One of the most deeply rooted concepts in American bankruptcy jurisprudence is the idea that, with few exceptions,¬†virtually any private debtor may seek relief under the US Bankruptcy Code.
Where the debtor is a public entity, however, such relief is not guaranteed.¬† Instead, municipalities seeking readjustment of their debt must be authorized to do so.¬† Such authorization is typically provided¬†by state statute.
In California, Government Code section 53760 gives “local public entities” the power to “file a petition and exercise powers pursuant to applicable federal bankruptcy law.”¬† To do so, however, these “local public entities” must meet the Bankruptcy Code’s tests for entry into Chapter 9 – the Code Chapter designed to afford “debt readjustment” relief for municipalities.¬† Specifically, such “local public entities” must be insolvent¬†(i.e., not paying or unable to pay their debts when due) – a status which may be contested before the debtor enters Chapter 9.¬† They must also propose a debt readjustment plan (as opposed to a plan of liquidation).¬† Finally, to obtain Chapter 9 relief, they must:
– have obtained the agreement of creditors holding at least a majority in amount of the claims of each class; or
– have negotiated in good faith with such creditors and failed to reach agreement with a majority in amount of the claims of each class; or
– be unable to negotiate with creditors because such negotiation is impracticable; or
– reasonably believe that a creditor may attempt to obtain a preferential transfer, to the detriment of other creditors.
It may sound like an awful lot.¬† But the fiscal impact of the global economic crisis – and¬†of Sacramento’s fiscal crisis – on municipal budgets¬†throughout California has sent local governments scrambling to review these provisions in earnest.
This week, the California legislature was introduced to what may yet become another barrier to Chapter 9 entry.¬† The Solano County Times-Herald reported yestereday¬†that State Sen. Pat Wiggins and Democratic Assemblyman Tony Mendoza (whose district includes Los Angeles and Orange counties) have co-authored new legislation that would make it harder for California municipalities to obtain¬†Chapter 9 bankruptcy protection.¬† According to staff writer Jessica York, the proposed legislation – Assembly Bill 155 – would require a municipality to receive filing approval from a 3-person state panel prior to commencing a Chapter 9 proceeding.
The bill is borne of concerns over the effects¬†a Chapter 9 filing can have on local taxpayers and on a bankrupt municipality’s credit-worthiness in the bond markets.¬† It is further prompted by a perceived need for state legislators to involve themselves with local deficits.
But not everyone welcomes that involvement.¬† As Ms. York reports:
League of California Cities leaders have some concerns with the bill, including who is sponsoring the legislation and motives behind the bill, said spokeswoman Megan Taylor.¬† She added that state leaders could do more good by resolving the state budget standoff, thereby providing economic certainty for cities and avoiding a bankruptcy avalanche.¬† “If the state is concerned with having local agencies getting to the point of bankruptcy, the most important thing that they can do is balance the state budget,” Taylor said.¬† Marc Levinson, [City of] Vallejo’s [Chapter 9] bankruptcy attorney, said he believed the bill was a bad idea at first glance. The state-appointed committee would likely have partisan political pressures weighing into their decisions, he said. “They’re going to have to spend a lot of time just getting up to speed . . . .”
Will “local public entities” in California now have to get the state’s permission to commence a Chapter 9?
Perhaps more importantly, should they?