The new minimal cities.

• Author: Anderson, Michelle Wilde
• Position: Municipal bankruptcy and residents' interests - III. The New Minimal Cities B. Doctrinal Boundaries of Residents' Interests through Conclusion: Shrinking Governance Responsibly, with appendix and footnotes, p. 1188-1227

2. Doctrinal Boundaries of Residents' Interests

   Legal proceedings governing insolvency must reconcile the competing financial claims of two groups of parties: the city (including its residents and current employees) and its creditors (including retirees, current employees with vested benefits, and bondholders). While there is rich and valuable research exploring how bond and labor creditors do fare and should fare in this balancing, (285) there is far too little focused on the financial claims of the city. The task of this Section is to articulate the legal issues that lie on the city's side of the line. I will root this discussion in Chapter 9 bankruptcy law, because receivership programs vary somewhat from state to state, and a recitation of their precise rules would be excessively technical for the present setting. All receivership programs, however, face the same threshfold issue of eligibility and the same main-stage issue of recovery planning, and all of them articulate these issues in ways similar to those described below for Chapter 9.

   A city's interest in an insolvency intervention boils down to this: What is the starting "contract" liability that cities bring to the bargaining table in a dispute with creditors over the allocation of revenues and assets, and what is the degree to which a bankruptcy plan can reduce that amount? This challenge arises at two stages: (1) the decision regarding whether a court or state receiver should intervene in local finances (an eligibility matter), and (2) if it does intervene, the balancing of creditors' interests against residents' interests in the city's recovery plan. At both junctures, decisionmakers must determine how much more a debtor city could reduce current spending in order to divert more revenues to creditors.

   Eligibility proceedings require decisionmakers to determine whether a city requires outside intervention to handle its debts. Not all struggling fiscal entities need a reorganization of debt or a third-party intervention to manage spending. Some can muddle through on their own, cutting deals with creditors on a case-by-case basis to the extent possible, facing creditor lawsuits in courts, and extracting new revenues from residents. This will usually mean surrendering assets or specific streams of revenue to creditors, either because those assets were collateral to the loan (as in some bond instruments) or because a creditor successfully obtains a judgment against the city in court and the asset is attached for payment of that judgment. At some point, muddling through creates a collective action problem: when each creditor individualistically pursues their interest in full repayment, they force inefficient liquidation of city assets and spending cuts that hurt the city's ability to pay other creditors and make creditors as a whole worse off. Intervention is arguably needed at this point in order to create a plan that systematically maximizes the share allocated to each creditor and achieves a fair balance among them. Intervention is also justified in bankruptcy because liquidation of a city is not possible. Just like an individual debtor in a Chapter 7 or 13 personal bankruptcy, "[c]ities cannot go out of business." (286) They exist in land and space, and the dissolution of their legal boundaries would simply pass the bill for their debts and spending needs to a county or neighboring city. Chapter 9 therefore is not geared towards dissolution but rather reorganization--"to enable a financially distressed city 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." (287)

   It is states that decide whether their cities can appeal to a federal bankruptcy court for intervention. (288) Once in court, however, Chapter 9 instructs bankruptcy judges to assess a city's eligibility for relief. This eligibility question turns on whether the city is insolvent, which is defined as the failure or inability to pay bona fide debts as they come due. (289) Insolvency is evaluated using a cash-flow analysis specially developed for Chapter 9, which assumes the need to fund current services, just as an individual debtor in a Chapter 7 or 13 bankruptcy must still fund housing, food, and subsistence expenses. Since Chapter 9 thus builds in some degree of protection for ongoing spending on current residents, cities seeking bankruptcy protection justify court intervention in terms of the city's inability to make further cuts to basic services without risking "minimum health and safety." Interestingly, this language reflects cities' authorization to serve "health, safety, and welfare" (i.e., local governments' so-called police powers, delegated by their state governments), but it has reframed that authorization as a duty. Pursuant to their authorization to serve health, safety, and welfare through regulation and the spending of tax revenues, this reasoning goes, local governments are in fact obligated to protect their citizens' health, safety, and welfare--at least to some degree.

