When City Hall Moves to the Bankruptcy Courthouse (Chapter 9 and AB 506)

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1 When City Hall Moves to the Bankruptcy Courthouse (Chapter 9 and AB 506) County Counsels Association of California 2012 Annual Meeting September 12-14, 2012 San Diego, California Presented By Allan H. Ickowitz, Partner Robert S. McWhorter, Partner The information contained herein does not constitute a legal opinion and should not be relied upon by the reader as legal advice or be regarded as a substitute for legal advice. Copyright, 2012 Nossaman LLP. All Rights Reserved.

2 Trends of Chapter 9 Bankruptcies 43 U.S. Cities and towns filed Chapter 9 since cities and towns have filed since

3 Recent Municipal Bankruptcies Boise County, Idaho March 2011 (dismissed) Central Falls, Rhode Island August 2011 Harrisburg, Pennsylvania Oct (dismissed) Jefferson County, Alabama Nov City of Stockton June 2012 Town of Mammoth Lakes July 2012 City of San Bernardino August

4 U.S. Cities Reportedly On the Edge of the Fiscal Cliff Miami, FL falling credit rating Detroit, MI - $270 million budget deficit; $2.5 billion in debt Fresno, CA. $462 million in debt; falling credit rating Rockland County, N.Y. - $100 million budget deficit Compton, CA Ba1 credit rating; $43 million deficit Gary, IN - $15 million shortfall on $60 million budget 4

5 What Economic Forces Are Driving the Municipal Filings? Decline in real estate values/foreclosures Labor costs Decrease in business license fees Over leveraged Pension obligations to city workers Decreased credit rating Increased borrowing costs High unemployment Business closing/lack of tax base Impact of Termination of Redvelopment Agencies 5

6 What Are We Going to Cover? Ability to File Chapter 9 AB 506 Mechanics Major Issues in Chapter 9 Eligibility Differences Between Chapters 9 and 11 Special Chapter of the Bankruptcy Code Available Only to Municipalities Collective Bargaining Agreements/Retiree Benefits 6

7 Eligibility for Chapter 9 Bankruptcy Filing Only municipalities can file; States cannot Municipalities = political subdivision or public agency or instrumentality of a State ; 11 U.S.C. 101(40) Typical municipalities include cities and towns, counties, special districts (e.g. hospital, water, school, ports) State law has to specifically authorize the public entity to file Chapter 9 (11 U.S.C. 109(c)(2) ) 7

8 California State Law Eligibility Requirements A local public entity is authorized to file bankruptcy in California A local public entity = county, city, district, public authority, public agency, or other entity, without limitation, that is a municipality as defined in Section 101(40) (but not a school district) Gov. Code 53760,

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10 AB Gov. Code et seq. A local public agency can only file if 1 of 2 factors are met: 1) Neutral Evaluation Process Completed (60-90 days) 2) Declaration of Fiscal Emergency by Resolution 10

11 AB 506 The Neutral Evaluation Process The neutral evaluation process is comprised of the following steps: 1) Local public agency notifies all interested parties by certified mail of its request for neutral evaluation. 2) Interested parties respond within 10 business days or waive right to participate PROBLEM: Participation is NOT Mandatory NOTE: An Interested Party = trustee, a committee of creditors, an affected creditor, an indenture trustee, a pension fund, a bondholder, a qualifying union, a qualifying representative selected by an association of retired employees of the public entity Contingent creditors may be invited if (i) that the contingency is likely to occur and (ii) the claim may represent five million dollars ($5,000,000) or comprise more than 5 percent of the local public entity s debt or obligation, whichever is less. 11

12 AB 506 The Neutral Evaluation Process 3) All responding interested parties and the public agency shall mutually select a neutral evaluator through a mutually agreed upon process typically done by way of conference call. PRACTICE TIP: At the onset, Public Agency sends list of 5 potential former bankruptcy judges and schedules conference call with interested parties to set schedule 4) If the parties are unable to mutually select a neutral evaluator, the public agency shall furnish the names and backgrounds of five qualified neutral evaluators. A majority of interested parties shall strike up to four names from the list and the remaining candidate shall serve as the neutral evaluator. 5) Participate and negotiate in good faith 12

