VALLEJO, Calif. - Vallejo and its public employee unions say they're willing to negotiate a settlement to end the city's three-and-a-half-month old Chapter 9 bankruptcy case.
There are tentative signs that they might mean it.
"The city has invited us to sit down and talk," said detective Mat Mustard, vice president of the Vallejo Police Officers Association. "We plan to do that."
Vallejo police fought the city's bankruptcy along with the International Brotherhood of Electrical Workers and the International Association of Firefighters. Mustard said workers are willing to reconsider city demands after a federal judge ruled last week that Vallejo is bankrupt and hinted that the unions may lose their contracts in bankruptcy.
For their part, city officials said they would still prefer to solve the conflict before it does further damage to Vallejo's long-term access to capital markets, and its ability to recruit and retain workers.
"This is a more opportune time to negotiate a settlement than there has ever been," said Mayor Osby Davis, adding that earlier negotiations quickly degraded into arguments over solvency. "We don't have to have that discussion anymore," he said.
The city and the unions went through many rounds of unsuccessful negotiations before the bankruptcy. In March, they reached an interim agreement that delayed the bankruptcy filing, but they failed to reach a permanent agreement to reduce the city's labor costs and avoid bankruptcy. The talks broke off entirely after their court battle began.
The adversaries refused this week to discuss their precise negotiating positions, and court testimony made it clear that they disagree on some key issues. They also have to agree to move past many months of acrimony. Union leaders and city officials hardly even looked at each other when they met in bankruptcy court in Sacramento.
Still, they are starting negotiations for the first time since the bankruptcy filing, and outside bankruptcy experts - and their own lawyers - say they have strong incentives to negotiate a solution that will end an increasingly costly trial. Both Vallejo and its unions face significant risks in continuing the case.
"Bankruptcy is like 'Deal or No Deal,' " said James Spiotto, a lawyer and municipal bankruptcy expert at Chapman and Cutler in Chicago, who is not involved in the case. "No deal, you get the judge to decide."
U.S. Bankruptcy Judge Michael McManus has given the city and its workers time to talk before asking him to settle their differences. Earlier this week, he scheduled hearings on a city motion to reject its collective bargaining agreements. He's not going to hear arguments on the request until December.
McManus, chief judge for the Eastern District of California in Sacramento, gave workers a strong incentive to negotiate with renewed realism - a decisive defeat. He not only rejected their contention that Vallejo was feigning insolvency, he also made it clear that workers shouldn't expect their contracts to survive a bankruptcy proceeding and that he didn't find their star witness credible.
"Given that the labor costs are a majority of the city's general fund expenditures, it is clear from the evidence that achieving solvency will require, among other things, serious consideration of economic concessions from the city's labor groups," McManus wrote in a 52-page ruling last Friday.
The unions have an option of appealing the ruling, but Spiotto said the judge's ruling was "thorough" and squared with established law on municipal bankruptcy.
Labor bankruptcy lawyer Dean Gloster, of Farella Braun + Martel in San Francisco, said the unions haven't decided whether to appeal.
An appeal would add to mounting legal bills on both sides of the case. Mustard estimated the unions have spent more than $1 million. The city budgeted $2 million for bankruptcy costs for this entire fiscal year and spent $1.1 million in just the first month and a half of the proceedings, before the current fiscal year even began, according to Joann West, the city's public information officer.
That's not a trivial amount of money in a city with a general fund budget of less than $90 million and municipal market debt of about $47 million.
The indirect costs of bankruptcy may be higher, and they've fallen largely on the residents of the city.
Vallejo has lost many police officers since the case began. The working-class city sits in one of the richest regions in the country. Nearby cities, such as San Francisco and Oakland, are offering signing bonus to experienced Vallejo cops who will jump ship.
"Police officers are marketable, and they're leaving," Mustard said. He said the city has lost five officers in the week since the ruling and the police force could shrink to 100 by the end of the year from 140 in 2007. "Over the course of a year, they'll lose a third of their police force," he said.
As always, the city and its unions dispute the precise figures, but they agree that the department has fewer officers than it needs. They also agree that crime is increasing. The police chief told the City Council that he doesn't have enough staff to do his job. The city has stopped investigating most property crimes.
Even the strongest proponents of Vallejo's bankruptcy acknowledge that there are limits to the cuts they can impose on workers if it expects to continue to provide city services in such a competitive labor market.
"We have to offer a fair, competitive wage," said Councilwoman Stephanie Gomes, who was an early proponent of bankruptcy and one of the public safety unions' toughest adversaries in local debates, though she says public safety advocates have exaggerated the bankruptcy's impact on crime.
"Crime is going up because the economy is weak," she said.
By anyone's estimate, Vallejo sits near the epicenter of the Bay Area's housing crisis. The Vallejo-Fairfield metropolitan area suffers the eighth-highest mortgage foreclosure rates in the nation, according to RealtyTrac.
Again, it's impossible to tell how much of the real estate market is suffering due to the bankruptcy case and how much underlying fundamentals are causing the pain.
