The balance sheets of many local governments in the United States are abysmal. As federal stimulus dollars dry up, pension obligations swell, and tax bases shrink, cities and towns across the country are having a hard time paying their bills. Nine in ten city finance managers reported that their cities were less capable of meeting their fiscal needs in 2010 than they were in 2009, according to the National League of Cities. Another sign of the municipal money woes: the Brookings Institution reported last December that shortfalls in the nation’s state and local pension funds total more than $3 trillion.

One possible way out is Chapter 9, the Depression-era bankruptcy code provision that allows local governments to seek protection from creditors while restructuring their debt. But while Chapter 9 does offer an escape route for hard-pressed municipalities, it’s only been used about 620 times since 1937. (Compare that to the 11,000 Chapter 11 filings in 2009 alone.) Bankruptcy lawyers don’t expect a wave of Chapter 9 filings—or a surge in related fee-generating work—anytime soon. Though it may seem like a potential solution to financial distress, says Cravath, Swaine & Moore restructuring head Richard Levin, it’s a painful, expensive, and difficult process that’s hardly a panacea. Case in point: Vallejo, California.

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