13 Timing of AB 506 Lasts for up to 60 days after neutral evaluator is selected Extended for additional 30 days if the public agency or a majority of interested parties chose to extend the process Problem: What constitutes a majority? 13

14 Cost of AB 506 The public entity is responsible for 50 percent of the cost of the neutral evaluation and creditors are responsible for the balance unless otherwise agreed to by the parties. Issues: Loan documents constitute an agreement? How do you split among the creditors majority of dollars, number? What do you do with creditors who cannot afford to pay? Valuable Lesson: Need Money to Conduct Process; Cannot Start Too Late 14

15 Confidentiality The process is confidential unless otherwise agreed to by the parties or disclosure is deemed necessary by the judge presiding over any subsequent bankruptcy. What is confidential? Benefits to disclosing? If waived, it must be in writing signed by all parties. 15

16 Financial Information & Proposal Major Hurdle for Local Agency = Dissemination of financial information & demonstration of cause of financial difficulties and efforts to correct same Local Agency should have a proposed written plan to propose; submission after financial information disclosed and explained Post protected v. public website 16

17 Ending the Neutral Evaluation Process The neutral evaluation process shall end if: The parties execute a settlement agreement OR The parties reach an agreement or proposed plan of readjustment that requires the approval of a bankruptcy judge OR The neutral evaluation process has exceeded the 60 days and the parties have not reached an agreement and no one wishes to extend the process further; OR The public agency received no responses from interested parties; OR The fiscal condition of the public agency deteriorates to the point that a fiscal emergency is declared and necessitates the need to pursue the protections of bankruptcy 17

18 Declaring a Fiscal Emergency Declaration must include findings that the financial state of the local public entity jeopardizes the health, safety, or well-being of the residents of the local public entity s jurisdiction or service area absent protections of Chapter 9 of the federal bankruptcy code.9 Resolution of the public agency must include a finding that the public agency will be unable to pay its obligations within the next 60 days. Public agency must comply with the requirements of the Brown Act and place the item on the agenda of a noticed public hearing where the public may comment on the state of the agency s fiscal condition. 18

19 Bankruptcy Code Eligibility Requirements/11 USC 109(c) 1. Debtor must be insolvent unable to pay debts as become due or generally not paying debts 2. The municipality must desire to effect a plan of adjustment and (a) has reached an agreement of creditors (majority in claim amount in each impaired class), (b) has negotiated in good faith with creditors and failed to obtain such agreement, (c) is unable to negotiate with creditors because negotiation is impracticable, or (d) reasonably believes a creditor may attempt to obtain a preference. 19

20 Bankruptcy Code Eligibility Requirements/11 USC 109(c) Need to Balance confidentiality under A.B. 506 with need to determine compliance with 11 USC 109(c)(5): See Stockton case in which disclosure initially was limited to the basics the number and length of meetings between the City and various creditors, the identity of the participants, the types of issues discussed and the status of negotiations between the City and each interested party as of the petition date. Other disclosures would be allowed as required incrementally starting with disclosure of the City s ASK to address the requirement to negotiate around a plan at least in concept (Vallejo) 20

21 Similarities to Other Bankruptcy Cases Numerous Bankruptcy Code provisions apply to Chapter 9 cases as specified in 11 U.S.C. 901: automatic stay (expanded by section 922(a) to prohibit action against officers or inhabitants (mandamus), executory contract provisions, avoidance provisions, proofs of claim, administrative expenses, provisions respecting classification and impairment of claims in plans 21

22 What Happens Upon Filing? Chief Judge of U.S. Court of Appeals appoints bankruptcy judge to preside ( 921(b)) Any party in interest may object to the petition and request dismissal on grounds that petition not filed in good faith ( 921(c)) or that the debtor is not eligible Courts schedule dates for litigating eligibility Stockton Evidentiary hearing if necessary (Vallejo, Stockton) 22

