60 RI Bar J., No. 4, Pg. 19. Rhode Island Municipal Insolvency Lite.

Author:Guy R. Bissonnette, Esq.

Rhode Island Bar Journal

Volume 60.

60 RI Bar J., No. 4, Pg. 19.

Rhode Island Municipal Insolvency Lite

Rhode Island Bar Journal60 RI Bar J., No. 4, Pg. 19January / February 2012Rhode Island Municipal Insolvency LiteGuy R. Bissonnette, Esq.Practices in Portsmouth, RI

Like most of you, I do not currently represent a municipality; but I do follow current events. So, as a lawyer with more than a passing familiarity with the bankruptcy code, I have been watching the Central Falls, Rhode Island receivership from afar, with more than a few nagging questions. Overcoming inertia, I began to examine some of those questions and have attempted to formulate what I believe to be the answers thereto.

Q. Can a state declare bankruptcy under federal law?

A. No. The 10th Amendment prohibits a federal entity from running the financial affairs of a state.(fn1) Conversely, a state cannot force a creditor to compromise its claim without violating the constitutional prohibition against the state impairment of contracts.(fn2)

Q. Can a municipality file for U.S. bankruptcy protection?

A. Yes, if there is a state law which permits it. The country is divided almost equally, with twenty-five (25) states not permitting the filing.(fn3) Rhode Island (until June 11, 2010) did not authorize the filing of a municipal bankruptcy petition, but now does. Once again, the reason that state permission is needed is the 10th Amendment to the U.S. Constitution.(fn4) A state cannot be compelled constitutionally to submit to federal fiscal regulation; but may do so voluntarily for its sub-entities, e.g. towns, cities, counties, other types of bonding/taxing authorities, etc.(fn5) In 2010, when the Rhode Island legislature created the new, so called "municipal receivership" statutes,(fn6) it did provide for the state-appointed receiver to file for protection under Chapter 9 of the bankruptcy code on behalf of the municipality under his/her control.(fn7) This is the only time a Rhode Island city or town can be placed into bankruptcy. In other words, for a city or town in Rhode Island to be placed into bankruptcy (Chapter 9), it must already be in state receivership. In effect, state receivership is a necessary predicate for a municipal bankruptcy filing in Rhode Island.

Q. If a municipality files for bankruptcy, can the bankruptcy Receiver (the term Trustee is not used in Chapter 9) sell off municipal assets (a park, firehouse, equipment, municipal buildings, etc.) to pay for the debts of the public entity?

A. No. The type of bankruptcy protection provided to municipalities is found in Chapter 9(fn8) (not in Chapters 7,(fn9) 11(fn10) or 13(fn 11) as is common for individuals or businesses). This type of bankruptcy provides only for a re-organization of debt analogous to Chapter 11 (for businesses) and therefore does not permit the forced sale of public assets to pay off creditors. It is not similar to a Chapter 7 filing which is, essentially, the liquidation of the assets of an individual/business for the benefit of creditors.

Q. So what is going on with Central Falls?

A. Prior to May of 2010, a municipality with budget problems in Rhode Island was required to work with the state auditor general to develop a deficit-reduction plan.(fn12) Without prior notification to the state, on May 19, 2010 the city of Central Falls bypassed this process and sought receivership protection in the Providence County Superior Court, ostensibly, in an effort to seek relief from its union and pension obligations.(fn13) This is believed to be the first time any municipality sought protection in a judicial receivership under Rhode Island law. The City's thinking was that it needed the power of a judicial receivership to address/change the then existing union/pension contracts.(fn14) On, May 19, 2010, the court appointed Attorney Jonathan N. Savage as the temporary receiver for Central Falls.(fn15) Almost immediately (June 11, 2010), the Governor and Rhode Island General Assembly acted to create a new receivership law granting the state the power to intervene in the affairs of budget-strapped municipalities and made the law retroactive in its application.(fn16) It is clear that the state legislature passed this modification to the state receivership statute specifically with Central Falls (and other struggling municipalities) in mind,(fn17) and that these efforts were motivated because of pressure being put on the state by nervous municipal bond rating agencies.(fn18) The new law is entitled, § 45-9 Budget Commissions.(fn19) This receivership statute prohibits future municipal judicial receiverships(fn20); but allows municipalities that are under "financial distress" to seek state receivership protection.(fn21) It creates, in essence, a three-step process. First, upon a petition by the city/town's finance director, and with the agreement...

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