Governor Signs AB 506 (Wieckowski) Affecting Chapter 9 Bankruptcy Filings

On October 9, 2011, Governor Brown signed legislation that creates new requirements for local government entities considering Chapter 9 bankruptcy filings. The final bill allows a local government entity to file a bankruptcy petition so long as it has either declared a fiscal emergency or engaged in a specified mediation process with its major creditors.

This legislation was promoted by public sector labor unions, which have made several attempts following the City of Vallejo bankruptcy filing to restrict local government entities’ access to the bankruptcy courts.

Local government entities took great interest in this legislation and, after significant negotiations, the bill was amended in the final days of the legislative session. As amended, the legislation provides that a Chapter 9 filer must either have engaged in mediation or declared a fiscal emergency by a majority vote of its governing board.

The bill’s mediation provisions are detailed, and may prove cumbersome in practice.  They provide for choice of a neutral evaluator with input from both the entity and its major creditors.  They provide that the mediation process must be completed within a limited time frame, which may make mediation success difficult to obtain.  In the alternative method, a declaration of fiscal emergency must be made following “a noticed public hearing that includes 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 the protections of Chapter 9.”  The resolution must also include “findings that the public entity is or will be unable to pay its obligations within the next 60 days.”  Prior to declaring a fiscal emergency, the local public entity must give notice of the public hearing and allow the public to comment on the proposed resolution.

The option to declare a fiscal emergency as an alternative to what could be a cumbersome and inconclusive mediation process (the only option offered in the initial version of this legislation) appears to provide local governments with some latitude in the event that a Chapter 9 filing is necessary on an accelerated schedule.  The requirement of inability to pay the entity’s “obligations within the next 60 days,” however, is considerably tighter than the general insolvency eligibility requirement for Chapter 9 under the Bankruptcy Code.

To view the Governor’s signing statement, please click here.