Dispossessing Residents: Municipal Bankruptcy and the Public Trust

Juliet Moringiello, Associate Dean for Research and Faculty Development, Widener University Commonwealth Law School, Harrisburg, PA 

Municipal bankruptcy occupies an obscure corner of bankruptcy law. Although the federal law for resolving municipal financial distress is located in chapter 9 of the Bankruptcy Code, there are significant differences between the bankruptcy processes used for municipal bankruptcy and the bankruptcy processes used by individuals and business entities. Constitutional constraints imposed by the balance between federal and state power enshrined in the Tenth Amendment dictate much of the structure of chapter 9. As a result, chapter 9 lacks some of the governance controls that exist in the other bankruptcy chapters.

Another significant difference between municipal bankruptcy and other types of bankruptcy is the role of bankruptcy in distributing the debtor’s property. A liquidation bankruptcy under chapter 7 distributes all of a debtor’s property to its creditors, which  is the floor for distributions in a reorganization bankruptcy. According to the public trust doctrine, a municipality has no property that can be forcibly distributed to its creditors. Municipal property belongs to all of the municipality’s residents and is thus held in trust by the municipality, immune from seizure by creditors.

So why talk about bankruptcy in a symposium about dispossessing Detroit? One of the most contentious issues in municipal bankruptcy is the treatment of pensions, and indeed bankruptcy can result in reduced pension payouts. But all residents stand to lose something in bankruptcy that is not property and is not always entitled to constitutional protection: voice.

Some criticize the municipal bankruptcy process because it leaves control of the bankruptcy in the hands of the municipality and therefore effects no change in the conditions that led to the bankruptcy in the first place. If a dysfunctional city government played a role in the distress that led to bankruptcy, there is nothing in the Bankruptcy Code to dislodge that government. While true, that’s only one half of the story. Chapter 9 of the Bankruptcy Code was designed to work with state financial intervention schemes. We saw that in Detroit, where the Emergency Manager had the primary role of guiding the city through the bankruptcy.

Back to dispossession and the public trust. There are several types of intervention – in Michigan, the Emergency Manager displaces city government as a bankruptcy decisionmaker. In Pennsylvania, a municipal receiver does not displace city government. The receiver takes the lead in making the decisions necessary to resolve municipal financial distress but must work with the elected officials to implement a recovery plan. Any municipal recovery plan can involve the sale of municipal property because the public trust doctrine means only that such property is immune from a forced sale, not a voluntary sale. Outside of the property context, public trust can mean trust in the process, and if the state insolvency scheme is viewed as a takeover, the citizens will feel dispossessed of their voice. In fashioning an intervention process, states should consider the impact of that process on the voice of the residents who are so critical to a city’s ongoing recovery.

Contract Selling as a Form of Property Dispossession

Beryl Satter
Professor of History, Rutgers University-Newark

A sure-fire way to lose one’s property is to pay too much for it — or to buy it on terms that are so onerous as to be predatory.  Both problems are endemic to properties purchased “on contract,” that is, on an installment plan.  I detailed the full repercussions of predatory contract sales in my 2009 book Family Properties: How the Struggle Over Race and Real Estate Transformed Chicago and Urban America.  That book described the mid-twentieth century exploitation of black Chicago homebuyers through predatory contract home purchases, a period during which banks’ refusal to make mortgage loans to African Americans left many with no alternative but to buy on contract.  Unfortunately, since the 2008 subprime meltdown, the practice has been revived, with predictably tragic results.

From the buyer’s perspective, purchasing a property on contract (also known as an “installment land contract,” “contract for deed,” or legally, “Articles of Agreement for Warranty Deed”), combines the worst of buying and renting.   In a contract sale the seller of the property provides the credit for the purchase – but on harsh terms.  Buyers must make a down payment.  They are also responsible for taxes, insurance, maintenance, and interest.  However, most installment land contracts specify that if the buyer misses even a single payment, the contract seller can repossess the property, keeping everything that the buyer invested to date.  Most also specify that all maintenance on the property is the responsibility of the contract buyer.  If the price charged for the property is excessive, or if maintenance costs are unusually high, then a missed payment and subsequent loss of the property is not uncommon.

In the mid-twentieth century, contract selling became an easy way for white speculators to exploit African Americans’ dreams of home ownership.   In cities across the country, speculators used borrowed money to buy properties from whites.  They then immediately sold those properties on contract to black buyers – routinely charging them double, and sometimes quadruple, the prices they’d paid.  Black buyers who could not keep up the exploitative payments lost their homes.  In Chicago, many of the most active contract sellers repossessed scores of properties every year – retaining the down payment and all money that their black buyers had invested to date. 

Contract selling died down in the 1970s as the now nominally illegal practice of bank redlining lessened in frequency, and as flawed federal housing programs created new ways to exploit black homebuyers.[i]  Unfortunately, it has reemerged in full force since the 2008 subprime meltdown.  Hedge Funds like Harbor Portfolio Advisors have purchased thousands of foreclosed homes from Fannie Mae (the Federal National Mortgage Association) for about $5000 each. They sell these properties days later at massive markups — $30,000 to $60,000 each. These properties have often been abandoned for years, and are in severely deteriorated condition, yet the contract buyer is solely responsible for the often staggering costs of restoring them to a habitable condition.  These costs mire them in debt and force them to miss payments, ensuring the loss of their properties.  Once again, those with plentiful access to credit are using contract sales to manipulate minority buyers’ dreams of mobility in order to entrap and defraud them, resulting in enrichment for the hedge funds, and property dispossession for those most in need. [ii]

[i] On the 1970s FHA-HUD scandal, see Keeanga-Yamahtta Taylor, Race For Profit:  How Banks and the Real Estate Industry Undermined Black Homeownership (University of North Carolina Press, 2019). 

[ii] On the recent resurgence of predatory contract selling, see Jeremiah Battle Jr., Sarah Mancini, Margot Saunders, and Odette Williamson, “Toxic Transactions:  How Land Installment Contraacts Once Again Threaten Communities of Color,” National Consumer Law Center, July 2016, https://www.nclc.org/issues/toxic-transactions-threaten-communities-of-color.html