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Henes: The Top 5 Questions About the Bankruptcy of Central Falls, Rhode Island

Central Falls, Rhode Island, the smallest city in the smallest state in the US, is making a big splash in the world of municipal bankruptcies.

On August 1, 2011, Central Falls commenced a chapter 9 case. But the act of filing for bankruptcy is not the story. Over 600 municipalities have sought refuge in bankruptcy since 1938. The real story is that Central Falls is attempting to use chapter 9 to actually fix its main fiscal problems, which are its pension and other retiree obligations.

Last week, Central Falls filed its proposed plan of adjustment with the bankruptcy court. This is the document that sets out what Central Falls’s obligations will be after it emerges from chapter 9. This plan needs to be voted on by impaired creditors – those parties receiving less than a full recovery, including the unions, employees and retirees. Consequently, Central Falls’ bankruptcy still has a way to go. However, based on the plan, Central Falls is demonstrating that it is serious about fixing its problems.

Here are the top 5 questions to ask about the Central Falls plan of adjustment.

1 – Who Is Impacted by the Plan of Adjustment? Both unsecured creditors and the lessor of an emergency vehicle are impaired under the plan, but the focus of the plan is on the city’s employees, retirees and unions. The unfunded pension obligations of Central Falls are stifling and, without a meaningful modification, Central Falls will not be able to continue to provide services to its citizens. As a result, the plan is designed to enable the proposed modifications of the collective bargaining agreements and pension obligations.

Broad Street, Central Falls, Rhode Island
Photo: Marc N. Belanger
Broad Street, Central Falls, Rhode Island

2 – Will the Plan Work? Yes, in some form it will. Central Falls is taking a serious approach to addressing its long term sustainability issues and is using chapter 9 to help make significant fiscal reforms. The end result may be different from what’s currently contained in the plan, but that would be a by-product of meaningful negotiations and compromise, which bankruptcy is supposed to foster.

3 – Is this Chapter 9 Case Different? It is. Common wisdom holds that chapter 9 cases are long, expensive and do not end up fixing the fiscal problems impacting cities. However, Central Falls’ chapter 9 case seems to be on track to move quickly and resolve its true fiscal problems. This is good news. Cities focusing on their issues as a corporation would and using the tools provided to them under federal bankruptcy law makes good sense. Once the fiscal issues are resolved, cities can turn their focus from fiscal pressure to providing the services taxpayers deserve.

4 – How Will the Bond Market React? It should react well. Central Falls’s proposed plan does not impact bondholders. Further, Central Falls is fixing its fiscal problems, thereby strengthening its financial situation. This should make Central Falls a stronger - not weaker - credit.

5 – Will the Central Falls Bankruptcy Spur Other Troubled Cities to Enter Chapter 9? It could - if Central Falls is successful in fixing its pension and other issues. Other cities may realize that an organized and orderly chapter 9 case can provide them with the tools and necessary framework to fix their fiscal issues. This could allow cities to get back on their feet and flourish.

The financial crisis is pounding cities, resulting in the shutdown of services. The major problem for many cities is the increase in unfunded pension obligations. To date, the negotiation process has been almost completely political. Central Falls demonstrates that chapter 9 of the Bankruptcy Code may provide cities with the tools and rules they need to successfully restructure.

Jon Henes is a partner in the restructuring group at Kirkland & Ellis LLP where he has led some of the most complex restructurings in a variety of industries, including media, chemicals, energy, manufacturing, real estate, retail and telecommunications. Jon has also frequently appeared on CNBC's "Worldwide Exchange" as a guest expert on various financial and economic topics and is a member of the Economic Club of New York.