Local Governments Need Bankruptcy Option

Local government bankruptcies are rare. Nevertheless, some public employee organizations aim to make the local government bankruptcy option nearly impossible, as evidenced by AB 506. This bill would require a tortuous process before a municipality could even file for federal bankruptcy protection. Other large, complex states, notably New York, Texas and Florida, do not hem in their local governments in anything like the way AB 506 threatens to do.

AB 506 would force local governments to satisfy a number of poorly defined conditions in a potentially time-consuming mediation process. In appears, moreover, that AB 506 duplicates safeguards already contained in Chapter 9 of the Federal Bankruptcy Code. The bill creates a powerful state mediator, who would decide whether a local government can manage its fiscal problems without going to bankruptcy and whether it has engaged in good-faith mediation. AB 506 also puts the administration of the mediation process into the hands of the California Debt Investment and Advisory Commission, whose governance is dominated by state elected officials.

If enacted, AB 506 would hamstring public managers trying to negotiate needed concessions from public employees and other creditors. Apparently, the 2008 Vallejo bankruptcy filing has spooked many public employee organizations, because that unfortunate case resulted in the negation of public employee contracts.

Concerned that other localities might use Vallejo as a road map to impairing their contracts, the public employee groups behind AB 506 seek to put the bankruptcy option into a locked box, only to be opened via a vague, cumbersome process. What they propose is akin to requiring insurance company approval for trauma victims brought to a hospital in an ambulance before they can be admitted to the emergency room.

Here are some points to keep in mind about municipal bankruptcy. First, even if Vallejo’s bankruptcy has been inevitable, that city’s situation is unique. Vallejo has had a history of acrimonious labor-management relations and a record of unusually high public safety payroll costs. Second, just because avoiding bankruptcy is preferred does not mean it should never be pursued. A bankruptcy option exists because it can inspire constructive and fairer negotiations among local stakeholders trying to distribute the pain of cut-back management in the most equitable and efficient way.

Third, in all but the most extraordinary situations, the Bankruptcy Code already requires that a municipality must negotiate in good faith with all its creditors to reach an out-of-bankruptcy restructuring of its obligations.

To assume, therefore, that local jurisdictions will casually choose bankruptcy is absurd. Vallejo’s painful post-bankruptcy experience serves as a cautionary tale for other communities. Since its “successful” bankruptcy petition, the city appears to have spent close to $10 million in legal costs related to the filing, and it has severely curtailed services and slashed its workforce, including deep cuts in public safety. Vallejo’s bankruptcy has resulted in lower ratings for the city’s bonding activity.

Should AB 506 advocates succeed in making it even more difficult for local governments to pursue bankruptcy, they will have to increase the severity of cutbacks and raise the costs for remaining services on members of their community. Because salaries and benefits will need to be sustained, local governments will inevitably lay off more employees and shut down services needed by some of the most politically vulnerable constituents.

It is important to remember that many local public employees and managers throughout the state have successfully crafted deals to get their respective communities through these tough times. Unfortunately, the noisy, contentious cases get most of the attention.

Public employees’ mounting anxiety in the current political climate is easy to understand. Yet, by seeking state intervention to make local bankruptcy declarations virtually impossible, public employees are playing into the hands of the very interests who wish to cast public employee unions in the worst possible light.

The bankruptcy option is already excruciating, and it will not be considered lightly or often by local agencies. Having a credible, albeit rarely used, bankruptcy option, unencumbered by special interest-inspired barriers, is necessary as California’s communities struggle to manage with shrinking or, at best, stagnant resources.

By Michael A. Sweet (former attorney at Meyers Nave) and Max Neiman is a senior resident scholar at the Institute of Governmental Studies, University of California, Berkeley.