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Vallejo Files for Chapter 9

SAN FRANCISCO – Vallejo, Calif., Friday filed for Chapter 9 bankruptcy protection, becoming the largest municipality to seek protection from creditors in more than a decade.

The San Francisco Bay Area city of 117,000 said it can no longer meet its financial obligations, particularly pay raises for public safety workers. It expects to exhaust its general fund by the end of the fiscal year on June 30 and post a $17 million deficit next year. The city is the largest municipality to seek protection from creditors since Orange County, Calif. in 1994.

The bankruptcy filing freezes creditor claims against the city and allows it to continue providing basic city services as it negotiates with its creditors. The Vallejo City Council and public employee unions negotiated until last week to avoid the bankruptcy, but in the end, the unions’ offer of a $10.6 million pay cut was not enough to stave off the filing. The city claims it is now “insolvent.”

Vallejo “has negotiated in good faith with creditors,” according to a filing with the U.S. Bankruptcy Court, Eastern District of California, by Marc Levinson of Orrick, Herrington & Sutcliffe. “These efforts resulted in short-term concessions but failed to achieve long-term solvency.”

Vallejo – which listed $277 million of long-term debt on its June 2007 Certified Annual Financial Report – listed four municipal-market debts totalling $80.1 million among its top 10 unsecured creditors. Those creditors are most at risk of losing money and may be appointed to the committee that the U.S. Trustee appoints to represent creditors in court, bankruptcy lawyers said. The city also recently discussed a debt reorganization plan proposed by Calvin Grigsby of Grigsby & Associates, according to a report in The San Francisco Chronicle.

Vallejo decided to go ahead with the bankruptcy filing instead. Its two biggest unsecured debts are owed to retired workers, via the California Public Employees Retirement System: $136 million obligation for retiree healthcare and $84 million for pensions.

The city also owes the following muni-related debt:

  • $27.3 million to Wells Fargo Bank, as the trustee for its 1999 and 2000 COPs;
  • $26.2 million to Union Bank of California, as the trustee and liquidity provider on its 2001 golf course COPs, 2002 and 2003 COPs;
  • $23.2 million to Union Bank, as the liquidity provider on its 2000 COPs; and
  • $4.1 million to MBIA Insurance Corp., as insurer on its 1999 COPs.
Union Bank spokeswoman Joanne Curran said the bank is monitoring the case closely but had no further comment. Both MBIA spokeswoman Elizabeth James and Wells Fargo trustee Cecil Bobey said their companies would refrain from making any comment until next week.

Now that the city has filed its case, it must convince a bankruptcy judge that it is truly insolvent.

The city’s labor unions, represented by bankruptcy lawyer Dean Gloster of Farella Braun + Martel, have pledged to contest the filing. They do not believe the city is insolvent. According to a labor-commissioned report by Harvey Rose & Associates, the city could have avoided bankruptcy through a series of one-time cuts and fee increases that would give the city a $6 million general-fund surplus next year.

The government finance consulting firm, which also serves as the independent budget analyst for the San Francisco Board of Supervisors, recommended delays in replacement of city vehicles, applications for state matching funds the city has left uncollected and a transfer from the city’s cash-rich redevelopment fund to its general fund to repay loans made in past years.

The city’s finance department has said it cannot legally transfer money from special funds to the general fund to cover its deficits. Mayor Osby Davis said such short-term solutions would just delay the inevitable even if they were legal.

“The general fund suffers from a fundamental structural imbalance where expenditures substantially exceed revenues,” the Vallejo’s bankruptcy filing said. The city’s labor costs surged 11% over the past two years, as a weakening housing market slowed the growth in tax collections to less than 3%, the Finance Department said earlier this month.

That means Vallejo must renegotiate its collective bargaining agreements, the city said in its filings, adding that it has already cut funding as far as it can for street maintenance, libraries, parks, and other community services.

“Additional funding reductions beyond the cuts the city already has made in these areas threatens the city’s ability to provide even minimal levels of service to its residents and, at some point, may create significant health and safety risks,” the city argued.

The battle over the city’s solvency is the first step in the upcoming bankruptcy proceedings, said outside bankruptcy experts. That’s one point where the rarely used municipal bankruptcy statutes seem to give Vallejo an advantage over its creditors.

“The city will probably be given the benefit of the doubt,” said Paul Glassman, a bankruptcy lawyer with Greenberg Traurig LLP in Los Angeles. He represented Irvine, Calif., and several other local cities when Orange County declared bankruptcy.

“The court will want to make sure the debtor is able to stabilize its operations,” he said. “From the point of view of the average citizen of Vallejo, the city should be operating as usual.”

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