From state to territory

California faces a $21 billion budget shortfall.

“I looked as hard as I could at how states could declare bankruptcy,” said Michael Genest, director of the California Department of Finance who is stepping down at the end of the year. “I literally looked at the federal constitution to see if there was a way for states to return to territory status.”(http://online.wsj.com/article/SB125814283469047497.html)

So, let’s saw the legislature decides it’s unable or unwilling to make anymore budgetary cuts and appeals to Washington become a territory, what happens in terms of government and finance?

Politically it would be suicide, since the now-territory of California would no longer have representation in Congress. One big question would be the legal validity of cities incorporated by state charter; how did towns incorporate when they were in what were still territories anyway? If there was no longer a state police, that function would have to be taken over by the US Marshalls.

Financially, you would have the question of whether local authorities would still have the legal power to tax property (see incorporation, above). I suppose under the Fourteenth Amendment the Federal government would be forced to guarantee the distribution of federal benefits such as Social Security, Food Stamps and Medicare, and possibly all of the benefits (schools?) that have come to be considered “rights”. All stretches of road considered Interstate or US Route highway would become the fed’s direct responsibility.

How were things handled in Alaska and Hawaii before they became states?

I am not sure about the statutes and cases in California that waive the state’s sovereign immunity to lawsuits. But this is how California would have to proceed, since states do not declare bankruptcy: legislation would have to passed (or portions of the California Constitution amended) to reassert its immunity. California’s creditors then would be barred from asserting their claims in court.

Of course, the contracts themselves may waive immunity, and these obviously could not be undone after the fact. Although the waivers must be unequivocal and are strictly construed in favor of the sovereign, there are enough traps (and, naturally, clear-eyed, intentional contractual waivers too) that California would not get rid of all its creditor litigation.

There is a legal precedent for this, but not in the United States. The Dominion of Newfoundland had a responsible government since 1854. They were a member of the British Commonwealth, and were self governing. In 1931, it was one of the territories under the Statue of Westminster that gave it full equality with Great Britain. At that time, Newfoundland was pretty much an independent nation on par with Canada and the Union of South Africa.

However, in 1933, Newfoundland went bankrupt. In 1934, the Newfoundland parliament voted itself out of existence, and governmental power was given to the nonelected Commission of Government. The Commission of Government consisted of six appointed representatives from Newfoundland and Great Britain and a governor appointed by the crown (that is the Prime Minister of Great Britain’s government).

After World War II, instead of once again returning to independence, Newfoundland voted to become a provence in the Dominion of Canada.