   Stockton's eligibility arguments are a case in point. Its brief on its qualifications for bankruptcy stated:

   During the past four years, in response to the declining economy, Stockton has out of necessity reduced or eliminated funding for almost all General Fund programs and services below levels that the City views as minimally acceptable. Little is left to cut in these areas, and what reductions could be made are not nearly enough to even approach solving the City's financial difficulties. The City is not only already cash-insolvent. It is service-insolvent as well. (290) Further cuts, the brief warned, would "endanger the welfare and safety of the city's residents and businesses," especially given the "state of crisis" of public safety in the city. (291)

   Similar arguments are made to the general public as well. Describing the decision to declare bankruptcy, for instance, the City Manager of Stockton explained in a radio interview how after three years of spending cuts and privatizations, the city "got to the point where we couldn't cut anymore while still maintaining the health and safety of our citizens." (292) Michigan's Governor and Detroit's Emergency Manager (a state-appointed receiver for the city) offered equivalent justifications for their petition for municipal bankruptcy. The Governor described the city's inability to "meet its basic obligations to its citizens" and pointed to statistics on the city's unemployment and homicide rates, emergency response times, abandoned structures, and other local conditions. (293) He emphasized that this inability to meet needs affected creditors: "reducing spending on basic services," he wrote, "would only decrease the population and tax base further" and compound the inability to fulfill promises to creditors. (294) Emergency Manager Kevyn Orr similarly explained: "Freeing up the cash flow allows us to focus on the key issue ... the health, safety, and welfare of 700,000 citizens in the city of Detroit." (295)

   Seeking to block a city's reorganization and reduction in debt, creditors of Vallejo, Stockton, San Bernardino, and Detroit all argued that their city debtor could still sell additional assets and reduce spending, and thus did not satisfy Chapter 9's requirement of fiscal insolvency. Yet bankruptcy courts upheld all four cities' qualifications for Chapter 9. In Vallejo, for instance, the bankruptcy court and a bankruptcy appellate panel for the Ninth Circuit found that the city could not cut services back any further. The panel held:

   Vallejo already cut much of its discretionary budget. Vallejo reduced employee rolls and continuously cut funding to services like the senior center, library and parks. Alarmingly, most of Vallejo's vehicles were near the end of their expected lives and many of the vehicles had already been extended past that life. Vallejo could have cut more services, but the court found that it had reduced expenditures to the point that municipal services were underfunded. More importantly, the court found further funding reductions would threaten Vallejo's ability to provide for the basic health and safety of its citizens. (296) Though these constituted legal holdings backed up with factual findings regarding prior funding cuts, aging city equipment, and other bits and pieces, words like "underfunded" or "basic health and safety" were not defined specifically in either opinion (for instance, "underfunded" relative to what?). In the opinion holding Stockton eligible for bankruptcy, the court's decision referenced a specific policing ratio (Stockton's number of officers per 1,000 residents compared to the comparable national statistic) and the city's troubling crime rates, but otherwise similarly relied on broad language about "public safety" and minimum standards. (297) The court also emphasized the concept of "service delivery insolvency"--the indication that without intervention, city services would continue to fall below acceptable levels. (298) In Detroit, the court found a series of facts about the state of the city's services and its recent budget cuts that are stunning enough to speak for themselves about the city's insolvency, but nonetheless do not reveal any baseline ideas about the extent of services the city should enjoy. (299)

   Once decisionmakers deem a city eligible for intervention, an insolvency proceeding comes to the second juncture where minimum standards issues loom large: the prospective recovery plan. In addition to other requirements, a bankruptcy court must be satisfied that a municipality's bankruptcy plan is "feasible." (300) Under Chapter 9, this standard includes, and then goes beyond, the Chapter 11 expectation that the debtor will not need another bankruptcy reorganization in the near future, i.e., that the plan "offers a...