Hannah Heck, Solving Insolvent Public Pensions: the Limitations of the Current Bankruptcy Option

• Publication year: 2011

SOLVING INSOLVENT PUBLIC PENSIONS: THE LIMITATIONS OF THE CURRENT BANKRUPTCY OPTION

INTRODUCTION

Prichard, Alabama is a city of approximately 23,0001 residents in the southwestern corner of the state. A dwindling population2 and $3.9 million of debt forced Prichard to file for bankruptcy in 1999.3 After emerging from bankruptcy in 2007,4 the city filed again in October of 2009, this time in the shadow of a lawsuit by pensioners questioning the solvency of their city

pensions.5 Prichard stopped paying pensions and the bankruptcy judge denied the pensioners’ claim to their pensions during the proceedings.6 The judge dismissed the case in March of the following year; however, Prichard failed to

resume payments.7 Nearly two years after pension payments stopped, Prichard announced a settlement with its retirees that would give them only one third of their promised pay.8 Prichard is currently awaiting a ruling from the Alabama Supreme Court to determine whether their bankruptcy case can proceed.9

The case of Prichard, Alabama is certainly unique in its circumstances, history, and financial and political challenges. It highlights, however, what is

1. State and County Quickfacts, U.S. CENSUS BUREAU, http://quickfacts.census.gov/qfd/states/01/ 0162496.html (last visited Nov. 11, 2011).

2. Michael Cooper & Mary Williams Walsh, Alabama Town’s Failed Pension is a Warning, N.Y. TIMES,

   Dec. 22, 2010, http://www.nytimes.com/2010/12/23/business/23prichard.html (noting that Prichard, Alabama has shrunk by nearly forty percent since the 1970s).

3. Douglas J. Watson, Donna Handley & Wendy L. Hassett, Financial Distress and Municipal

   Bankruptcy: The Case of Prichard, Alabama, 17 J. PUB. BUDGETING ACCT. & FIN. MGMT. 129, 142 (2005).

4. David Ferrara, Prichard Files for Bankruptcy Protection; City Faces Lawsuit Over Nearly Empty Pension Fund, AL.COM (Oct. 28, 2009, 7:02 AM), http://blog.al.com/live/2009/10/prichard_files_for_ bankruptcy_1.html.

5. David Ferrara, After Bankruptcy Case Gets Tossed, Prichard Retirees Sue City, AL.COM (Sept. 2, 2010, 6:00 AM), http://blog.al.com/live/2010/09/after_bankruptcy_case_gets_tos.html.

6. Order Denying Prichard Retirees’ Motion for Administrative Claim and to Compel Payment of

   Administrative Expenses, In re City of Prichard, No. 09-15000-WSS (Bankr. S.D. Ala. Mar. 10, 2010); David Ferrera, Motion to Force Prichard to Pay Pensioners Denied by Judge, AL.COM (March 10, 2010, 6:34 AM), http://blog.al.com/live/2010/03/motion_to_force_prichard_to_pa.html.

7. Ferrara, supra note 5.

8. Katherine Sayre, Prichard Pension Crisis: Judge Approves Settlement; Payments to Restart Next Month, AL.COM (May 25, 2011, 5:46 PM), http://blog.al.com/live/2011/05/judge_approves_prichard_pensio.

   html.

9. In re City of Prichard, No. 1:10-00622-KD-M, 2011 U.S. Dist. LEXIS 68747, at *4 (S.D. Ala. May 17, 2011).

   likely to be an increasingly frequent problem for municipalities across the United States.10 The problems of municipalities that are unable to pay their pension obligations are similar to the basic problem of any debtor in bankruptcy: the debtor (in this case the municipality) has taken on more debt

   (including pension obligations, among other debt) than it can afford to pay. However, these problems are also uniquely political and have a very direct public impact.11 Municipalities are faced with the conundrum of how to provide adequate protection for pensioners without either (a) crippling municipal services and the basic operations of their governmental unit or (b) disproportionately pushing pension obligations onto the current and future

   municipal workforce and future taxpayers.

   
   

   The state law tools available for municipalities to manage these pension obligations are limited.12 Chapter 9, the portion of the Bankruptcy Code governing municipal bankruptcy, offers what may be a last resort for many municipalities unable to pay pension obligations. “Chapter 9 is intended to

   enable a financially distressed municipality to ‘continue to provide its residents with essential services such as police protection, fire protection, sewage and garbage removal, and schools[],’ while it works out a plan to adjust its debts and obligations.”13 Importantly, federal law requires that states authorize municipal bankruptcy,14 which a majority of states have failed to do.15 As such, municipalities in a majority of states are left without access to chapter 9.16 Chapter 9 does not explicitly contemplate pensioners as debtors,17 and

   
   

10. Bill Vidonic & Debra Erdley, Pension Crisis Extends Far Beyond Pittsburgh, PITTSBURGH TRIB.- REV., Nov. 8, 2010, http://www.pittsburghlive.com/x/pittsburghtrib/news/s_708214.html; Pension Review Panel Meets to Discuss Options for Atlanta’s Pension Plan, CITY OF ATLANTA, http://www.atlantaga.gov/ media/nr_pension_022210.aspx (last visited Jan. 4, 2011); see also Liam Dillon, Explainer: Are Pensions Fair Game in Bankruptcy, VOICEOFSANDIEGO.ORG (Feb. 15, 2010, 6:11 PM), http://www.voiceofsandiego.org/ government/article_0418be36-1aa3-11df-840f-001cc4c03286.html (showing that ongoing public suggestions indicate that municipal bankruptcy might be an appropriate remedy for the reported $2.1 billion in pension obligations that the city owes).