23 Differences Between Chapter 9 and Other Forms of Bankruptcy Only specified sections of Bankruptcy Code apply in Chapter 9 ( 901) (Example: Section 1113 regarding rejection of collective bargaining agreements does not apply in Chapter 9) Chapter 9 does not limit or impair the power of a state to control a municipality by legislation or otherwise 11 USC 903 The bankruptcy court may not interfere with any of the political or governmental powers of the debtor or any of the property or revenues of the debtor. ( 904) 23

24 Differences Between Chapter 9 and Other Forms of Bankruptcy No involuntary Chapter 9 No Trustee appointed No competing plans Case cannot be converted to Chapter 7 24

25 Differences Between Chapter 9 and Other Forms of Bankruptcy Obligations secured by pledged special revenues (are treated differently than other obligations) lien continues in post-bankruptcy revenues (except for operating expenses) applying pledged special revenues to payment of secure debt is not stayed by 362 (11 USC 922(b) recent decisions in Jefferson County required payment of post-petition revenues net of allowed expenses 25

26 Vallejo vs. Orange County State exerted pressure particularly on governmental creditors in Orange County and exerted pressure on the County in the form of a plan deadline and takeover in the alternative Vallejo creditor claims received substantial reductions in payments including bonds but CalPERS contracts assumed without modification 26

27 Collective Bargaining Agreements and Retiree Benefits Section 1113 of the Bankruptcy Code regarding CBAs does not apply in Chapter 9 Debtors under Section 1113 are not entitled to unilaterally terminate or modify CBA terms pending rejection Section 365 allowing assumption or rejection of executory contracts including CBAs applies/preempts state law regarding CBAs Bildisco Supreme Court decision held to apply in Chapter 9 cases 27

28 Collective Bargaining Agreements and Retiree Benefits Under Bildisco debtor must engage in reasonable effort to negotiate and show the CBA burdens the debtor and equities balance in favor of rejection Vallejo court agreed Bildisco applies but deferred ruling on the City s rejection motion in order to enable negotiations deals ultimately reached In Vallejo, court kept unions hands tied after the City unilaterally modified contract terms (staff reductions) by denying relief from the automatic stay to permit action to force debtors to honor obligation pending rejection and did not grant relief against unilateral modifications (Orange County court enjoined County from unilaterally laying off employees pending rejection) 28

29 Collective Bargaining Agreements and Retiree Benefits Stockton court also denied an application for injunctive relief and relief from the automatic stay against the unilateral reduction of retiree health benefit payments citing section 904 of the Bankruptcy Code Prichard court in Alabama applied the same principles in the context of pension contributions and denied stay relief to retirees seeking to take action against the City s unilateral failure to pay pension payments and denied a request to treat the obligation as an administrative priority expense 29

30 Treatment of Pension Obligation Subject to California Law California State law treats pension rights as vested interests, not merely contract rights Statutes restrict the termination of contracts with CalPERS Public Employees Retirement Law (PERL) as to pension plans and the Public Employees Medical and Hospital Care Act (PEMHCA) as to health benefit plans 30

31 Treatment of Pension Obligation Subject to California Law Cal. Gov't. Code expressly prohibits rejection of a municipality's contract with Ca1PERS whether for pension or health care benefits, without CaIPERS' consent Does the requirement that a debtor manage its property in compliance with state law under 11 USC 959(b) required compliance with CalPERS laws Is authorization in Cal. Gov t Code sections et seq limited by Cal. Gov t Code notwithstanding preemption 31

32 Treatment of Pension Obligation Subject to California Law Does section 903 of the Bankruptcy Code require compliance with CalPERS laws Creditors, particularly bond claimants, have filed papers in Stockton objecting to the City s eligibility/qualifications arguing that the City did not negotiate in good faith because it did not ask for concessions from CalPERS Comments in the press in San Bernardino case challenging calculation of obligations by CalPERS/actuarial value vs. current market value 32

33 Questions? Allan H. Ickowitz NOSSAMAN LLP 777 South Figueroa Street Los Angeles, CA Robert S. McWhorter NOSSAMAN LLP 915 L Street, Suite 1000 Sacramento, CA rmcwhorter@nossaman.com 33