A new law heading to Rhode Island Gov. Donald Carcieri’s desk for his signature is intended to bring the insolvent city of Central Falls out of receivership and under a new state oversight regime.

The law, which was drafted by Carcieri’s staff and passed the General Assembly last week in an amended version, would prevent municipalities from entering into judicially appointed receivership on their own — as Central Falls did — though it would still allow the state to appoint a receiver.

Carcieri will sign the law, said spokeswoman Amy Kempe.

“The goal of the legislation is to allow the state to intervene much earlier on to address the issues so that [municipalities] do not go into bankruptcy,” Kempe said. “It’s in the state’s interest to make sure that all the cities and towns are financially viable. There’s bond ratings the state is concerned about but [it’s] also to make sure the city or town is performing the services for its residents.”

The law would apply retroactively to Central Falls, which has a court date on June 17 to address the issue of appointing a permanent receiver, something the state doesn’t want to happen. Kempe said the state will argue that it is in the best interest of Rhode Island for the city to come out of temporary receivership, for which it filed on May 18, and go into the new oversight system. Receivership is Rhode Island’s equivalent of municipal bankruptcy.

Central Falls is a city of approximately 19,000 people located northeast of Providence. It faces a $3 million current fiscal year deficit on its nearly $18 million budget. The deficit will grow to a projected $5 million next year. Last month, Moody’s Investors Service and Standard & Poor’s downgraded its $17.1 million of general obligation debt to junk.

The bond-financed Donald W. Wyatt Detention Center, operated by the quasi-public Central Falls Detention Facility Corp., was meant to generate $1.2 million for the city last year but the revenue did not materialize after the death of an immigrant detainee there in 2008 prompted the U.S. Immigration and Customs Enforcement agency to stop using the facility.

Adding to the city’s troubles, its mayor, Charles Moreau, is under investigation by state and federal law enforcement.

The statute, was modeled on laws in Massachusetts for Chelsea, Springfield, and Lawrence, which had gone through fiscal distress. It would create a three-tiered gatekeeper system that would prevent municipalities like Central Falls from going into judicial receivership.

The first level would be the appointment of a fiscal overseer. If that step proved insufficient, a budget commission could be imposed. The final tier would be the appointment of a receiver by the state director of revenue. As a last resort, the receiver could take the municipality into federal bankruptcy court.

Rhode Island had systems in place to deal with fiscally distressed municipalities, but Central Falls was able to avoid them and go directly into judicial receivership.

Under the new system, the occurrence of two events from a list of five would allow the director of revenue to appoint a fiscal overseer. Those events include: having projected deficits in the current and upcoming fiscal years; failing to file audits with the auditor general two years in a row; a rating downgrade; the inability to access credit markets on “reasonable terms”; and failure to promptly respond to requests for information from the director of revenue and other government officials.

Kempe said the state had requested fiscal information from Central Falls but got no response.

The fiscal overseer would act as an adviser and supervisor in the municipality’s budgetary affairs and would be responsible for approving its annual or supplemental budgets. The overseer would also develop a three-year operating and capital plan.

If that is not enough, the next level is the creation of a five-member budget commission at the request of either the fiscal overseer in consultation with the auditor general or by request of the municipality.

The budget commission would have wide-ranging powers to exercise all powers held by elected officials. All decisions about spending and borrowing — including deficit borrowing — would be subject to the commission’s approval. The commission could also craft the municipality’s operating and capital budgets and review, approve, or disapprove contracts.

The final level is state-appointed receivership, if the commission proves unable to restore fiscal stability to the city or town. The receiver would have additional powers to fire city employees and could file for Chapter 9 municipal bankruptcy. Federal bankruptcy has not been available to Rhode Island’s municipalities.

“The bill that’s pending in Rhode Island is representative of an increasing trend where states don’t simply allow or deny their municipalities access to Chapter 9 but serve as gatekeepers to Chapter 9 or other restructuring mechanisms like receivers,” said William Kannel, a bankruptcy lawyer at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC. “The increasing trend is to have these gatekeeping statutes, which say Chapter 9 is permissible but only if the municipality has run this gauntlet of reporting requirements and financial control boards or financial overseers or other mechanisms like that.”

One power the overseer, commission, or receiver would not have is the ability to change existing collective bargaining agreements, though they could reject new ones. Central Falls, in its receivership petition, specified collective bargaining agreements and unfunded pension liabilities as reasons for receivership.

This was an issue in Vallejo, Calif., which declared bankruptcy in 2008. A 2009 federal court ruling said the city could reject collective bargaining agreements. This year it did so, cutting firefighters’ salaries and unfunded medical liabilities and reducing pension benefits for new firefighters.

Now California lawmakers are considering a bill to make it more difficult for its cities or local agencies to file for Chapter 9. The bill was approved by a Senate committee and would require municipalities to get approval from the California Debt and Investment Advisory Commission before filing for federal bankruptcy, though they could override a commission’s rejection.

Harrisburg, Pa., has been considering bankruptcy because of debt sold by the Harrisburg Authority to finance the construction of an incinerator. Revenues from the incinerator have been insufficient to cover debt service on $282 million of bonds. Assured Guaranty Municipal Corp., insures the bonds, though Harrisburg is on the hook because it is the first guarantor. Pennsylvania Gov. Edward Rendell last week said Harrisburg should lease municipal assets to meet its debt obligations rather than file for bankruptcy.

Though the recession has spurred heightened discussion about municipal bankruptcy, it is mostly just talk, said Paul Glassman, an attorney with Greenberg Traurig LLP in Santa Monica, Calif.

“There haven’t really been a lot of filings and hopefully there are more negotiations to get these issues resolved because really no one wants to file bankruptcy unless they have to,” said Glassman, who represented cities affected by Orange County, Calif.’s 1994 bankruptcy. “It’s not a pleasant process. It’s an emergency room, not a health spa.”

The threat of Chapter 9 can give distressed municipalities some leverage when trying to resolve fiscal issues, he said. “There’s some precedent that it maybe facilitates negotiations with unions and other parties outside of bankruptcy to avoid bankruptcy filings,” he said.

In Rhode Island, two other municipalities are under fiscal distress. Woonsocket was downgraded to junk by Moody’s in April and is in talks with the state about deficit borrowing. North Providence is also talking to the state about deficit borrowing. They may not go into the new oversight system, however, because they have been working with the state to resolve their problems, Kempe said.

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