Bankruptcy advocates point out that the bankruptcy is an attempt to solve the city's financial problems, which would help the local housing market in the long term.
"Anytime you try to make profound changes, it's painful," Gomes said.
Opponents point out that the uncertainty around future tax rates, crime, and the level of city services can't improve the marketability of local homes.
"I have heard a couple of anecdotal reports about people who chose not to buy here because of the bankruptcy, but for the most part, that doesn't appear to be the case," said Lori Collins, a Vallejo realtor and president of the Solano County Association of Realtors
She said she discloses the bankruptcy filing to buyers, but she has seen volume pick up recently because "prices have come way down here."
In the capital markets, the damage increases the longer the city is in bankruptcy and the more damage it does to its municipal creditors, said Spiotto, who has been working on municipal credit defaults and bankruptcies for almost three decades.
Vallejo officials have said they want to minimize the impact of the bankruptcy on bondholders and on Union Bank of California, the letter-of-credit bank on $47 million of the city's $53 million of outstanding variable-rate certificates of participation at the time of the bankruptcy filing.
The city has since repaid about $7 million of the debt by returning unspent bond proceeds to lenders, but it has also unilaterally capped the interest rate it will pay on its outstanding debt at 6%. The bank rate on the bonds is indexed to the prime rate, plus a penalty of one to three percentage points, which increases the longer the bank holds the bonds.
Vallejo doesn't want to permanently forgo access to the funds that will be necessary to develop the city's economy and infrastructure.
Mayor Davis understands the damage that does to the city's long-term prospects. He served as a legal counsel on some of Vallejo's outstanding issues, and he wants to see it take advantage of its ample natural assets in any turnaround.
Vallejo is working to redevelop its downtown waterfront and the former Mare Island Naval Shipyard, which closed in 1996. Developers are restoring historic structures and building thousands of new homes on the island, in addition to parks, mixed-use developments, and the Touro University, a school of osteopathic medicine. It's the sort of project that could expand the city's tax base over the long term.
Locals often bemoan their city's untapped potential. "The p-word," as Gomes calls it, is easy to see in Vallejo.
The city sits just south of the Napa Valley wine country, nestled between rolling, undeveloped hills and the San Francisco Bay. It has rich and poor sections and below-average incomes for the wealthy region. But its strengths include ethnic diversity, relatively affordable housing, a charming but underutilized downtown, and some of the best weather in the notoriously cold and foggy Bay Area.
With three months until the next hearing, the two sides have plenty of time to negotiate.
"It's always preferable to cut an acceptable deal and get out of bankruptcy because it does put a stigma on them," said David Dubrow, a lawyer at Arent Fox in New York. Dubrow, who represented letter of credit banks in Orange County, Calif.'s 1994 bankruptcy, is not involved with the Vallejo case.
The city continues to incur damage claims that it will have to pay to creditors for any contracts they break in bankruptcy. While lawyers say those claims will have to be paid off in "itty-bitty bankruptcy dollars" - that is, with a significant haircut - Vallejo can avoid those expenses if it negotiates a settlement that allows them to dismiss the case.
While none of those economic incentives makes a settlement certain, the city and the unions did get a clearer view of the each other's negotiating position in the bankruptcy hearings.
"If they can cut a good enough deal, it's in the interests of the city to get out relatively quickly," Dubrow said. "But from the city's point of view, they already went into bankruptcy, so they've got to clean up their problem. You've got to hit your bottom line or it's not worth coming out."
The unions offered the city $10.6 million in pay cuts before the filing. In court, Vallejo officials said they couldn't take the offer because it was temporary. Union lawyers said workers were hesitant to offer more out of fear the city would take the concessions and file for bankruptcy anyway, undercutting workers' bankruptcy damage claims.
As Mustard sees it, the city wouldn't accept the union concessions for four reasons:
* The unions offered temporary pay cuts, not permanent ones.
* The unions demanded contract extensions in exchange for pay concessions.
* The unions refused to give up minimum staffing requirements for the police and fire departments.
* The parties failed to agree on limits on the amount of paid leave union leaders can take for union business.
"I don't disagree that it's the time for compromise," Mustard said. "If they stay on those four topics, I'm optimistic that we can come to a resolution. If they step outside of that box, I'm unsure if we're going to be able to do anything." He suggested the city may have bigger goals than solvency, including rewriting work rules and revising retirement benefits.
For its part, Vallejo won't say how hard it will press its newfound advantage. Gomes and Davis - the two officials who agreed to talk on the record - would not say what the city's negotiating stance would be. Its offer will be determined by the whole City Council and won't be made in public.
Both men said they would push for a settlement that includes a resolution of Vallejo's biggest debt, an unfunded $135 million retiree health care liability. The city offers employees retirement health benefits after just five years of service. That wasn't a key issue in earlier negotiations, according to testimony at the bankruptcy trial.
If Vallejo wants to solve that problem now, it may prevent any quick settlement of the case. The court says the unions don't represent the holders of retiree health claims, and it's not yet clear who will.