by Edith Honan
(Reuters) - Pennsylvania's capital, Harrisburg, filed for a rare Chapter 9 municipal bankruptcy on Wednesday after it was unable to resolve its debt crisis with creditors and faced a possible takeover by the state.
Harrisburg becomes one of the biggest cities to opt for the little-used chapter of the U.S. bankruptcy code.
Orange County, California, filed the largest Chapter 9 bankruptcy nearly 20 years ago after losing more than $1 billion in soured investments.
Harrisburg said in a court filing it was unable to continue paying for critical services as well as roughly $300 million in debt that funded an incinerator project.
Mark Schwartz, the council's attorney in this matter, said that the bankruptcy filing would give the city "bargaining power" with its creditors and with the state, which is considering a takeover plan.
"They were tired of being humiliated and denigrated," he said of the council members who voted for a bankruptcy filing on Tuesday.
Chapter 9 is "a much better forum if you really want to address the financial problems of the city," Schwartz added.
The city's bondholders and the surrounding county of Dauphin have sued Harrisburg to seek a ruling that all tax revenue be directed first to bond payments.
The city said it cannot make such payments and still provide for the health and safety of its residents.
Though few cities have opted for Chapter 9, the deep U.S. recession and sluggish recovery have placed huge burdens on local governments that have suffered a big drop in revenue after the deflation of the last decade's housing bubble.
Pennsylvania's legislature is considering a bill that would call for an eventual takeover of Harrisburg and the forced implementation of a fiscal rescue plan.
In July, the city council rejected a state-approved rescue plan, which called on it to renegotiate labor deals, cut jobs, and sell or lease its most valuable assets, including the incinerator and parking garages.
In August, the council rejected a similar approach crafted by Mayor Linda Thompson, saying that both plans were overly burdensome for Harrisburg residents and did not ask enough of the county, bondholders and the bond insurer, Assured Guaranty.
On Wednesday, a spokesman for Thompson said the council's actions could accelerate state approval of a takeover.
"(The bankruptcy) is hugely unpopular, but the council ... is an independent body," said spokesman Robert Philbin.
He also said the city's solicitor had raised questions about the legality of the vote during the meeting on Tuesday. The solicitor, Jason Hess, was not immediately available for comment.
However, City Controller Dan Miller said on Wednesday the filing was the right move for Harrisburg.
"I think it's the only real option that we had," said Miller, adding that the previous plans rejected by city council would have benefited creditors at the expense of the city.
"They wanted to sell all of our assets and make Harrisburg destitute for decades to come," he said.
(Additional reporting by Tom Hals in Delaware; Editing by Theodore d'Afflisio and Padraic Cassidy)