When Towns Go Bankrupt – Chapter 9 Filings Increase From California to Rhode Island

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Jeffrey Johnson is a legal writer with a focus on personal injury. He has worked on personal injury and sovereign immunity litigation in addition to experience in family, estate, and criminal law. He earned a J.D. from the University of Baltimore and has worked in legal offices and non-profits in Maryland, Texas, and North Carolina. He has also earned an MFA in screenwriting from Chapman Univer...

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UPDATED: Sep 15, 2012

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We hear a lot about individuals and businesses filing for bankruptcy, but did you know that cities and towns can file for protection as well? Under the U.S. Bankruptcy Code, a municipality can undergo a Chapter 9 bankruptcy to restructure debts and work out a plan to pay their creditors. 

Municipalities are defined by the Bankruptcy Code as “political subdivision or public agency or instrumentality of a state.” This includes townships, cities, counties, school districts, and public improvement districts. Other entities such as bridge, highway or gas authorities may also file under Chapter 9. 

Although historically, Chapter 9 is uncommon, recent months have seen a flurry of voluntary petitions from U.S. townships and cities: three in California, two in Alabama, one in Rhode Island, one in Pennsylvania, and more.

Chapter 9 is a tool that can provide municipalities protection from creditors while drafting a debt repayment plan. During a time of economic uncertainty, a town facing high poverty rates, unpaid employee pensions, and lowered property and sales tax, can use bankruptcy to effectively address severe budget problems or excessive debts. This is typically done by extending debt maturities, reducing interest, or refinancing with new loans, according to the U.S. Court’s official website.

Three California Cities File Chapter 9

In California, Stockton, San Bernardino and Mammoth Lakes have all filed for protection under Chapter 9.

Stockton, the largest city to undergo bankruptcy, filed their petition listing assets of more than $1 billion and debt of $500 million to $1 billion. Bondholders and city employees were named as the main creditors, and after failed talks with employee unions and bondholders, the decision to file bankruptcy seemed to be the only remaining resort. 

San Bernardino, when faced with rising pension costs, inescapable bond debt, and sharply declining property tax, turned to Chapter 9, reporting over $1 billion dollars in debt.

Mammoth Lakes, a Sierra Mountains resort town, filed for bankruptcy to seek protection from a $43 million legal judgment placed against it in a property development dispute. One reason people; more often, businesses; or in this case, municipalities, file bankruptcy is to safeguard against large judgments from lawsuits absorbing all of their assets.

Unlike other states, California has a hands-off policy when it comes to lending a financial hand. The state government does not intervene to help individual municipalities, assuming cities already possess the necessary tools to address financial woes. But a report by Moody’s Investor Services maintains that each of these cities have “struggled with rapidly rising costs of labor agreements and pension costs,” and that many other California cities are in deep fiscal trouble. Many are viewing the three bankruptcies as litmus tests for Chapter 9 municipal filings; whether they emerge in a better way remains to be seen.

Central Falls, Rhode Island 

Across the country in Rhode Island, the small but dense town of Central Falls is set to emerge from their recent Chapter 9 filing. With a population of 94,000 people living within a mere 1.2 square miles, it is surely hard to escape the slumped economy. Leading up to the filing were slashed pensions and raised property taxes, with as many as a quarter of the residents living below poverty. The tiny city has “$80 million unfunded pension and retiree health benefit liability that is nearly quadruple its annual budget of $17 million,” according to Reuters.  

Central Falls will move forward with a 5-year repayment plan that will be overseen by the Bankruptcy Court. In this case, unlike in California, the state was and will continue to have control over the bankruptcy. Even when local officials soon take the reins, the state will be able to interject at any time if it is thought that local officials are deviating from the set plan. The country will be watching, and hoping, that the small town’s post-bankruptcy future is brighter.

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