Chester, Pennsylvania’s bankruptcy nears two-year mark

Chester, Pennsylvania, is broke, its state-appointed receiver says.

This fact is not in dispute. Chester is one of the only two municipalities in the country with an active bankruptcy, and is millions of dollars short of its pension obligations.

But nearly everything else about the Chester bankruptcy — the causes, the town’s obligations, the receiver’s proposals — is more complicated.

As the city nears the end of its second year in Chapter 9 proceedings, it’s weathered explosive disputes within the city council and spurred court cases testing state and national laws.

The city’s murky finances and contentious policymaking, so far, have stayed mostly contained within its limits. But the court cases in progress as the troubled city southwest of Philadelphia nears year three of bankruptcy could have wide-ranging precedents.

Chester’s problems have deep roots. The city, which is one of Pennsylvania’s oldest and poorest, sits right next to Philadelphia on the bank of the Delaware River. Its economy was once boosted by textile mills, factories and a shipyard. 

When the city started hemorrhaging manufacturing jobs in the mid-20th century, many residents fled, too — especially the wealthier, whiter residents. Stark racial tensions and extreme poverty remained. 

By 1995, when Pennsylvania designated Chester a distressed municipality under its Act 47 program, residents felt left behind by the government. Just three years later, the state opened a new prison directly on Chester’s waterfront. 

An Act 47 distressed designation grants municipalities access to new funding, but it also compels them to cooperate with the state, and make their required pension payments in full. Chester, according to former officials, made no attempt to cooperate, and repeatedly ignored the state’s recommendations and audits. 

The pandemic exacerbated Chester’s problems, and then-Gov. Tom Wolf declared a fiscal emergency in the city. Michael Doweary, former administrator for the city of York, Pennsylvania, was appointed receiver in June of 2020, with PFM veteran Vijay Kapoor as his chief of staff. 

The declaration of “emergency” was apt, Kapoor said. Chester had laid off most of its public works department, leaving the city of 34,000 people with just two full-time workers and four part-time workers. 

“We were going into December later that year worrying about the ability to plow snow,” Kapoor said. 

Doweary was required to create a recovery plan within the first thirty days of his tenure, Kapoor said, with a more fleshed out plan due in six months. But the team quickly realized it would take much longer than that to ascertain Chester’s problems. 

Within Doweary’s first month, the Pennsylvania auditor general released a report that Chester had failed to make its legally required pension payments for years. Not only did Chester owe its pension plans more than $34 million, it may also have misallocated $10 million of pension-related state aid, the auditor general said. 

The city’s police pension fund contained just $1.2 million, or around two months of payments, Kapoor said; far lower than what everyone assumed. Chester had also neglected to pay payroll taxes, and owed $750,000 to the IRS. 

The city council and mayor, who had been cooperating with the state and its advisors since 2015, once again became “adversarial” to the state and the receiver, Doweary said. 

Members of the city council also served as department heads, Kapoor said, an arrangement unique to Pennsylvania and most parts of the country. It enabled the corruption and mismanagement that the receiver argued was widespread in the city.

There are many potential explanations for how Chester’s finances ended up so poorly, Doweary said, but he lays much of the blame with the city’s government; many Pennsylvania municipalities suffered “the same decline of urban manufacturing” as Chester, and received the same “counseling” through Act 47, he said.

“That local entity, it’s up to them to negotiate contracts, take appropriate actions, be conservative, foresee whatever it is that they need to do,” Doweary said. 

But Chester didn’t receive the same level of state involvement as other distressed municipalities, Pew Charitable Trusts journalist Liz Farmer said.

“In some ways, you could say that the state prevented other cities from taking it this far,” Farmer said. 

Pennsylvania intervened heavily to prevent a bankruptcy in Scranton, and the state legislature outright blocked Harrisburg’s bankruptcy filing in 2011. “None of that happened with Chester,” Farmer said.

The state made no attempt to stop the city council’s corruption until the declaration of emergency in 2020, and Chester’s failure to make its pension contributions went either unnoticed or unpunished for years. 

