Counsel for Harrisburg City Council, which is trying to declare the city bankrupt so it can better negotiate down hundreds of millions of dollars in debt for an ill-advised trash incinerator project, has challenged the tax-exempt status of more than $300 million in city bonds.
The move, if successful, could leave the law firms, advisers, insurers and banks that helped Harrisburg arrange the ill-fated financial deal open to legal action to try and force them to help pay the city's costs, says Bryn Mawr lawyer Mark D. Schwartz, who has been representing the council in its Chapter 9 federal bankruptcy filing.

"I question whether there was adequate due diligence" in professional advisers' promises to the city that the bonds would be "self-supporting from money generated by the facility," Schwartz, wrote in a letter to Internal Revenue Service chief counsel William J. Wilkins and IRS Office of Tax Exempt Bonds director Clifford J. Gannett.

Schwartz also questioned "whether there was adequate disclosure in general" about the expensive and failed effort to upgrade the facility using bond proceeds in the mid-2000s, and whether the "reasonable expectations" test that determines whether government bonds can be tax exempt was met in the incinerator's case.

The incinerator failed to win enough trash business to cover its costs, leaving Harrisburg in danger of default. Schwartz argues the professionals, who included members or employees of firms based in New York, Philadelphia, Pittsburgh and Harrisburg, had an incentive to urge the city to approve the deal - so they could get paid - but that the city may have been inadequately advised on the likelihood the renovations would fail, leaving the city responsible for covering millions in unpaid expenses.
A generation of prolific borrowing by Pennsylvania's counties, cities, boroughs, townships, and local authorities have left many local governments stressed in the long recession, as property tax collections and local wage taxes that most Pennsylvania communities rely on have fallen, according to downgrades and warnings issued by Moody's Investor Service and Standard & Poor's this year.
Harrisburg's city council majority and controller Dan Miller have proposed local sales tax or property tax surcharges, as have been enacted in Philadelpha and other financially-challenged cities, to meet the city's financing bills. They also say they expect the city's bond insurers to help make up part of the losses - which the insurers have so far refused.
The proposed taxes have been unpopular among the city's largely suburban commuter workforce. To prevent Harrisburg from going into bankruptcy, Gov. Tom Corbett has signed legislation written by suburban lawmakers that would force Harrisburg to follow Philadelphia, Pittsburgh and other big cities in accepting the state's financial oversight. The state's draft plan would sell city parks and other assets and break labor and other contracts to save money without hurting the bondholders or bond advisers. 

Schwartz's IRS letter also called for "an investigation into the swaps that were conducted." Harrisburg, like the Philadelphia School District, the Delaware River Port Authority, Philadelphia's Board of City trusts (which runs Girard College), and other Pennsylvania bond issuers. has ended up owing millions after purchasing interest-rate swaps from big New York banks. The contracts, typically sold in connection with city bond issues, were supposed to protect from rising interest rates but ended up costing the issuers instead when interest rates stayed low.
Swaps became widespread in Pennsylvania in the past decade after former Gov. Ed Rendell championed legislation to extend their sale, allowing salespeople at Morgan Stanley, JPMorgan, Goldman Sachs, Citibank, Bank of America and European banks to sell swaps to municipal governments - essentially betting against local officials on the future direction of interest rates.

State treasurer Jack Wagner has condemned swaps contracts and urged towns to cancel them, paying to end the contracts, when possible, instead of waiting for interest rates to rise and reduce the liability.