bankruptcy

What if your city files for bankruptcy?

Municipal bankruptcies are nothing new, but several filings over the past year -- punctuated by the July 2013 bankruptcy in Detroit -- have transformed Chapter 9 of the U.S. bankruptcy code for municipal reorganization from a relatively obscure body of law into a hot topic. Residents of struggling cities are wondering what the possibility of bankruptcy means for them.

"We've had cities go bankrupt in the past, but usually those are isolated events that occur because the city lost a big lawsuit or had a local catastrophe," says Franklin C. Adams, a bankruptcy lawyer in Riverside, Calif. "What's different and quite troubling is that larger economic conditions seem to be the cause, and we haven't seen that since the Great Depression."

Congress enacted federal bankruptcy legislation for municipalities in the 1930s. Between 1991 and 2012, there have been 217 muni bankruptcies, according to data from the U.S. court system. Of those, 20 were filed just last year. These are some of the more recent filings have been noteworthy:

  • Detroit: The one-time auto capital of the world filed for bankruptcy protection in July 2013, citing more than $18 billion in debt. It marks the largest civic bankruptcy by amount of debt and by population. About 700,000 residents live in the Motor City.
  • Jefferson County, Ala.: The county filed in November 2011, citing more than $4 billion in debt. Before Detroit's filing this month, the filing was the largest civic bankruptcy in U.S. history in terms of dollar amount, according to Reuters.
  • Stockton, Calif.: The city filed for bankruptcy in June 2012. At the time, it was the largest American city, in terms of population, to seek protection from creditors under Chapter 9. City officials estimate that Stockton, which has just fewer than 300,000 residents, could owe creditors as much as $1 billion, according to CBSNews.com.
  • Harrisburg, Pa.: The city has more than $340 million in debt, but back in 2011 state Sen. Jeff Piccola banned "third-class cities" from filing bankruptcy, leading a judge to block the bankruptcy. According to Reuters, the ban was extended in 2012. Currently the city has been auctioning off Wild West artifacts in an effort to raise money.

What is Chapter 9?

In many ways, a Chapter 9 filing is akin to Chapters 11 and 13 of the bankruptcy code, which deal with business and personal reorganizations, respectively. Under all three scenarios, debtors get a reprieve for paying creditors while they propose and implement a restructuring plan. But unlike private citizens and companies, municipalities are sovereign entities, which present an unusual wrinkle, Adams says.

"Realistically, the court doesn't have as much power to force the city to do anything," Adams says. "So, unlike other provisions of the bankruptcy code where the creditors have a vote on the reorganization plan, the city has a lot more latitude."

Once a municipality is bankrupt, it can cut costs, which usually means fewer services such as firefighting, garbage collection and library branches. Or it can increase revenue by raising taxes. Usually, it's a combination of both, Adams says. But real change is often a matter of political will.

What happens to services?

"Municipal bankruptcies usually mean a reduction in the size, scope and quality of services because that's where the biggest costs are," says Adams.

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