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When Cities Go Broke: Local Government Bankruptcies

The sharp economic downturn of recent years has impacted not only families and businesses, but municipalities too. When local governments can no longer afford to meet their obligations to lenders and creditors, they may be forced to file for bankruptcy protection. Since 2010, nearly 40 municipal bankruptcies have been filed by cities and local governments. This figure includes localities that filed Chapter 9 bankruptcies as well as other government entities that sought bankruptcy protection, such as sanitation authorities and other lesser-known special districts.

municipality bankruptcy

Detroit Goes Bankrupt

In July, the city of Detroit filed for bankruptcy protection after decades of economic decline. The automobile capital once exemplified the strength of American industry, but Detroit was eventually hollowed out by an exodus of residents and businesses to surrounding suburbs. In 1950, Detroit’s population reached a peak of 1.8 million. But now, the city is home to just 700,000 people and “tens of thousands of abandoned buildings, vacant lots, and unlit streets.”

The Chapter 9 filing in the U.S. Bankruptcy Court for the Eastern District of Michigan marked the country’s largest-ever municipal bankruptcy case. Having failed to reach out-of-court agreements with creditors and bondholders, Detroit could no longer afford to keep up with its obligations on more than $18 billion in liabilities. The city of Detroit’s bankruptcy is currently ongoing.

Municipal Bankruptcies Across the United States

Detroit has now joined many other cities that were forced to file for bankruptcy protection. In 2011, Jefferson County, Alabama filed Chapter 9 bankruptcy in the U.S. Bankruptcy Court for the Northern District of Alabama. The county’s debts exceeded $4 billion, more than $3 billion of which related to sewer work.

The cities of Harrisburg, Pennsylvania and Central Falls, Rhode Island also filed Chapter 9 bankruptcy, as well as Boise County, Idaho.

California Cities Go Broke

Several other large municipal bankruptcies have been filed by California cities. In 1994, our very own County of Orange filed a Chapter 9 bankruptcy after it lost approximately $1.5 billion through high-risk investments in bonds. At the time, the filing was the largest ever for any city or municipality.

In 2012, both Stockton and San Bernardino filed Chapter 9 bankruptcies. Stockton, a city of 300,000 in northern California, could not avert bankruptcy after three months of confidential talks with its creditors. In the documents filed in the U.S. Bankruptcy Court for the Eastern District of California, Stockton listed its major unsecured creditors and debts which included the California Public Employees’ Retirement System (with a $147.5 million claim), $124.3 million in pension obligation bonds, and parking garage debt exceeding $31 million.

The City of San Bernardino sought relief from a Chapter 9 bankruptcy after it’s City Council declared a fiscal emergency in June 2012. The city could no longer meet its daily obligations due to a housing bust, a decades-long manufacturing slump, and soaring employee salary and pension costs. The U.S. Bankruptcy Court for the Central District of California approved San Bernardino’s plan to restructure its debt under Chapter 9 in an August 2013 ruling, but now a major creditor is appealing the decision. The California Public Employees’ Retirement System (Calpers), which has opposed San Bernardino’s bankruptcy since it was initiated, announced this month that it will argue that the city did not file its bankruptcy petition in good faith.

Municipal Bankruptcies May Continue

With the slow pace of economic recovery, distressed municipalities may continue to seek bankruptcy protection in the coming years. But overall, these filings are rare. A recent study indicated that only one of every 1,668 localities that are eligible to file for bankruptcy protection have done so over the past five years.

Image courtesy of Flickr user JasonParis

About the Author
Christian Spaulding is the founder and principal attorney at Spaulding Law Group. Mr. Spaulding has lived in Southern California his entire life and his family has been in Southern California since the late 1800’s. Mr. Spaulding received his undergraduate degree from Chapman University in Orange with a Bachelor of Science in Accounting. While completing his undergraduate studies, Mr. Spaulding was the recipient of the prestigious Wall Street Journal Student Business Award. Mr. Spaulding graduated at the top of his accounting program at Chapman University and attended law school at Chapman University School of Law where he was a Merit Scholarship recipient. Mr. Spaulding has focused his firm’s practice solely on consumer protection and bankruptcy since 2009.

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