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'Municipalities' considering--and entering--Chapter 9 bankruptcy more common in wake of Great Recession

Part 2: Which entities can file under Chapter 9? What are the causes?


Alabama county at crossroads of dubious record--largest municipal bankruptcy in USA

In Part 1, we discussed the Chapter 9 petition filed by Central Falls, Rhode Island and the looming bankruptcy of Jefferson County, Alabama; if it comes to pass, the county's filing stands to be the largest municipal bankruptcy in the nation's history. (As explained, municipal can describe and governmental entity below at or below the state level.)

Current record-holder shows differences between Rhode Island, Alabama cases

The current holder of that record belongs to Orange County, California, which filed for bankruptcy protection in 1994. In a July 22 post, Business Insider explains ". . . What You Need to Know About Muni Bankruptcy," which explains the two basic causes in a way that contrasts the two current cases. The following is from one of the lead attorneys in the Orange County case; he was asked, "Under what circumstances do municipalities file for bankruptcy?"
Johnston: Chapter 9 filings are relatively uncommon — it is the option of absolute last resort for distressed municipalities.

I tend to group Chapter 9 filings into two general categories.

A 'one-time event'

The first is a “shock to the system” -- a one-time event that makes it impossible for a municipality to fill their obligations for their creditors.

The Orange County bankruptcy was because of a shock to the system, which was the revelation that the county treasurer had made risky bets on sophisticated financial instruments and lost $1 billion dollars. So all of a sudden there was a billion dollars missing. The Desert Hot Springs, [California], filing, another case I worked on [in 2001], was also the result of a shock to the system. In that case, it was because of a multimillion dollar judgment against the city.

'Structural issues': revenue loss vs. pension 'promises'

The other category is structural issues. You see this with a lot of special districts that file for Chapter 9 because there is a big drop in revenue — they aren’t taking in enough taxes or fees to cover operating costs. Structural problems also include pension issues, when the government makes promises to workers and finds out later that it doesn’t have the money to pay for it. Eventually the municipality gets to the point where it simply can’t satisfy its obligations.

Central Falls appears to be a classic structural problem. There is a very large pension obligation that the city just doesn’t have the revenues to satisfy.

In other words, the attorney, Jim Johnston, is comparing the Orange County case what that of Jefferson County, which has delayed its threatened filing in lieu of more talks with creditors and the governor about being crushed by an ill-schemed bond-for-sewer package, contrasted against Central Falls, which apparently will pay back its bondholders but severely cut back on pension payments to former employees.

Eligibility decided at state level

The BI reporter also asked Johnston whether any municipality can file for Chapter 9 protection. He explained that eligibility begins with the state charter; for instance, California has granted "blanket approval," but other states proceed on a case-by-case basis and others forbid it outright.

Reneging on labor agreements

Asked whether a bankruptcy court can "change or overturn labor agreements," Johnston said, "In a bankruptcy, the municipality has the ability to modify its collective bargaining agreements and reduce its pension payments. That typically is a real flashpoint in cases where labor contracts are an issue in a Chapter 9 bankruptcy.

"While you can renegotiate contracts for the future, there is not a lot of precedent for whether a municipality can renegotiate its pension promises to workers who have already retired."

He said that exact issue is likely to be litigated more and more and that bankruptcy courts will have lots of discretion because of lack of precedents. We're guessing that if pension-holders in Central Falls wind up with any clout, this will be hotly contested by "workers have already retired."

'Political suicide'

Johnston also said that Chapter 9 filings historically have been rare because it's "political suicide": "The city council that decides to file for bankruptcy is probably not likely to be reelected." Because of the costs involved, the discretion available to bankruptcy courts and the threat to creditors of receiving cents-on-the-dollar, most cases are usually settled outside of court.

Attorney thinks no 'huge wave' is on the way

The attorney told BI he doesn't agree with projections of huge waves of Chapter 9 filings: "It really is the option of last resort — if the cities or counties have any other options, they are going to look at doing those first. In most cases, they are other things they can do besides file for bankruptcy — they can raise taxes, raise fees, cut costs, negotiate with their creditors, negotiate with workers — there are a lot of options."

14 cities with serious 'public sector' problems

That being said, BI also has a July 13 article-cum-slideshow entitled "14 Cities That Are Being Eaten Alive By Public Sector Workers." In the intro copy about these entities with what Johnston would call "structural issues," this graf mentions cutbacks of federal aid to states: "As federal stimulus money runs dry, states are scaling back on municipal aid and revenue sharing. The cuts are adding immense pressure to strained local governments, many of which are already struggling under huge debt burdens. After years of declining tax revenues, cities and towns across the country are now running out of ways to deal with their ballooning budget deficits." Each "slide" presents a thumbnail description of the fiscal situation in the following municipalities:

  1. New York City

  2. Los Angeles

  3. Chicago

  4. San Francisco

  5. Pittsburgh

  6. North Las Vegas

  7. San Jose, CA

  8. Providence, RI

  9. New Haven, CT

  10. Newark, NJ

  11. Stockton, CA

  12. Colorado Springs, CO

  13. Costa Mesa, CA

  14. Central Falls, RI

Consumer bankruptcy for yourself

If you're considering filing for consumer-level bankruptcy protection, be aware that legally you can file the petition yourself. You can also hire "advocates" who can point you toward the correct forms and provide a minimal amount of information--although they can not offer legal advice. That being said, bankruptcy experts and legal authorities recommend hiring a trained, experienced attorney who keeps up with changes to the code and is familiar with all the principals in your area's bankruptcy court.

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