PROVIDENCE – Why didn’t Central Falls file for bankruptcy on Wednesday rather than get put into receivership?
The short answer: Rhode Island law does not allow it.
Bankruptcy is a federal court process, and since 1934 the bankruptcy code has included a section – Chapter 9 – that sets out how a municipality or other public body can file for bankruptcy. (States cannot file for bankruptcy.)
The biggest Chapter 9 bankruptcy took place in 1994, when Orange County, Calif., filed. More recently, Vallejo, Calif., went into bankruptcy protection in 2008, and other communities in California, Michigan and Pennsylvania have considered it, too. More often it has been utilities or economic-improvement districts, rather than municipalities, that have filed.
But Rhode Island is one of 26 states that do not allow their municipalities to file for bankruptcy under Chapter 9, according to the American Bankruptcy Institute. (Massachusetts does not, either.)
“A municipality in those states must seek enactment of a specific statute particular to it authorizing the filing,” John H. Knox and Marc A. Levinson, lawyers with Orrick, Herrington & Sutcliffe in San Francisco, wrote last year in a primer on Chapter 9. “It goes without saying that a floundering municipality faces an uphill battle in such states.”
Without Chapter 9 available, then, Central Falls’ only option after its leaders determined the city was insolvent was to ask an R.I. Superior Court judge to put its finances in the hands of a receiver, who will now be empowered to deal with the city’s creditors and renegotiate contracts.
Nevertheless, the possibility of Chapter 9 has been on the minds of Central Falls’ leaders in recent weeks. Last month, the City Council voted to ask the General Assembly to pass a law allowing municipalities to file for bankruptcy protection.
That decision was enough to convince Standard & Poor’s Ratings Service to downgrade Central Falls’ credit rating on April 29 from ‘BBB’ to ‘BBB-’ and to put a negative watch on the city.
Larry Berman, a spokesman for the House leadership, said he had not heard any discussion about the General Assembly taking action to either allow Chapter 9 or do something else to aid Central Falls.
In 1989, Central Falls officials publicly discussed the possibility of either dissolving the city or declaring bankruptcy under Chapter 9. At the time, a law professor advised the city that it was unclear what would happen to its residents and land if it surrendered its municipal charter.
The following year, the General Assembly created the Central Falls Review Commission, which issued a report that led state taxpayers to take responsibility for the Central Falls School District as a way to ease the community’s fiscal woes. The commission continued to oversee Central Falls’ finances until 2000, and the state continues to pay for its schools.
I can tell you why Chapter 9 was not chosen. The “insiders” wanted a favorable outcome for pensioners and wanted to push liabilities to the “debtors” (i.e. the bond holders).
If this had been a Chapter 9, the pensioners would have been classified as “debtors” (see Prichard Alabama Chapter 9 filing, March 9, 2010 Court Decision). But In RI we punish the bond holders and will likely treat the pension plan as immune or close to being immune.
This view will ultimately punish RI’s bond rating. But what the heck, this is RI.
It should also be pointed out that there exists no specific law In RI that disallows an RI municipality from filing a Chapter 9 Bankruptcy in federal court. It is only that in RI, you cannot go directly to Federal Court as a first step. A municipality must first allow the state to offer up their own solution, but then they are allowed to go to federal court if no solution is offered.