Vallejo Bankruptcy Morass Spurs States to Prevent Other Filings

Soon after Indiana state Senator Ed Charbonneau introduced legislation in January to bolster cash- strapped cities on the verge of bankruptcy, he got an unexpected phone call.

It was Bill Cooper, city manager of Hamtramck, Michigan, whose own state has refused permission for the Detroit suburb to file for reorganization. Cooper urged sending state help to cities before they reach a crisis, Charbonneau said.

“We’re putting a process in place with the intent of avoiding the need for bankruptcy,” Charbonneau, a Valparaiso Republican, said in a telephone interview April 19. “The whole purpose of it is to try to get fiscal help to distressed local units of government so they can correct their situation before any need for bankruptcy would arise.”

Insurmountable budget deficits gripping some U.S. cities are prompting state intervention to avert municipal bankruptcies through mechanisms to renegotiate labor contracts, devise financial plans and pay debts. Cities face an estimated $20 billion in combined shortfalls this year, according to the National League of Cities, a Washington-based lobbying group.

States are also pressing their cities to resolve fiscal troubles before they get out of hand, heeding lessons learned from the 2008 bankruptcy of Vallejo, California, which has spent about $10.6 million in legal fees and still had to slash its police and fire departments by more than 40 percent.

Weighing Legislation

Indiana and California are among states weighing legislation to head off such bankruptcies following similar efforts last year in Rhode Island. In Michigan, Governor Rick Snyder, a Republican, signed a law last month empowering a state-appointed emergency manager to renegotiate a city’s contracts, sell assets and set minimal staffing levels.

The Michigan managers will develop a financial and operating plan for a distressed local government that includes meeting scheduled debt service on all bonds, notes and municipal securities, making pension-fund contributions and changing, rejecting, ending and renegotiating contracts.

The bills aim to protect states from the harm to their credit ratings that could result from a municipal bankruptcy, increasing their borrowing costs, said James Spiotto of the Chicago-based law firm Chapman and Cutler LLP.

“It’s a responsible trend,” Spiotto said in a telephone interview April 20. Often in such situations, cities “need a bridge, they need additional revenues to weather the storm, and that’s what the state provides,” he said.

Emergency Manager

In Indiana, Charbonneau’s bill would allow a troubled municipality to seek state appointment of an emergency manager with broad powers over city finances, including reviewing budgets and salaries, creating a plan to repay debts, renegotiating labor contracts, representing the city in collective bargaining, and reducing or suspending salaries. The manager would also be empowered to make, approve or reject a contract, expense or loan.

Indiana’s House of Representatives approved the proposal on April 21, sending it to a conference committee to resolve differences with the Senate version of the bill, Charbonneau’s office said in a news release.

“To the extent that they are helpful in improving local government budget management and overall performance, they’ve been a positive development from a credit standpoint,” Robin Prunty, a credit analyst at New York-based Standard & Poor’s, said of such legislative moves in a phone interview April 20.

In California, lawmakers are considering legislation that would require a distressed municipality to attempt renegotiating financial and contractual obligations with investors and public employees, through mediation, before considering a bankruptcy filing.

‘Struggling’ Cities

“A lot of cities are struggling, but parties are not talking all together,” Assemblyman Bob Wieckowski, a Fremont Democrat and bankruptcy attorney, said in a telephone interview April 19. “My legislation would appoint a third party, someone who is skilled in bankruptcy work and would be the adult in the room.”

Two days after cash-strapped Central Falls, Rhode Island, filed for appointment of a state receiver in May 2010, Standard & Poor’s and Moody’s Investors Service downgraded the city’s general-obligation debt to junk. State legislators responded by enacting a law setting up a process to help cities stabilize their finances. The law allows appointment of a fiscal overseer to develop an operating and capital plan to help a city recover.

If the overseer determines the city can’t balance its budget or faces a fiscal crisis, the state revenue director may appoint a budget commission. If the budget commission can’t restore stability, a receiver is appointed and can file a federal Chapter 9 bankruptcy petition for the city.

Bond Obligations

When a city can’t meet its bond obligations, the state’s treasurer would make the payments and deduct the amount from future funds due the city, according to a statement.

Michigan this month began building an army of emergency managers for troubled municipalities by offering training for financial professionals and public employees. As many as 400 accountants, lawyers, school workers and city staffers are taking classes on topics including negotiating contracts and dealing with a unionized workforce.

Michigan already has emergency managers running schools in Detroit and overseeing the cities of Pontiac, Ecorse and Benton Harbor. Hamtramck, which had such a manager in the past, has sought to reorganize under Chapter 9 of the U.S. Bankruptcy Code, saying that Detroit, which largely surrounds it, owes it money. In March 2010, Detroit said it was considering moving toward a filing.

State Safeguards

Michigan is not the only state with safeguards already in place.

In Pennsylvania, officials use the law known as Act 47 to offer loans and grants to financially distressed local governments and help in creating a recovery plan. The state has declared 26 municipalities to be distressed since the law was enacted in 1987, according to the Department of Community and Economic Development.

Among them is Harrisburg, the Pennsylvania capital with a debt burden at least five times its general-fund budget. Consultants hired under Act 47 said they’ll propose a recovery plan in May. Harrisburg Controller Dan Miller said in a report this month he expects a $6 million deficit this year.

-- With assistance from Jeff Green in Southfield, Michigan, Jonathan Keehner in New York, and Romy Varghese in Harrisburg, Pennsylvania. Editors: Pete Young, Stephen Merelman

To contact the reporter on this story: Alison Vekshin in San Francisco at avekshin@bloomberg.net.

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net.

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