This story was reported for San Diego News Network on October 22, 2009.
Experts in municipal bankruptcy did not endorse Chapter 9 filing as an option for San Diego County cities during a Thursday morning forum hosted by the San Diego County Taxpayers Association (SDCTA).
The SDCTA invited members to learn more about municipal bankruptcy, but avoided recommending the solution for cash-strapped San Diego.
The SDCTA forum featured Margaret Mann, a local commercial litigation and bankruptcy lawyer; Ali Mojdehi, a partner of the San Diego Baker & Mackenzie and former chair of the Financial Restructuring, Creditors’ Rights and Bankruptcy Practice Group in North America; and Judge John Ryan, who played a critical role forming the Orange County Bankruptcy Forum.
Lani Lutar, president of SDCTA, said the forum was meant to address “very serious issues” that affect the “lives and pocketbooks” of San Diegans. Later, CityBeat’s David Rolland asked Lutar on Twitter, “Did anyone recommend bankruptcy for San Diego?” Lutar responded, “No, because that (question) deliberately wasn’t asked. We wanted a substantive, quality discussion with no emphasis on any (one) city.”
Instead, the panelists referenced the city of Vallejo, which is in the process of completing is bankruptcy filing, and the county of Orange, which filed for bankruptcy in 1994, and used those cases as examples for how municipal bankruptcy works.
Getting into bankruptcy and the qualifications of Chapter 9
Municipalities must meet five criteria to qualify for bankruptcy. The two most important requirements, said Mojdehi, are proving insolvency, and demonstrating negotiations were attempted with labor groups. He said a municipality must prove that its cash system is dry and it can no longer pay its bills.
He noted bankruptcy, however, should be considered a “last resort,” looked to only after the government has done everything it can to remedy the problems. He noted that raising taxes or cutting costs were not “technical requirements” and that “people naturally expect governments to the cut the fat” before filing for Chapter 9.
The process and classification of creditors
If a municipality files for Chapter 9, it must create a “plan of adjustment” to revamp its budget. Governments are forced to enter into “good faith” negotiations with all agencies financially involved with the city or county, including creditors and labor unions.
Additionally, it must categorize its creditors who have invested into the city or county. This includes defining which creditors are insured and uninsured, said Mann. Three steps are then taken. First, the municipality must determine the cost of administration, that is, cost of keeping the “things running.” Next, it must prioritize claims that should be paid first, such as pensions or wages. Last, it must complete general uninsured claims by either accepting or rejecting a contract.
Furthermore, panelists noted that governments continue to function under state and federal legislation and elected officials maintain their duties.
Roles of judge and state
Judge Ryan, who played a pivotal part in the Orange County bankruptcy, said his role was to simply ensure the agreements were fair to all players.
“A judge is restricted from telling anyone to do anything,” Ryan said. “A judge has limited powers.”
SDCTA also gave attendees a handout titled, “Introduction to Municipal Bankruptcy.” Some points include:
– Bankruptcy isn’t a “low-cost endeavor.” The Orange County bankruptcy costs more than $100 million.
– Credit ratings and higher interest rates can be a result of bankruptcy.
– Labor contracts can be “voided” in a municipal bankruptcy.
Ryan elaborated, saying that a judge’s role is to ensure municipalities enter into “good faith negotiations with its employee groups, it cannot just decide arbitrarily to reject negotiations.”
The role of the state government, however, is unique. A major power the state holds is changing the municipality’s charter, should it be a charter city. For example, if a city shows that its charter system and its laws have played a role in its financial crisis, the state government can determine whether or not to allow the city to change its system, said Ryan.
The cost
Legal costs of bankruptcy fluctuate. Although, a range of costs wasn’t discussed among panelists – the three noted that the cost of bankruptcy should be compared to the cost of not filing for bankruptcy.
Ryan said one must “look at it at a value standpoint.”
“When you’re having heart surgery, you don’t ask how much this is going to cost,” Mojdehi said. “[The] restructuring of financial health is incredibly valuable.”
Mojedhi continued, “everyone must share some of the pain as legally permitted, the whole process is based on consensual agreement.”
“Bankruptcy has a very negative mystique about it,” Mann said. “It’s just a process.”
Hoa Quach is the political editor for the San Diego News Network.