11. See, e.g., Charles Duhigg, Public Unions Take on Boss to Win Big Pensions, N.Y. TIMES, June 21,

    2011, http://www.nytimes.com/2011/06/22/business/22union.html (discussing the fact that Costa Mesa, CA had a $100,000 public-union-funded opposition campaign to a pension reform candidate).

12. See, e.g., Navlet v. Port of Seattle, 194 P.3d 221, 232 (Wash. 2008) (en banc).

13. In re City of Bridgeport, 129 B.R. 332, 336–37 (Bankr. D. Conn. 1991) (quoting H.R. REP. NO. 100-

1011, at 2 (1988), reprinted in 1988 U.S.C.C.A.N. 4115, 4116) (citation omitted).

14 11 U.S.C. § 109(c)(2) (2006).

1. Only nineteen states currently authorize municipal bankruptcy. Issue Summary: Municipal Bankruptcy, ALLEGHENY INSTITUTE, http://www.alleghenyinstitute.org/government/munbankruptcy.html (last visited Jan.

   5, 2011).

2. Id.

17 See 11 U.S.C. § 901. But see 11 U.S.C. §§ 1113–1114.

Congress has recognized the need to study pension issues in municipal bankruptcy.18 However, to date, Congress has not modified chapter 9 to address potential pension concerns.19

Changes in local practice, state laws, and federal laws are necessary to give municipal governments tools to manage pension debt. Local governments can, and should, take preventative measures to ensure that retirement obligations do not limit their future ability to provide basic government services while simultaneously honoring obligations to pensioners. However, these preventative measures alone will not provide the relief needed for many municipalities in crisis. Neither state legal structures nor federal municipal bankruptcy law, as they presently exist, can provide the more immediate relief that municipalities need, especially given the unique voter-employee, government-employer dynamics. For municipalities to continue providing essential governmental services, provisions should be added to state law to ensure that chapter 9, when used to manage pension debt, is both politically feasible and fair to pensioners. Additionally, provisions should be added to chapter 9 guaranteeing greater municipal employee protections for these same purposes.

This Comment first summarizes current economic factors driving the recent increased likelihood of municipal insolvency, explores the unique taxpayer and voter constituency impacting municipal bankruptcy, and provides a brief background of municipal bankruptcy law. This Comment then reviews the legal framework surrounding municipalities’ options for managing pension obligations, including state pension and labor law. Subsequently, this Comment contrasts the process by which a pension is discharged and the manner in which employee pensions are protected in traditional chapter 11 bankruptcy as compared to chapter 9. Next, this Comment suggests how chapter 9 might enable a municipality to reduce or discharge pension obligations and highlights the gaps in such a process. Finally, this Comment proposes changes in local practice and state and federal law that are necessary to allow municipalities in crisis to fairly and effectively manage pension obligations.

1. See H.R. REP. NO. 102-459, at 368 (1992) (“The depressed economic situation . . . has raised a number of important questions, including the treatment of labor agreements, pensions, health benefits, et cetera. The subcommittee may wish to review the impact of municipal bankruptcy in these areas.”).

2. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, 119 Stat. 23.

   1. BACKGROUND

      
      

      1. Current Economic Conditions and Stakeholders

         
         

         1. Federal, State, and Municipal Revenue and Debt Crises

            
            

            Municipal bankruptcy has been a rarity since Congress first authorized it in

            1934.20 However, reduced municipal revenues, coupled with increased municipal obligations, have given rise to speculation that more municipalities will consider this tool in the future.21 Moreover, Standard & Poor’s recent historic downgrade of the United States’ credit rating has led some to speculate that this national debt uncertainty could lead to further instability in the municipal bond market.22

            
            

            Municipal bond defaults are rare.23 Moody’s reports only fifty-four defaults of their rated municipal bonds since 1970, and of these, only three were defaults of general obligation debt.24 However, the municipal bond default trend suggests that they are becoming more common, with 13% of the defaults in the last forty years occurring in the 2008-2009 period.25 During that time frame, an increased number of municipal bond ratings were downgraded.26

            
            

3. See Nicholas McGrath & Ji Hun Kim, The Next Chapter for Municipal Bankruptcy, AM. BANKR. INST. J., June 2010, at 14, 14 (“[T]here have only been approximately 566 [c]hapter 9 filings.”).

4. See, e.g., id. at 14; Robert J. Landry III & Keren H. Deal, More Municipalities Likely to Face Chapter

   9: Is a Perfect Storm Brewing?, AM. BANKR. INST...