When a company or individual files for bankruptcy, they are in a state of insolvency: Unable to pay their debts, they require legal protection to relieve or restructure outstanding obligations. Although it’s much more common for these private parties to declare bankruptcy, U.S. public entities such as towns, counties and other municipal agencies in financial straits can also file for bankruptcy protection under Chapter 9.
On June 28, Stockton, Calif., pop. 290,000, became the largest U.S. city to file for bankruptcy protection. Five days later, a small ski resort town in California called Mammoth Lakes, pop. 8,000, filed for bankruptcy due to a $43 million legal judgment against it. Then on July 10, the city council of San Bernardino, a city of 209,000 residents east of Los Angeles, voted to seek bankruptcy protection. On August 2, the city officially filed for bankruptcy, citing more than $1 billion in debts.
“Bankruptcy is absolutely the last resort for municipalities and it is certainly not a cure-all,” says Juliet Moringiello, professor of law at Widener University who specializes in bankruptcies, including Chapter 9. Municipal bankruptcies are handled on the federal level, so constitutional issues prevent judges from dictating how a state entity is run and thus the process cannot mandate actions such as tax increases, budget cuts, asset sales or the removal of local politicians.
When a municipality reaches the point of insolvency, it must essentially renegotiate its obligations, and if the parties involved can’t agree, Chapter 9 bankruptcy is often the only option. The process can solve the ‘hold-out’ problem by forcing nonconsensual contract negotiations on a minority of creditors, says Moringiello, although all creditors vote on a proposed plan that has to meet certain requirements for confirmation. With so much hanging in the balance, “sometimes Chapter 9 can be used as leverage to force parties to negotiate a new deal,” says Moringiello.
Although the financial crisis played a major part the bankruptcies of many U.S. corporations, the number of municipalities filing for bankruptcy wasn’t an outlier by historical standards. According to data from the American Bankruptcy Institute, there were 41 municipal bankruptcies, about eight per year, between 2007 and 2011, which is on par with average in the U.S. since 1980.
Some experts predict that under-funded pension liabilities and stagnant tax revenues could cause anincreasing number of municipal bankruptcies. Scranton is the latest Pennsylvania city in serious financial trouble. Recently Mayor Chris Doherty, abruptly cut the pay of about 400 public workers,including himself, to the federal minimum wage of $7.25 to avoid resorting to bankruptcy.
So how do the events of these municipal bankruptcies occur? Click ahead for some of the most notable examples of bankruptcies that hit U.S. towns and counties.
By Paul Toscano, Joseph O'Dell, Jill Weinberger & Morgan Giordano
Updated 29 June 2012