California Bill Revived to Restrict Municipal Bankruptcies

April 12, 2010


The California state legislature has revived a bill that would require state commission approval before a California municipality may seek bankruptcy relief. Distressed municipalities throughout California would be wise to carefully consider the impact such a law would have on their options.

Chapter 9 of the Bankruptcy Code

Federal bankruptcy law is divided into chapters. While chapter 11 of the Bankruptcy Code can help a corporation restructure its debts, chapter 9 was drafted solely for municipalities. The general policy considerations underlying the municipal debt adjustment plan of chapter 9 are the same as that of chapter 11 reorganization: to give the debtor a breathing spell from debt collection efforts to establish a repayment plan with creditors. A primary distinction between chapter 11 and chapter 9 proceedings is that in the latter, the law must respect the sovereignty of the states.[1] Therefore, a municipality may resort to bankruptcy only with authorization from its state. However, such approval need not require a case-by-case state review. Indeed, many states broadly authorize municipalities within their jurisdictions to file for chapter 9 by statute.

California’s Authorization Statute

Currently, though perhaps not for long, California’s Government Code section 53760 provides municipalities in California with rather broad and explicit authority to file for chapter 9: “Except as otherwise provided by statute, a local public entity in this state may file a petition and exercise powers pursuant to applicable federal bankruptcy law.”

This provision of California’s Government Code has been interpreted to authorize municipalities in California to file for chapter 9 relief without further involvement of the state government. California Assembly Bill 155 aims to alter this statutory framework by requiring municipalities to meet certain requirements, including approval by a state commission, in order to obtain authority to file for bankruptcy.

California Assembly Bill 155

Assemblyman Tony Mendoza of California’s 56th District originally introduced AB 155 (the “Bill”) in January of 2009. On June 3, 2009, the Bill sailed through the Assembly with a vote of 47 to 25. In July, the Senate appeared to resist the Bill, but in September, Senator Mark DeSaulnier of California’s 7th District introduced the Bill as part of Senate Bill 88 in the legislature’s final week of the session. On the last day of the session, it was reported that the Bill was dead for the year, with Senator DeSaulnier promising to try again this year.

As promised, the Bill has been revived, and a public hearing is scheduled for April 21, 2010. By its terms, the Bill would require a municipality considering bankruptcy to first seek approval to file for chapter 9 from the California Debt and Investment Advisory Commission (“CDIAC”).

Interestingly, the Bill forces municipalities to do all of the following before CDIAC will allow them to file for bankruptcy:

(A) Acknowledge that the state’s fiscal and financial responsibilities are not changed by the application to CDIAC.

(B) Demonstrate that it is or will be unable to pay its undisputed debts.

(C) Demonstrate that it has exhausted all options to avoid seeking relief under chapter 9.

(D) Detail a specific plan for restoring the soundness of the entity’s financial plans.

(E) Itemize creditors that may be impaired or may seek damages as a result of the proposed plan.

Bankruptcy practitioners will recognize that many of these measures would ordinarily occur through a bankruptcy process, adjudicated by a federal bankruptcy judge as opposed to a state commission. And even those unfamiliar with bankruptcy will recognize that these requirements could delay a municipality from obtaining the relief that it might desperately require. Indeed, the Bill mandates an initial 30-day evaluation period, followed by a 15-day hearing period. While it does allow a municipality to provide evidence of “irreparable harm that may result during the 30-day evaluation period... and the 15 days allotted for a hearing,” the Bill provides neither what a municipality would need to produce in this regard nor a mechanism for CDIAC to handle such emergency cases. Denial of approval by CDIAC would bar a municipality from filing for bankruptcy relief.

The Bill’s involvement of a state commission may further politicize a process that is already, inherently, politically sensitive. Indeed, the Bill grants CDIAC with the authority to condition its approval of a bankruptcy filing by limiting the nature and extent of the relief a municipality might obtain through a chapter 9 proceeding, including all of the following:

(A) The commission may limit the changes to a contract.

(B) The commission may prohibit the abrogation of contracts.

(C) The commission may limit the amount of relief to ensure the protection of debt service payments.

Perhaps unsurprisingly, then, the Bill is broadly supported by unions, whose contracts could otherwise be renegotiated through a chapter 9 proceeding. On the other hand, the Bill is opposed by cities and counties throughout California.

Next Steps

The Bill is set for a public hearing on April 21, 2010. In 2009, the Bill received scattered attention throughout the state. As noted above, the Bill seemed to die in the Senate in July of 2009, but Senator DeSaulnier revived the Bill in the last week of the legislative session under the guise of Senate Bill 88. It remains to be seen if municipalities in California, already over-worked and over-stressed by unprecedented financial turmoil, will devote time or resources to fighting the Bill this time around.

[1] Once in bankruptcy, however, the municipal debtor is subject to many fewer constraints than its private corporate counterpart, both in terms of operations and in obtaining court approval for a repayment plan.