipal distress.

New York State is another example of a state with a long standing policy of protecting the ability of its cities to access the capital markets. When New York City was insolvent in the 1970's, the state intervened with strong oversight and state created financial structures to help save the city. The Municipal Assistance Corp. allowed New York City to have access to the capital markets even during its time of crisis. This was the beginning of a continuing history of State Control Boards intervening to help distressed municipalities address fiscal crisis. The result has been a vibrant bond market throughout New York State.

However, if state policy is not to protect municipalities in a state from the negative impact of filings by some municipalities in the state, then bonds are at material risk in Chapter 9 filings. Michigan is the best example of this policy. The governor completely abandoned support for the capital markets in his approach to the Detroit bankruptcy. The emergency manager, with the support of the governor, made a frontal attack on all types of bonds from unlimited general obligation bonds to limited general obligation bonds to pension obligation bonds to water and sewer bonds.

While these attacks had varying degrees of success, the Detroit case was the most severe treatment of municipal debt in any major city bankruptcy in U.S. history. The long term consequences for the City of Detroit, cities in Michigan seeking to access the market and the State of Michigan are not totally clear at this time. However, over the next 5-10 years we will better understand the financial consequences of this policy.

State policy in California presents another approach with significant impact. California has abandoned support for the fiscal health of its municipalities. The approach of the state to the liquidation of its redevelopment agencies placed state interests above the interests of municipalities and created serious fiscal dislocation and hardship. In addition the state's approach in supporting Ca1PERS in its absolute defense of enormous pension liabilities and in its determination to prevent municipalities from leaving the Ca1PERS system, has had a devastating impact on municipalities. The dire condition of municipalities in California creates increased risk for bondholders, particularly in a bankruptcy context given the state's and Ca1PERS' approach to pension restructuring.

Investors and insurers should closely examine state policy in determining which bonds to buy or insure. States with widespread pension issues, fiscal distress and a lack of commitment to protecting capital market participants pose a risk which is meaningfully different from states without such a profile. State policy matters in times of distress.

Municipal Policy Matters
Municipalities with significant troubled projects tend to focus restructuring the bonds which financed the project and to seek to maintain future capital market access by treating their other bonds well. Jefferson County and Harrisburg took this approach and did not impair the principal amount of their general obligation bonds. The capital markets are likely to be more receptive to municipalities which take such an approach.

Politics Matters
State and municipal policy is influenced significantly by politics. Pensioners, public workers and their friends and families vote. Capital market participants are not voting constituencies. This reality influences decisions by politicians. The political ambitions of governors, mayors and other public officials and their perceptions of voter attitudes often shape the approach to policy.

A dysfunctional city government with rifts between a mayor and city council, or a city manager and city attorney, or any such combination can paralyze a city in its approach to a bankruptcy. A strong executive or united city government or receiver with centralized power can accomplish a lot in a reasonable time frame.

The Judge Matters
Judges can exercise significant influence in a Chapter 9 case despite limited powers provided under the Bankruptcy Code. Given the very limited case law in Chapter 9 cases, judges have a lot of room to drive the outcome and direction of the case. In particular an activist judge can push parties towards settlements by stressing to the parties the uncertainty of the outcome of litigation and by signaling that one party is more likely to win than the other.

Judge Rhodes in Detroit was a very activist judge who influenced the case more than anyone expected by utilizing creative tactics. At the very beginning of the case Judge Rhodes picked a creative, pro-active and authoritative lead mediator along with a strong team of mediators and ordered all parties to mediation. He also set a quick plan filing deadline and expressed his clear intentions for when he wanted the City to emerge from bankruptcy. In addition during the case he insisted upon and imposed very aggressive deadlines, held chambers conferences with lawyers, hired his own feasibility expert and took pro-active positions from the bench in a manner which highly encouraged mediation and settlements.

Pensions Can Legally Be Impaired
Pensions can be legally impaired in a bankruptcy as determined in the Detroit and Stockton cases. Importantly, however, politics often mitigates against the use this legal weapon.

While bondholders, pensioners and workers can all be impaired in a bankruptcy as a general matter, public policy and politics determine outcome more than any other factor given the limited legal precedents in Chapter 9.

The Most Important Protection for Bondholders is a Good Security Package
Bonds secured by special revenues and/or statutory liens are preferable, especially those issued by special purpose authorities established to provide for bankruptcy protection. The Municipal Assistance Corporation was such an entity and similar entities have-been established throughout the country. The nature of a security package must be analyzed very carefully.

Certificates of Participation or Lease Revenue Bonds are viewed as either secured debt or leases which may be assumed or rejected. The fundamental determinant of outcome for such debt is the importance and value of the leased property to the municipality. Police and fire stations which need to remain open are good security. Golf courses, as demonstrated in Stockton, in a down economy are not.

Unsecured bonds whether in the form of unsecured general obligation debt or unsecured general fund debt, such as pension obligation bonds, face material risk and their treatment will be most influenced by the public policy approaches discussed above and by political considerations. In each state there may be various legal arguments that can be used in defense of such bonds but the lack of legal precedent poses serious risk.

Conclusion
Pockets of continuing economic hardship and sudden economic dislocation, such as the severe drop in oil prices, will serve as the backdrop for municipal distress in 2015. Developments in Atlantic City and Kern County, California and the introduction of legislation to permit chapter 9 filings in Illinois demonstrate this continuing trend. To the extent the economy keeps improving, this trend will be mitigated. However, the pension crisis is a long term structural problem which will persist. One way or another it will have to be addressed.

David Dubrow is a partner at Arent Fox LLP in New York.