Stockton Tests New Municipal Bankruptcy Law in California

With several of its cities facing fiscal crisis, California last year approved a new law intended to make it more difficult for municipalities to declare Chapter 9 bankruptcy. Now, with the city of Stockton on the verge of becoming the largest American city ever to go bankrupt, state and local officials alike are hoping the new law works.

The law requires fiscally stressed municipalities, which previously could declare bankruptcy on their own, to enter into a 90-day mediation period before any formal Chapter 9 declaration can be filed. It is intended to make bankruptcy a last resort for local officials, with state lawmakers hoping that municipalities will avoid the fate of other California localities, such as Orange County and the city of Vallejo, that previously declared bankruptcy.

Officials in Stockton, a city of 290,000 about 80 miles east of San Francisco, voted unanimously on Tuesday night (February 28) to enter into the mediation process established under the new law, The New York Times reports . The meeting “stretched late into the night” and the decision “is widely seen as the city’s last-ditch attempt to restructure its finances outside of bankruptcy.” Stockton faces a budget deficit of as much as $38 million on a total city budget of about $165 million, according to The Times .

As Stateline has noted in an explainer on municipal bankruptcy , California is one of 15 states where municipalities have the right to declare bankruptcy on their own, though the state’s new law makes that harder. In the rest of the country, state governments have a say in the process. In Pennsylvania, for instance, the state must sign off on any municipal bankruptcy declaration, and the state went to court against its own capital city, Harrisburg, when the city council declared Chapter 9 bankruptcy on its own last October.

Local bankruptcy declarations are rare, but increasingly they have appeared on states’ radar amid the severe budget problems facing city and county governments. Jefferson County, Alabama, filed the largest local bankruptcy declaration in history last November, and municipal governments in Rhode Island also have flirted with bankruptcy. In both cases, local problems have turned into state headaches, with governors and state lawmakers worrying about damaged credit ratings or being asked to bail out stressed municipalities.