Distressed municipal governments often have acrimonious relationships with state-appointed officials, Farmer said. But Doweary’s treatment in Chester was unusually hostile. 

In a municipal bankruptcy, “the baseline is friction,” Farmer said. “But just the way in which the entire government resisted, because of the power of the elected officials who also ran the city agencies,” was unique. 

Tensions eventually escalated and Doweary filed a lawsuit to wrest control of the city’s finances from the council. 

The Pennsylvania Supreme Court sided with Doweary in January, affirming that receivers under Act 47 have the power to “protect the health, safety and welfare of a municipality’s citizens.” 

“The City of Chester’s local officials must accept the exercise of that power,” the court found, “whether they like it or not.”

The lawsuit was the first test of Act 47’s powers since it was passed in 1987. Doweary acknowledges it was necessary, but also regards it as a waste of time and money. Kapoor viewed the legal battle more positively. 

“It also demonstrated to the public and to the parties here that this receiver was actually serious about doing the things that needed to be done in order to turn the city around.”

The first thing Doweary did with his newfound power was to file for bankruptcy in November 2022. Chester’s budget had a $46.5 million deficit in 2023, and the city faced liabilities worth hundreds of millions of dollars with just $10-50 million of assets.

“Had it not been for the revenue replacement dollars that are given to the city and the capital dollars and the return to work dollars, the full package,” Doweary said, “if it were not for that, probably we would have had to declare bankruptcy two years earlier.”

Municipal bankruptcies are rare, according to Cadwalader partner Lary Stromfeld. They’re rare enough that certain legal principles are less settled than many bondholders assume.

The newly-bankrupt city filed an adversarial proceeding challenging the liens on its 2017 revenue bonds, in a “creative” effort to exploit some undefined terms, Stromfeld said.

The municipal bankruptcy code was modeled after the commercial bankruptcy code, where property acquired after a commercial bankruptcy is not subject to liens. Commercial entities often put liens on their physical properties, Cadwalader partner Casey Servais noted, and cutting off a lien on propeties acquired post-bankruptcy gives those entities “a fresh start.” But a government cannot issue a lien on its physical property, and in most municipal finance contexts, the lien is almost exclusively on their revenue.

“But that whole financing structure doesn’t work if the lien then gets cut off in bankruptcy,” Servais said.

“In a municipal revenue deal, every time revenues are paid, like in a toll booth, every time that toll money comes in,” Stromfeld said, it “could be viewed as property that was acquired after the bankruptcy.”

The municipal bankruptcy law has an exception for this context, preserving liens on “special revenues” acquired after a bankruptcy, Servais said. The category of “special revenues” includes “special excise taxes,” but special excise taxes have no clear definition.  

Chester argued that special excise taxes should not include the revenue it pledged in its bonds: slot machine license fees, gambling tax revenue, and fees from a waste incinerator operator. The bankruptcy court sided with the city on this part of its challenge late last year.

But bondholders appealed, and earlier this month, the federal Third Circuit court agreed to hear the case.

“And so the Third Circuit, as a result of this direct appeal that’s going to occur now, is really going to get the first crack at trying to impose some kind of definition on that term,” Servais said.

The municipal market has lalways expected bondholders’ liens on revenue to continue after bankruptcy, Stromfeld said; Detroit could have challenged the liens to its revenue during its bankruptcy but, for many special revenue bonds, made no attempt to do so.

“It was always assumed [the liens were] fine,” Stromfeld said. “And if Chester is able to make the argument and win that, it may be good for the case, but it creates a problem for the municipal market generally. The market has expectations about continuing to be secured.”

In August, Doweary filed a proposed plan of adjustment with the bankruptcy court.

Its centerpiece is “a process to generate annual revenue for City services by monetizing Chester’s water, wastewater and stormwater assets, while keeping them in public hands, the receiver’s office said.

Even assuming the monetization goes to plan, Doweary said, it will never generate enough revenue to cover the city’s liabilities and necessary investments, especially considering the impending fiscal cliff when ARPA funds run out in 2026. The city is in mediation with its pensioners and other creditors to create a plan of adjustment to its pension obligations, Doweary said.