Providence Bankruptcy Seen as Unavoidable on Budget Gap

By Brian Chappatta and Romy Varghese - Mar 28, 2012 5:35 AM GMT+0700

Providence (1055MF), Rhode Island’s capital and biggest city, probably will seek bankruptcy court protection to deal with a budget deficit, Robert Flanders, the state- appointed receiver for nearby Central Falls, said today.

“I don’t see how they can get out of it without going there,” said Flanders, a former state Supreme Court justice and a partner at Hinckley, Allen & Snyder LLP. He put Central Falls into bankruptcy in August and has used the city’s legal status to tear up contracts with city workers and cut pension benefits.

Enlarge image

Robert Flanders Jr., the Rhode Island state appointed receiver running the financially troubled city of Central Falls, during a meeting. Photographer: Stephan Savoia/AP Photo

Providence Mayor Angel Taveras has put pressure on Brown University and other nonprofit organizations to help close a budget gap of at least $20 million, while Governor Lincoln Chafee is pressing lawmakers for action on measures to help communities curb pension costs. Unsustainable retiree expenses helped push Central Falls (1058MF) into insolvency. Moody’s Investors Service cut Providence debt a step to Baa1, third-lowest investment grade, yesterday citing its “strained” finances.

“Bankruptcy is not the preferred option for restoring Providence’s fiscal health; it is the last option, and I will do everything in my power to prevent it from happening,” Taveras said in a statement in response to a request for comment on Flanders’ remark. “I respectfully disagree with Judge Flanders that bankruptcy is unavoidable.”

More Common

Chapter 9 bankruptcy may become more common in the near future, Flanders said in an interview before a Bond Buyer conference on distressed cities in Philadelphia. Once municipal officials become aware of how useful a tool court protection can be, it will be hard to resist, he said, suggesting as many as 20 cities a year may take the option, if it’s open to them.

Entering bankruptcy remains a rare move by municipalities. Since 1937, 635 municipalities have sought Chapter 9 protection, according to James Spiotto, a lawyer with Chapman & Cutler LLP in Chicago. Some states prohibit communities from doing so.

Legal analysts consider bankruptcy as something to be avoided at all costs. Governments already have the tools they need to deal with debt and budget issues, Richard L. Sigal, who teaches at the University of Connecticut Law School and is a partner at Hawkins Delafield & Wood LLP, said during a panel discussion at the conference.

‘Lawyer’s Heaven’

Bankruptcy is “a lawyer’s heaven and doesn’t seem to be worthwhile,” said Sigal, who helped resolve New York City’s fiscal crisis in 1975. Even Orange County, California, the biggest municipal bankruptcy before Jefferson County, Alabama, entered Chapter 9 last year, could have gotten its finances in order by borrowing, he said.

“Bankruptcy is never a desirable option,” Chafee said today in a statement. “It has broad implications and consequences in terms of bond assessments, property values, and negative national perception.”

“That is why the state of Rhode Island is taking every possible step to help our municipalities -- including our capital city of Providence -- avoid bankruptcy,” Chafee said.

Many municipalities are at risk of defaulting on their debts, said William Rhodes, a partner at Ballard Spahr LLP who moderated a conference panel discussion. Some community leaders must choose between paying bondholders and maintaining vital services, such as police and fire protection, he said.

Making Payroll

Flanders cited the need to keep paying the Central Falls workforce as a reason to seek bankruptcy. Once under the court’s wing, he cut the city’s workforce by 32 percent and trimmed pensions by as much as half, while continuing to pay debts.

“The decision to file Chapter 9 is not the cause of the municipality’s dire financial condition -- it’s the remedy,” Flanders said. “Do you want to die an inevitable financial death by being unable to meet your obligations and defaulting, or do you want to get right financially by coming up with a plan of reorganization?”

In Providence, Taveras refuted Flanders’ view of the situation for his city.

“Providence is not Central Falls,” Taveras said. “We’ve already accomplished much in our work to put Providence back on firm financial ground.”

Naomi Richman, a Moody’s managing partner in public finance said she is monitoring how municipal-bond issuers view bankruptcy. In the 1980s, the stigma attached to seeking court protection declined for companies and has more recently started to fade for individuals who take that step, she said during a panel discussion.

Perception Issue

Whether the perception of municipal bankruptcy will also change is “something we’re watching and cautious about because you can see more if there is a perception that the outcome is favorable,” she said.

“Central Falls’ bankruptcy came with painful experiences for residents, employees, and retirees -- lessons that should discourage anyone from thinking bankruptcy is a quick, easy fix to complex financial problems,” Chafee said. “Bankruptcy should be pursued only when there are no other options, and I will continue to push for passage of my legislative package so that other municipalities do not go the way of Central Falls.”

To contact the reporters on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net; Romy Varghese in Philadelphia at rvarghese8@bloomberg.net.

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