February 9, 2012
Municipalities and other local governments in the United States continue to struggle financially in the aftermath of the Great Recession. While recession has technically ended, revenues for many governments have not returned to pre-recession levels and expenditures and liabilities continue to grow. This has led to much discussion about the possibility of local governments filing for bankruptcy protection.
Since Congress passed the Municipality Bankruptcy Act in 1937, about 624 municipal bankruptcies have been filed, according to James Spiotto, one of the nation's leading municipal bankruptcy experts at the law firm of Chapman and Cutler and a Civic Federation Board member. The two largest municipal bankruptcies since 1937 have been Jefferson County, Alabama in 2011 and Orange County, California in 1994. These two cases involved millions of dollars in municipal debt.
Three local governments have been prominently featured in the news recently regarding bankruptcy filings. Central Falls, Rhode Island and Jefferson County, Alabama successfully filed for bankruptcy in 2011. Harrisburg, Pennsylvania, which is struggling to pay for $300 million in overdue debt related to a garbage incinerator project, failed in two attempts in 2011 and 2012 to successfully file for bankruptcy.
Central Falls is a small Rhode Island city of 19,000 residents near Providence. It filed for bankruptcy because of an $80 million unfunded pension and retiree health benefit liability that is more than four times greater than its annual budget of $17 million.
Jefferson County is Alabama's most populous county with about 660,000 residents. It contains the city of Birmingham. In November 2011, the County government entered into the largest municipal bankruptcy in U.S. history. The goal is to restructure more than $4 billion of County debt, including $3.14 billion incurred by the County sewer system. The County had financed debt with floating rate securities that were coupled with interest swaps. Fallout from the subprime mortgage crisis led to soaring interest costs the County could not afford. The sewer bond deal was tainted by allegations of political corruption; County Commissioner Larry Langford was convicted on charges of accepting bribes.The County will have to sharply increase sewer rates as part of a bankruptcy agreement and it has already eliminated 500 jobs as a cost cutting measure.
Chapter 9, Title 11 of the United States Bankruptcy Code provides for the reorganization of municipalities, which are defined as political subdivisions or public agencies or instrumentalities of a State. The definition of municipality includes cities, towns, villages, counties, taxing districts, municipal utilities, school districts and public improvement districts. It also covers revenue-producing bodies that provide services paid for by users rather than by general taxes, such as bridge authorities, highway authorities and gas authorities.
The purpose of filing for bankruptcy under Chapter 9 is to allow a municipality in financial distress the ability to obtain protection from its creditors while developing a debt payment or adjustment plan.
To be eligible for Chapter 9, a municipality must meet the following conditions:
1. It must be specifically authorized to be a debtor by state law or by a governmental officer or organization empowered by State law to authorize the municipality to be a debtor;
2. It must be insolvent, as defined in 11 U.S.C. § 101(32) (C)
3 It must desire to effect a plan to adjust its debts; and
4. It must either:
- Obtain the agreement of creditors holding at least a majority in amount of the claims of each class that the debtor intends to impair under a plan in a case under chapter 9;
- Negotiate in good faith with creditors and fail to obtain the agreement of creditors holding at least a majority in amount of the claims of each class that the debtor intends to impair under a plan;
- Be unable to negotiate with creditors because such negotiation is impracticable; or
- Reasonably believe that a creditor may attempt to obtain a preference.
Reorganizing a municipal government's debts is usually accomplished by extending debt maturities, reducing the amount of principal or interest owed on debt outstanding or refinancing the debt by obtaining a new loan.
Chapter 9 is significantly different than other chapters of the bankruptcy code because there is no provision to liquidate assets and distribute proceeds to creditors. Such a transaction would likely be a violation of the 10th Amendment to the Constitution. Bankruptcy courts in chapter 9 cases usually limit their actions to approving the bankruptcy petition, confirming the plan or adjusting debts and ensuring the implementation of the plan. In some cases, however, the municipality may ask the court to exercise greater oversight.