Bondholders have cut the line

August 3, 2011

Something doesn’t seem right in Central Falls, the Rhode Island city that declared municipal bankruptcy yesterday. Now that the state receiver has filed Chapter 9, all the town’s dirty laundry has been hung out in public, and, like any bankruptcy, it’s not pretty. Overspending and declining tax revenues doomed this poor town, along with liberal doses of alleged corruption.

Here is what doesn’t seem right in Central Falls. The city is dead broke and those they owe money to are lined up at City Hall to collect. But for some odd reason, the city’s bondholders have pushed ahead of all the others in line to claim full repayment of their debts; those later in line must settle for 50 cents on the dollar. Retired police officers and firemen will have their pensions cut by 50%.

It wasn’t Central Falls’s decision to give preferential treatment to bondholders. Last year legislators in the state capitol passed a law making the claims of bondholders superior to all other claims in bankruptcy. The Rhode Island General Assembly’s action flies in the the face of common bond market practice, which is that bondholders get in line with everyone else and a judge overseeing bankruptcy proceedings gives a fair resolution to all the creditors.

The law passed by the Rhode Island General Assembly upends the order of priority for payments in bankruptcy. Municipal bankruptcy is filed in federal court, and cities cast themselves at the mercy of the federal bankruptcy law. Because our federal constitution reserves all rights to the states that the federal government does not claim, it makes this area of the law a funny hash of competing jurisdictions. And it possibly encourages the Rhode Island legislators to try and change the rules.

The federal bankruptcy code does create some special protection for holders of “special revenue” bonds. The law firm Jones, Day characterizes the exemption:

Protection of Special Bond Revenues.

Chapter 9 of the Bankruptcy Code expressly provides protection to creditors holding liens on special project revenues of a municipal debtor. For example, municipalities often finance special projects, such as water and sewer plants, with bonds that are collateralized with the revenues and fees earned by such projects. Section 928 of the Bankruptcy Code states that the “special revenues” from these projects remain subject to the liens of the bondholders in the specific projects.

The bondholders of Central Falls hold “general obligation,” or GO, bonds. This type of bond has access to the revenues of the central taxing authority of the municipality. These are not “special revenue” bonds issued by a sewer or water entity that is legally separate from the municipal entity. So within Chapter 9 law, general obligation bondholders would not receive preferential treatment in bankruptcy proceedings.

Because a state is asserting privileges beyond current law, this issue could be litigated for a decade.  It will probably go before the U.S. Supreme Court and provide lots of billings for the legal profession. But what about the moral issue of denying a retired policeman half of his annual $30,000 pension to pay a bond holder 100 cents on the dollar? Has our country enshrined creditors’ rights at so many levels above pension rights?

The Providence Journal has been doing an excellent job covering this story and made this video about the meeting between the state receiver and retired police officers and firemen. This is the human side of the story.

Central Falls, Vallejo and Jefferson County are local communities where fiscal issues spiraled out of control. For public entities in distress, we have a law, Chapter 9, to resolve their problems. The law was first enacted in 1934 during the Great Depression and has provided a template for fair treatment of all parties demanding payment. The Rhode Island General Assembly doesn’t need to mess with the coroner who is laying the deceased claims to rest. The legislature should instead devote its time to addressing solutions for Central Falls and other communities who are broken. This bold move to upset the order of things does not seem right or in the public interest.


Reuters:  Loss of bankruptcy card would weaken cities’ hands

Bloomberg:  Central Falls Bankruptcy Casts Pall on Pensions

Bond Buyer:  Central Falls Aims to Protect GOs

Provindence Journal: State credit rating seen unaffected by filing

Moody’s:  City of Central Falls’ (RI) Caa1 General Obligation bond rating on review for possible downgrade

Moody’s: Moody’s Affirms B3 Rating on Central Falls (RI) General Obligations Debt; Negative Outlook Assigned

Financial Times:  Rhode Island city files for bankruptcy

New York Times:  Small City, Big Debt Problems


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see

The language passed by the Rhode Island General Assembly re priority of bond payments.

Act Relating to Cities and Towns – Providing Financial Stability, Chapter 24/27 of the Rhode Island Public Laws of 2010

g. § 45-12-1, as amended. grants a self-executing statutory lien on all ad valorem taxes and general fund revenues to secure the payment of all general obligation bonds and notes and other financing obligations of cities or towns.

Posted by Cate_Long | Report as abusive

[…] interesting appearance by Alexandra Lebenthal on CNBC yesterday. The discussion ranged from the Central Falls, RI bankruptcy filing (Alexandra repeats the conventional wisdom that Rhode Island’s recently passed legislation […]

Posted by Regulator wants to require “fair dealing” | MuniLand | Report as abusive

Bodah added that it takes time for those being asked to make the sacrifices to evaluate their choices. He said he was not surprised that when given a yes-or-no offer July 19 and told to answer in 10 days, the retirees balked.

“People who were pondering the loss of about half of their pensions were given a relatively short time to say yes,” Bodah said. O_08-03-11_IEPHCPH_v37.54729.html

Posted by Cate_Long | Report as abusive

The City of Central Falls, Rhode Island filed a Chapter 9 bankruptcy petition at 9:03 AM, August 1, 2011. The case is assigned bankruptcy number 11-13105. Chief Judge Sandra Lynch of the First Circuit Court of Appeals has designated Bankruptcy Judge Frank Bailey, of the District of Massachusetts, to preside over the case. Additional case filing information will be posted on this page as appropriate.

Link to bankruptcy proceedings: ral%20falls.asp

Posted by Cate_Long | Report as abusive

Providence Journal: Central Falls bankruptcy a cautionary tale for R.I., state leaders say ITICAL_REACTION_08-02-11_K0PGV39_v23.476 03.html

Posted by Cate_Long | Report as abusive

[…] Not everyone thinks Rhode Island’s law is such a great innovation. Here’s Cate Long, who writes about municipal bonds for Reuters: The Rhode Island General Assembly’s action flies […]

Posted by Wall Street Journal says ‘Bondholders Win in Rhode Island’ | Blogs | Report as abusive

[…] take this public display into account when weighing the fairness of proposed reorganization.  I complained about bondholders jumping the creditor line, and this is a greater indication of the odd path this bankruptcy is taking. I’ll write more […]

Posted by Munis gain as stocks sell off | MuniLand | Report as abusive

[…] funds were far from funded but has never given a public account of their finances. There are also deeper issues for Central Falls and Rhode Island as they intend to pay bondholders 100 cents on the dollar while reducing pension […]

Posted by The unsustainability of public pensions | MuniLand | Report as abusive

[…] communities would increase. Using the Alabama data we can see that this is not true and that pension holders basically got shafted, while bondholders received 100 cents on the […]

Posted by A municipal bankruptcy does not ruin a state | MuniLand | Report as abusive

[…] pension problems are. But Nocera glosses over the biggest issue in this story: In 2010 the Rhode Island General Assembly passed legislation that protects municipal bondholders by exempting them from creditor writedowns in bankruptcy […]

Posted by Conservative ideologues aren’t bankrupting Rhode Island | MuniLand | Report as abusive

[…] some messy litigious entanglements. It’s doubtful that a state, that has cherished bondholders in its really authorised structure, will. Josh Barro parsed a bankruptcy-bound city of Woonsocket, and suggested how a state’s bad […]

Posted by HOT NEWS & ENTERTAINMENT » Curt Schilling and the Ineptitude of Rhode Island | Report as abusive