Public officials in many financially distressed Northeast communities are glancing westward to Stockton for any precedent that could emerge from that northern California city’s bankruptcy filing.
Stockton filed for bankruptcy protection in Sacramento on June 28. Its City Council passed a so-called bankruptcy budget that calls for ending retiree health care benefits a year after the city’s filing date.
Health care and pension costs resonate in many Northeast states.
“It will be interesting to see if [Stockton] sets a precedent,” said Dan Miller, the city controller in Harrisburg. Pennsylvania’s capital city is $310 million in the hole, under receivership and could run out of money in October, although state lawmakers recently extended a bankruptcy ban there for another five months.
Chapter 9, which pertains to municipalities, is the least-known provision of the U.S. Bankruptcy Code despite a spate of filings of late. It has little precedent, with local officials, market analysts and even bankruptcy attorneys more familiar with the easier-to-fathom Chapter 11 eyeballing each new filing for possible trends.
“A detailed rulebook for distressed municipalities has yet to be written,” Natalie Cohen, head of municipal research for Wells Fargo Securities LLC, wrote in a report.
According to the American Bankruptcy Institute, the 13 Chapter 9 bankruptcy filings in 2011 represent the most in a single year since 1994. Six filings occurred in the fourth quarter of last year alone, ABI says.
“They’re getting bigger and at a significantly alarming growth rate,” said Anthony Sabino, a business professor at St. John’s University in New York. Stockton, in the third-largest filing by debt behind Jefferson County, Ala., and Orange County, Calif., cited more than $300 million of bonds outstanding tied to its general fund, and more than $700 million in bond debt overall.
Tales of distress back East, meanwhile, vary from optimism to woe to fear of the unknown.
Central Falls, R.I., striking a more upbeat note, is on the verge of exiting Chapter 9 after only a one-year stay and is now on review from Moody’s Investors Service for a possible upgrade. But in Pennsylvania, the state government and the federal courts have so far prevented Harrisburg from filing, and local officials up Interstate 81 in Scranton seem wary of filing, even with a broke city and after spending 20 years to no avail in a state-sponsored workout program.
Central Falls, once a poster child for municipal basket cases, filed under Chapter 9 on Aug. 1, citing $80 million in unfunded pension and health-care-related liabilities. But under former receiver Robert Flanders, the city used Chapter 9 to rework pension agreements. Retirees finally accepted cuts totaling 55%. Rhode Island essentially set up Central Falls for a smooth march through Chapter 9 by passing a law that placed bondholders ahead of other creditors.
Moody’s, which rates Central Falls Caa1, cited active oversight of the bankruptcy proceedings, financial operations and cash flow with state legal-default protection as well as the ratified collective bargaining agreements between the city and its unions.
“That’s a tribute to having a tone from the top,” said chief of staff Gayle Corrigan, who became the city’s highest-ranking official after Flanders stripped the mayor and City Council of their powers. Corrigan praised Gov. Lincoln Chafee and revenue director Rosemary Booth Gallogly. “They set the tone to make this work out.”
Market observers over the past year praised Rhode Island for its 2011 law granting priority to bondholders in a Chapter 9 filing — and for a willingness to work together.
“What’s remarkable about Rhode Island is the convergence of the governor, the treasurer, the city of Providence, where they reworked the pensions, and even a recent executive order about shared services — they’re taking this very civic approach and talking about the future of the state and the cities,” Cohen said. “Even though Central Falls is a small example, it’s still an example.”
More often, however, municipal distress features prickly relations among state, county and city officials. Recently, one Detroit activist even said he would rather let his city burn than have Michigan take it over.
Cohen suggested that some states are becoming more investor-friendly than others.
Harrisburg can attest to that. Mired in bond debt that it cannot pay related to an incinerator retrofit project, it remains fractured — and handcuffed. Pennsylvania’s legislature, right before the end of the session, extended a provision in the fiscal code essentially banning the city from filing under Chapter 9 until Nov. 30. Critics of the measure said the extension merely benefits Wall Street creditors by taking the bankruptcy option off the bargaining table.
The city’s newest receiver, William Lynch, said two weeks ago that Harrisburg could run out of money in October.
Only Lynch, with the approval of the state Department of Community and Economic Development, can file for bankruptcy on behalf of Harrisburg after the ban expires on Nov. 30. The City Council filed on behalf of the city last fall, without Mayor Linda Thompson’s support, but a federal judge invalidated it.
Mark Schwartz, who represented the City Council in that case, said Harrisburg could have exited bankruptcy by now, had it been allowed to file.
“I think that California has more responsible public officials. The same in Rhode Island. In Pennsylvania, the legislature just wants to pummel Harrisburg. That’s the difference. Pennsylvania remains fundamentally corrupt,” said Schwartz, a former investment banker and bond lawyer.
Westfall, Pa., filed under Chapter 9 in 2009, faced with a $20 million dispute over payments to a developer after the town’s supervisors halted a 1,500-unit residential project. While in bankruptcy, the town restructured its initial debt to $6 million, payable over 20 years. Westfall’s single-creditor circumstances, however, were unusual.
In Scranton, the mayor, City Council and its money-bleeding Scranton Parking Authority are jousting over how to fix a city that according to its business administrator was down to roughly its last $5,000 on Thursday after paying all municipal workers the federal minimum wage, $7.25 per hour, in defiance of an order from the Lackawanna County Court of Common Pleas.
Judge Michael Barrasse ordered Mayor Chris Doherty not to pay the minimum wage, but Doherty did just that on Thursday. Barrasse on Friday issued a preliminary permanent injunction against Doherty. But he mayor said the city was still too broke to pay.
Scranton can’t get a bridge loan to cover its regular operations because it hasn’t revised its recovery plan under the state-sponsored Act 47 workout program. Scranton, with a population of 77,000, has been in the program since 1992.
Last month the council held up a $1 million Parking Authority bond payment that the city had guaranteed beyond its June 1 due date, citing concerns with the authority over accountability and transparency. It finally released the funds mid-month, but Scranton has since had trouble obtaining the $16 million loan it says it needs to make payroll and settle past-due bills.
But despite the city’s problems, elected officials there have not seriously considered a bankruptcy filing as an option. Fear of a stigma still scares local officials.
“Going to Chapter 9 doesn’t provide revenue. Chapter 9 doesn’t pay the bills. It may stop payment on some things, but it doesn’t pay the bills. It doesn’t solve the revenue problems that we have,” council member Robert McGoff said.
Sabino warned that Chapter 9 wields huge variables. “The fear factor is starting to evaporate, given the increase in filings, but people should have a good, healthy fear,” he said. “Chapter 9 is still fraught with land mines. It should be the last of the last of the last of the options.”
According to Cohen, a Chapter 9 learning curve also exists in the legal world.
“One of the things about Chapter 9 is that I see a lot of Chapter 11 attorneys — people who are not necessarily public sector attorneys — jumping into the fray. The two are different,” she said. “You can’t chop the city into pieces and sell off the assets. A cram-down is extremely rare and the judge has far less power.”