Legal Brief                                                  Page 10


Is Default Even an Option

for School Districts?




Across the nation, school districts are collapsing under the weight of contractual obligations to current and retired employees. The cost of salaries, health insurance and pensions are driving districts across the country to insolvency.

Could declaring bankruptcy be a realistic solution? It might be the only answer for districts permitted to file bankruptcy.

Federal law allows a school district, like a municipality, to seek protection from creditors and to reorganize its debt under Chapter 9 of the U.S. Bankruptcy Code. But a school district’s capacity to file for bankruptcy protection depends on whether the state allows the district to do so. Currently, only 27 states permit municipalities to file for bankruptcy protection, but 15 of those states require additional state approval prior to filing. In New York, school districts cannot file bankruptcy without express authorization from the governor.

Municipal bankruptcies are rare. Fewer than 500 municipalities have filed bankruptcies in the past 60 years, and fewer than 2 percent of those municipal filings have been schools. In California, approximately seven school districts have filed for bankruptcy protection in the past 30 years.

Major Victories?
The San Jose, Calif., Unified School District filed bankruptcy in 1983, enabling it to void employee contracts. The district filed for protection after state legislation that cut property taxes and contractual obligations increased employee wages by 9.6 percent in the first year, 6.1 percent the second year and 6 percent the third year. San Jose went through the restructuring process and ultimately resolved its financial woes by negotiating new terms with its employees

In 2004, the Richmond Unified School District, near Oakland, Calif., discovered it had miscalculated revenue and faced a hard choice — close down school in May or file bankruptcy. The district declared bankruptcy and borrowed $60 million from the state. In exchange, the local school board relinquished control as the state appointed administrators to run district affairs. Richmond Unified finally regained control in 2013, nine years after declaring bankruptcy.

San Jose won a major victory when the bankruptcy judge allowed the district to throw out all of the employment contracts to prevent the school district from collapsing. Just last December, the city of Detroit won a major victory when the bankruptcy judge ruled public sector pensions can be restructured through bankruptcy. These rulings could be powerful tools during contract negotiations for districts struggling with the high costs of wages, health insurance and pensions.

Long-Running Cases
So with reserve funds depleted and state aid being cut annually, why aren’t more public schools filing for protection?

Bankruptcy is a complicated process with an uncertain outcome. Of the 13 municipalities that filed bankruptcy in the past five years, five applications have been dismissed. A California district that sought bankruptcy protection voluntarily withdrew its petition. Furthermore, a filling almost certainly means the district must surrender local control over education decisions to the state.

Bankruptcies are long running and cost millions to litigate. Taxpayers bear the brunt of the negative fiscal impact on credit ratings, and creditors such as the public employees in Detroit often are the stakeholders municipalities need to succeed. It could take years before a district actually sees any savings.

Alternative Avenues
A dedicated funding mechanism for school districts would be the best solution to prevent school district insolvency. Alternatively, districts could engage employees in discussions about managing wages and restructuring benefits to ensure the sustainablility of the school district during tough economic times.

Absent this cooperative problem solving at the local level, it is likely that school districts with the capacity to file bankruptcy will do so, and the districts that can’t file may have to shut its schools’ doors or be forced to consolidate with neighboring districts. None of the options are palatable, leaving schools districts to be creative in seeking other revenue sources to avoid insolvency.


Michele Handzel is school attorney with Capital Region BOCES in Albany, N.Y. E-mail: michele.handzel@neric.org.


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