In 2008, the City of Vallejo was essentially bankrupt. Hammered by the housing market and unable to bring its budget into balance, city and union officials attempted – without success – to renegotiate labor contracts and benefits. Ultimately, this impasse led Vallejo to file for protection under Chapter 9 of the U.S. Bankruptcy Code. What went wrong in Vallejo is the stuff of which urban legends are made. Only in this particular circumstance, it’s not legend; it’s Vallejo’s reality.
After three years of legal wrangling and over $10 million in legal fees paid by taxpayers, Vallejo is readying itself to exit its self-imposed torture through bankruptcy court. Bankruptcy court has resulted in protracted litigation followed by tumultuous negotiations between unions, bondholders and unsecured creditors. These negotiations are expected to lead to the settlements necessary to approve what is likely to be a short-term plan of rehabilitation.
The damage? Half of the city firefighters were laid off and almost 40 percent of the police were cut. These cutbacks meant that only the most serious crimes get investigated and the city is now a haven for prostitutes. Vallejo’s future is uncertain as it exits Chapter 9 and seeks to raise general obligation bonds needed to address the declining tax base and provide basic services to its residents. In short, Vallejo’s gamble with the bankruptcy process has left the city high and dry.
Vallejo learned that bankruptcy is not a panacea because the process has no teeth. The bankruptcy judge can only do two things: dismiss the case or continue to herd the cats while the case is pending. The tension between state and federal rights makes Chapter 9 an expensive and uncertain bet, unless the debtor negotiates a plan with its creditors before filing, something Chapter 9 requires. And, it is important to remember, in order for a California municipality to file for bankruptcy it must establish: (1) it is insolvent; (2) it has desire to effect a plan to adjust its debt; and (3) it has tried to negotiate a plan with its creditors.
Assemblyman Bob Wieckowski, a bankruptcy lawyer and former local elected official, has a plan to help cities like Vallejo. He has introduced a new law (AB 506) that would require any municipality to engage in mediation with its creditors before filing a bankruptcy petition. This law would assist the parties in negotiations with creditors prior to filing as required by the Bankruptcy Code and has the added benefit of cutting legal costs.
Currently California is one of only 10 states that allow municipalities to file for bankruptcy without some form of intervention. Under the proposed new law, mediation would be facilitated by specially trained mediators who can help the parties identify business alternatives to a bankruptcy filing or negotiate a plan prior to filing. Unlike prior legislation, this latest effort does not require municipalities to get approval from any state agency, nor does it tie the hands of local governments. It does, however, bring all sides to the table – consistent with the Chapter 9 process – instead of watching as they jump off the bankruptcy cliff.
Mediation, through AB 506 will bring a neutral and experienced mediator to the table who can help the parties communicate in more constructive ways, exchange needed information and work constructively with the municipality to design a mutually agreeable plan of rehabilitation.
Mediation is non-binding and allows the municipality and each creditor constituency to go through its formal internal approval process before any agreement or plan is finalized. And, if court orders are needed, the parties are better prepared to make a consensual Chapter 9 filing.
As a legal professional, bankruptcy lawyer and a mediator, I applaud this new thoughtful approach to a serious problem. This proposed new law creates an opportunity to address municipal financial issues in a timely, fair and cost-effective manner benefitting the municipality, creditors and taxpayers.
Vallejo’s bankruptcy attorney summed it up nicely, “You have to be crazy to file a bankruptcy case because you’ll spend money on lawyers you should be spending on firefighters and police.”