‘Innovative Bankruptcy’ Sweeping the Nation?

JUL 3, 2012 3:12pm ET

It’s no secret that many of our cities are financially strapped for cash as their expenses continue to outweigh their revenues year after year.However, declaring bankruptcy is not necessarily the answer.

The negative connotation, as well as the legal expense, for a city to file bankruptcy has city managers, mayors and city councils looking for creative alternatives. North Las Vegas appears to be one of the first to pull the trigger on a creative alternative by declaring the city a state of emergency and making itself an official disaster area.

North Las Vegas was one of the hardes-hit cities in the U.S. during the recent housing crisis, with high unemployment rates and an overwhelming number of foreclosures and bankruptcies.

As property values plummeted, so did revenue generated from property taxes for five consecutive years. One in every 195 homes is in foreclosure, which dropped its tax revenue from $817 million in 2009 to $298 million in 2012. 

The city can no longer meet its union contract obligations, scheduled salary increases and retirement benefits without massive layoffs which would decimate the public services the city provides to its residents.

The state statute that allows municipalities to declare a state of emergency will potentially save North Las Vegas $9 million as union contracts are suspended and salaries freeze.

The police union filed a lawsuit on June 14 claiming the city is misusing the state of emergency law to its advantage.

They claim the law was originally enacted to protect municipalities from unforeseen disasters and not reductions in its coffers and potential financial mismanagement. No doubt the city will be required to demonstrate to the court that it explored other options, including raising taxes, renegotiating labor agreements, and consolidating or eliminating services.

It is no coincidence that areas with high foreclosure rates run parallel to cities in financial crisis. The housing crisis, high unemployment and economic recession have taken a toll on our communities across America.

But will “innovative bankruptcy” be a trend among cities to impair union contracts and derail pension plans? The public entity, as a service provider, must document legislative findings based on evidence in order to be successful with this strategy in a court of law. The documentation should include:

1.                Details and information showing that a true emergency exists. Courts have defined an “emergency” as an “an unforeseen situation calling for immediate action.” Opponents may argue that a fiscal emergency is not sudden and occurs over a period of time. They may also argue that a cash shortfall is not an unforeseen event. In contrast, supporters of the state of emergency may argue that a city can be in such dire fiscal condition that essential services to protect and serve the public are cut so thin that it creates a service level issue, resulting in an emergency situation.

2.                Details that other options have been explored. A declaration of an emergency is temporary in nature. The intent is to give the city the time it needs to find ways to generate revenues and continue to provide services consistent with public health and safety. The city need not show that all steps have been taken but that reasonable steps have been taken prior to declaring an emergency.

3.               Details showing a measured consideration of alternatives to declaring a state of emergency. Alternative measures can be taken other than impairing contracts including raising taxes, collective bargaining, the consolidation or elimination of services, depleting reserve funds, etc. If these options are not enough to avoid a fiscal emergency, the city may have no viable alternative but to declare a disaster.

Regardless of a city’s decision to file bankruptcy or declare a state of emergency, either option will create a public relations nightmare. Nobody wants to live in a disaster area or a city that decimated its credit to the point where it defaults on municipal bonds, and can no longer borrow money, resulting in the complete erosion of the quality of services it intended to provide to the general public.


Diane Gozza is EVP, Integrated Mortgage Solutions, Houston.


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