The new minimal cities.

• Author: Anderson, Michelle Wilde
• Position: Municipal bankruptcy and residents' interests - I. Cities in Distress B. In Law through III. The New Minimal Cities A. A Local Nightwatchman State, p. 1151-1188

2. In Law

   When a city cannot pay its bills or meet its obligations to creditors, one of three legal systems kicks in, depending on state law: municipal bankruptcy, a state insolvency program, or traditional common law remedies. (119) This Section provides an overview of these legal approaches to municipal insolvency.

   The first track for dealing with municipal fiscal distress is bankruptcy, offered under Chapter 9 of the U.S. Bankruptcy Code. (120) For Tenth Amendment reasons, this option is available only where the state has "specifically authorized" the municipality, or all municipalities in the state, to so file. (121) Twenty-seven states permit their municipalities to petition for bankruptcy in some circumstances, but most of these states set very narrow pre-conditions and approval requirements. (122) The substance of Chapter 9 is very much in flux. The current wave of Chapter 9 filings from California, Michigan, and Alabama is raising new and difficult legal questions regarding (1) the meaning of fiscal insolvency, an eligibility requirement for Chapter 9; (123) (2) the nature of a city's obligation to negotiate "in good faith with creditors" if such negotiations are practicable and it has not obtained plan approval from a majority of claims; (124) (3) the meaning of California's 2012 statute establishing new pre-conditions for filing Chapter 9; (125) and (4) most controversially and consequentially, the status of collective bargaining agreements under Chapter 9. (126) Detroit's bankruptcy filing, which is orders of magnitude bigger than any in history, has the potential to remake the legal and political landscape of these issues.

   More broadly, Detroit and the other current bankruptcies will give cities and creditors a better sense of the consequences of municipal bankruptcy. Cities already have a pretty good sense of how painful it is to try to forestall bankruptcy. As explored here in Part II, avoidance means austerity measures such as slashing cuts to services and widespread employee layoffs; emergency asset sales that, because they are so rushed, may yield lower dollar amounts than the full value of the property; and high-cost, high-risk credit deals with investment banks. Cities also know some of the punishing downsides of bankruptcy that have made Chapter 9 so rarely used: a bankrupt city loses the ability to borrow; it may hurt other municipalities' ability to borrow in its state or region; the filing is stigmatizing for the city, making it harder to retain and attract businesses and residents; it is terribly expensive in legal and administrative fees; and it is politically damaging, if not disastrous, for sitting officials.

   Cities do not, however, have as good a sense of what lies on the other side of bankruptcy: whether they will be able to restore an acceptable level of services, whether they will be able to attract competent employees, what it will take to recover their creditworthiness, and so forth. That means that creditors are still learning too: they have to adjust their expectations on whether states and federal governments will bail out insolvent cities; unions and public employees have to learn how much to trust deferred forms of compensation like pensions and retirement health care; and bond markets have to adjust how they think about the credit risks of lending to municipalities.

   State municipal insolvency laws and programs, which at least twenty-three states have formally put in place, provide an alternative to municipal bankruptcy, and thus a reassurance to creditors that the state will avoid rewriting municipal debt agreements under Chapter 9. (127) State insolvency laws, which can be generally applicable or ad hoc legislation, call for intervention by the state in local fiscal affairs (commonly called a receivership) during a period of distress or emergency. (128) State supervision varies widely in terms of the state's proactive monitoring and auditing of local finances, the procedures and management of the state intervention, and the terms and circumstances of the state's withdrawal. (129) Typically, municipal insolvency legislation identifies economic criteria or other triggering conditions for intervention. Upon satisfaction of those pre-conditions, a state financial board or state-appointed receiver is authorized to gather information about the city's financial condition, to manage its debt or guarantee the city's loans, and to manage the city's finances through a recovery plan. (130) State programs vary widely in the amount of control wielded by the state; from "oversight" programs with weak authority to intervene in cases of fiscal distress to "control" programs with strong intervention authority. (131) In stronger systems, the receiver may be empowered to raise taxes and user fees, cut or contract out services, liquidate assets, and approve or negotiate collective bargaining agreements. (132) While receiverships were traditionally coupled with state funds to help fund services and stabilize credit through grants, loans, or loan guarantees, state budget stress and weakened political will to "bail out" municipalities have meant that some states are providing less fiscal relief. (133)

