UPDATE 1-Alabama county clears way for debt talks

(Adds details, quotes, background and byline)

By Melinda Dickinson

BIRMINGHAM, Ala., Oct 2 (Reuters) - Alabama's Jefferson County Commission on Thursday approved a seven-day extension of a standstill agreement so the state's governor and creditors can keep bargaining on a deal to avert a municipal bankruptcy.

The commissioners voted 3-2 for extending forbearance against default penalties after Gov. Bob Riley said he wanted the extra time to negotiate a restructuring of $3.2 billion of county sewer-system debt the county says it can longer afford to service.

Forbearance agreements can be valuable tools for lenders as it provides the borrower with additional time to attempt to solve its problems. They are usually limited and for a short time period, subject to renewal.

Riley stepped into the long-running negotiations a month ago and has been meeting privately with Wall Street creditors on restructuring the sewer debt that could bring on the largest municipal bankruptcy filing in U.S. history.

On Wednesday Riley briefed the county commissioners, who have repeatedly threatened to file for Chapter 9 bankruptcy protection, on the talks and told reporters he was optimistic about reaching a deal with creditors, bond insurers and counterparties in swaps agreements that soured on the county.

"I wouldn't be here talking to the commissioners if I weren't" optimistic," Riley said.

Chapter 9 of the bankruptcy code provides for the reorganization of municipalities. It provides a financially distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts. Only a municipality may file for relief under Chapter 9 and filings are rare.

The commissioners said they have seen no formal proposals in the latest round of talks, though local news media said the possibility of keeping an expiring penny sales tax levy in Jefferson County in place was being discussed.

That tax, which is now used for education projects, could be switched to paying off the sewer debt.

The new standstill, or forbearance, agreement runs until Oct. 8 and required no payment from the county, the commissioners said. Past forbearance agreements hammered out in a half year of talks came with substantial payments to the creditors. (Writing by Michael Connor in Miami; Editing by Theodore d'Afflisio)