Will Police Misconduct Liability Allow a City to File Bankruptcy? — “Insolvent” Eligibility Standard (Part 2 of 3)

11 U.S.C. Sec. 101(32)(C) — definition of municipal insolvency

By Donald L. Swanson


A City has been struggling for years to provide adequate services.
Then, the City and its police officer are sued for violating the plaintiff’s civil rights.
A jury verdict is for many-millions of dollars—an amount multiple times the City’s annual budget. Defendants appeal.
Plaintiff starts executing on the judgement. So the City files bankruptcy.


Does the City meet the “insolvent” element of eligibility for bankruptcy filing, under § 109(c)(3) of the Bankruptcy Code?

Statutory Standard:

“Insolvent” for a municipality is defined in § 101(32)(c) of the Bankruptcy Code as follows:

(32)The term “insolvent” means—  . . .

(C) with reference to a municipality, financial condition such that the municipality is—

(i) generally not paying its debts as they become due unless such debts are the subject of a bona fide dispute; or
(ii) unable to pay its debts as they become due.

The difference between sub-parts (C)(i) and (C)(2) of § 101(32) is this:

–(C)(1) deals with whether debts are currently being paid when due.
–(C)(2) deals with whether debts will be paid when due in the future.

Applying the Standard:

How these two standards are applied can be an interesting study.

An early case is In re City of Bridgeport, a 1991 ruling in Connecticut. The Bankruptcy Court says the § 101(32)(C) insolvency analysis is made as of the bankruptcy filing date. On that date, the City, (i) was paying its debts as they came due, and (ii) had sufficient cash for the foreseeable future. Therefore, the Bankruptcy Court dismisses the bankruptcy case because the City was solvent on the bankruptcy filing date.

In re City of Stockton, California, is a 2013 case dealing with municipal insolvency. The court examines three types of insolvency under part (C)(2) of § 101(32) (cash insolvency, budget insolvency, and service insolvency) and finds the City to be “insolvent” under all three types:

(i) Cash:

“[T]he City would run out of cash within a matter of weeks after the case was filed.”
“While cash insolvency — the opposite of paying debts as they become due — is the controlling chapter 9 criterion under § 101(32)(C), longer-term budget imbalances (budget insolvency) and the degree of inability to fund essential government services (service delivery insolvency) also inform the trier of fact’s assessment of the relative degree and likely duration of cash insolvency.”

(ii) Budget:

“Budget insolvency focuses on the ability of a municipality to create a balanced budget that provides sufficient revenues to pay for its expenses that occur within the budgeted period. . . . The projections . . . demonstrate imbalances that would persist for decades without some radical surgery.
Nor do there appear to be untapped resources that would make a material difference. Few fixed assets are available to be sold or otherwise monetized. . . .
Nor will normal property tax revenues improve enough to make a material difference. . . .
It follows that the extra revenues needed to fund a plan of arrangement probably will have to come from tax increases. The difficulty is that local tax increases in California generally require a vote of the people.

(iii) Service:

“The evidence demonstrates that the police department has been decimated. The crime rate has soared. Homicides are at record levels. The City has among the ten highest rates in the nation of aggravated assaults with a firearm. Police often respond only to crimes-in-progress. That is a paradigm example of service delivery insolvency that confirms that the cash insolvency is no chimera.”

The Standard and the Hypothetical:

Part (C)(1) would not apply to the hypothetical above because the judgment is on appeal and is, therefore, “the subject of a bona fide dispute.”

Part(C)(2) could apply and might demonstrate insolvency because:

–the judgment is currently due and payable (and can be enforced) in its entirety, despite the appeal; and
–the magnitude of the judgment amount, and its immediately-due status, might enable the City to prove it is “unable to pay its debts as they become due.”

Note: The first article in this series reviews a new report of a study (titled “Who Pays for Police Misconduct in Bankruptcy Cities?”) and explains the mediation connection to the subject.  The third article in this series will address the “good faith” requirement for a municipality in bankruptcy.  A fourth article is “10 Practical Lessons for Cities Facing Bankruptcy.”

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