Academic journal article The Journal of Government Financial Management

40 Years Later: AN ANALYSIS OF CURRENT MUNICIPAL BANKRUPTCY CASES

Academic journal article The Journal of Government Financial Management

40 Years Later: AN ANALYSIS OF CURRENT MUNICIPAL BANKRUPTCY CASES

Article excerpt

Relating the Fiscal Stress Indicators Found in 1973 by the Advisory Commission on Intergovernmental Relations

Municipal bankruptcies, known as Chapter 9 filings in federal bankruptcy court, have escalated in recent years due to the current economic climate of lower federal and tax revenues coupled with the increased costs of delivering services to citizens. Since 1938, approximately 650 munieipal bankruptcy cases were filed in federal court with over 250 of those filings, roughly 40 percent, occurring since 1980.1 The municipal debt market currently accounts for over $3 trillion in current bond issuances2 with household investors holding the bulk of the debentures mainly due to the tax-free income stream, as well as, the historically low default rates.

The Great Depression is noted for the largest number of municipal defaults3; however, defaults have numbered more than 2,500 since 1958 according to a recent report by Appleson, Parsons and Haughwout of the New York Federal Reserve.4 The research found that most of these occurred in bond financing for industrial development activities (28 percent), health and human services (23 percent), special assessments (8 percent), and to the lower end of the range in pension bond issue defaults (5 percent),

Typically, a municipality, if allowable under state law, turns to Chapter 9, which provides the municipality protection from creditors while it develops and negotiates a plan for adjusting their debts.

Brief History of U.S. Municipal Bankruptcy Law

In 1934, Congress enacted the Municipal Bankruptcy Act5 to give states a mechanism for local governments to deal with the increasing rates of tax delinquency, decreasing property values, increasing demand for public services, and growing unemployment problems brought on by the Great Depression. To date, the legislation has several amendments on the books with the most recent change due to the 1991 Bridgeport, Connecticut Chapter 9 filing. At the time of the filing, Bridgeport had a $16 million deficit and was experiencing population decline due to increasing crime rates and a higher tax burden on residents than found elsewhere in the state. The State of Connecticut objected, unsuccessfully, to the filing due to lack of specific authorization by the state.6 Noting the court's dismissal of the objection, other states placed pressure on Congress to enact new legislation requiring specific authorization in state statutes allowing municipalities to file Chapter 9 in federal court. Congress amended the federal legislation.

Current Municipal Bankruptcy Law

Under current law7, municipalities are eligible to file for Chapter 9 protection in federal bankruptcy court if they satisfy five statutory requirements8, detailed below:

1 The local governing body must * meet the definition of "municipality" which is defined in the U.S. Bankruptcy Code as a "political subdivision or public agency or instrumentality of a State." This definition includes cities, counties, townships, school districts, special authorities and public improvement districts such as airport authorities and utility boards.

2 The municipality must have *specific authority to file for Chapter 9 under state law. As of 2012, 24 states currently have enacted legislation to allow municipalities to file for bankruptcy.9 Twelve of these states currently require additional steps such as permission from the governor and/or fiscal intervention on the state's part prior to filing with the additional 12 states taking a "hands off" approach of no state involvement prior to the bankruptcy petition on behalf of the municipality. The remaining 26 states are either legally silent in their administrative codes regarding a municipal bankruptcy, or are specifically prohibited from Chapter 9 filings, which, then prevents the state's municipalities from filing in federal court.10

3 The municipality must be insol* vent. This is interpreted by the courts as the local entity either not paying their debts as they become due, or unable to pay their debts as they become due. …

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