   The final category of law that has evolved to address municipal fiscal meltdown is the default position of "traditional creditors' remedies" where bankruptcy or a receivership program is not in place. (134) If a city cannot pay a creditor, that creditor can simply take the city to court, bringing a state mandamus action to compel the city to pay its debts. Creditors' remedies, which can be organized and enforced through a judicial receivership, can include the sale of city property not in public use (i.e., property owned in a proprietary capacity rather than active public use) or the compulsory levy of new taxes. (135) Judicial receivers do not have the power to impair the city's contractual obligations, but they can stay proceedings against a municipality while it comes up with a plan for paying its debts. (136)

   It would be sensible if the choice among Chapter 9, a state insolvency program, and a judicial receivership depended on the nature of the city's fiscal distress. That is not the case, however, because states rarely offer more than one of the three systems to manage insolvency. The choice among them reflects a range of issues related to politics, history, and ideology. For instance, this choice implicates both local autonomy (how much independence and discretion will local governments have?) and state governance (is the state willing to fund staffing and administrative costs to monitor local finances?). It reflects state lawmakers' views on contagion effect theories positing that any write-down on municipal bond debt will drive up the costs of borrowing for all other municipalities in the state. Choices among insolvency regimes also reflect different views about why cities in a particular state have floundered, diverging roughly into mismanagement explanations (including corruption), political theories (including excessive rent seeking by special interests), and socioeconomic decline theories (emphasizing urban poverty and suburbanization). (137) Historically and ideologically driven views about the predominant cause of insolvency in a particular state inform whether decisionmakers seek to make insolvency a punishment, a quarantine, or a safety net.

   The cities covered in this study have all crossed the legal line into one of these systems of law. Three of the four California cities on the list filed for bankruptcy as permitted under state law, after each city followed the prescribed procedure of pre-bankruptcy negotiations and findings. The fourth city, Atwater, declared a fiscal emergency as required by these procedures, and started down the road to a Chapter 9 filing. Pritchard, Alabama also filed for Chapter 9 protection. Michigan and Rhode Island have formal state receivership programs in which all of the listed cities are participants; and in each state, one city (Detroit and Central Falls, respectively) went past a receivership and into bankruptcy. (138) Illinois, Indiana, Massachusetts, New Jersey, Ohio, and Pennsylvania have formal intervention programs for municipal bankruptcy, but none of their struggling municipalities have entered bankruptcy. (139) The City of Harris burg did file for Chapter 9, but the state acted to block the filing and the judge determined that the city was thus ineligible for Chapter 9-a sequence that reiterates the state gatekeeping function in accessing Chapter 9, regardless of municipal will or depth of deficits. (140)

   When cities are scrambling to avoid these programs and managing affairs once inside them, how do local governments and governance change?

   Understanding these adaptations is a first step to thinking about how cities can manage fiscal distress strategically and responsibly.

   2. SHRINKING GOVERNMENT

   Referring to former workers in the auto industry, the head of a Michigan-based career center recounted:

   The hardest thing for many auto workers who've been doing the same job for 25 years or so to accept is that instantly, permanently, their standard of living has been ratcheted down 80 percent.... You may have been making $25 an hour making widgets for years, but now your skill set means you're worth $8 an hour. (141) That fall-experienced by individual households across the country-is also evocative of the depopulation, revenue losses, business closures, and physical ossification that industrial cities have been experiencing since the 1950s. Cities that once symbolized American prosperity now symbolize decline.

   What does it look like to go from prosperity to poverty for a city government? Long-term decline and acute recession mean less money in city coffers, and lower revenues necessarily mean less purchasing power for a city government or a growing overhang of debt, or both. One way or another, sooner or later, the government...