California publishes a municipal bankruptcy guide

August 9, 2012

In the wake of three cities’ recent bankruptcy filings, California’s Legislative Analysts Office has published a municipal bankruptcy guide. Authored by Brian Uhler, the report gets down into the nitty-gritty of Chapter 9 municipal bankruptcy proceedings. To my knowledge California is the first state to detail the mechanics of federal bankruptcy law as it applies to its own municipalities.

I think this is an excellent report, but I imagine it was intended for members of the California legislature as much as city officials coping with distressed finances. There are swarms of bankruptcy attorneys circling weak municipalities, willing and able to establish an hourly relationship and give advice. But California legislators have a lot of constituencies to placate, and every muni bankruptcy affects public unions and their retirees. Public unions have long been a powerful force in Sacramento. Bloomberg reported that public unions contributed $76 million to California politicians and ballot measures in 2010, the single largest interest group that year.

The report provides the mechanics for assessing whether a municipality qualifies as “insolvent;” how California’s mediation process, AB 506, works; and what happens after the bankruptcy paperwork is filed. For most municipalities the largest area of spending is wages and benefits for employees, and the report addresses both. Basically, wage contracts can be broken in Chapter 9 if the city can show:

(1) the agreement hinders its ability to achieve fiscal stability
(2) the employee group otherwise would bear a disproportionately small burden of the locality’s bankruptcy
(3) the locality negotiated in good faith with the employee group but no resolution was reached

As to the bigger, more complex issue of benefits for retirees (emphasis mine):

A local government’s agreements with retirees to provide pension or health benefits are generally considered contracts which may be subject to rejection under Chapter 9. However, Chapter 9 cases addressing retiree benefits have been rare. In its Chapter 9 case, Vallejo became the first and only California locality to use a plan of adjustment to significantly reduce health benefits for its retirees by decreasing its payments to a flat rate of $300 per month.

To date, no California local governments have used Chapter 9 to change pension benefits for current retirees; however, pension benefits were changed in at least one case in another state (Central Falls, Rhode Island). Due to the lack of case law regarding the treatment of retiree benefits in Chapter 9, it is not clear if and under what circumstances local governments would be permitted to reduce retiree benefits in future Chapter 9 filings. It is possible that differing benefit and contractual requirements in different states could result in Chapter 9 applying differently from one state to another.

I had a little back and forth with Uhler regarding the Vallejo bankruptcy judge’s decision that allowed the city to renegotiate pension benefits. This was a useful quote from the blog

Vallejo Councilwoman Stephanie Gomes, a pension reform advocate, e-mailed this reply when asked for a comment on the Times story:

“In bankruptcy, the City considered a number of options regarding reductions in existing employee compensation, current retiree health care and current retiree pension benefits. According to our lawyers, CalPERS’ outside bankruptcy lawyers told them that they would challenge any attempt by the City to reduce current retiree pensions.

“So while the City considered pursuing reductions of current pensions of existing retirees, we had to make our decision in light of the legal issues (primarily California constitutional and statutory protections), equity/fairness issues, and cost issues (CalPERS would likely have devoted significant resources to challenge the ability of the City to modify current retiree pension benefits)…”

Given California’s high unemployment and the massive damage from the housing bust, it’s likely that there are other cities looking over their books and contemplating Chapter 9. Reducing labor contracts and pension payments to CalPERS will have to be the target in a bankruptcy proceeding for most cities to regain fiscal stability. The report is an excellent start for California to help support its cities through this tough process.

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see