Chapter 9 Bankruptcy Process Breeds Uncertainty

SAN FRANCISCO -- Until there more of a track record is established for cities filing bankruptcy in California, no one can be quite sure how the process will go – or if it will encourage more cities to head down that road.

That was the gist of a breakfast panel aimed at discussing issues and opportunities for investors related to the Chapter 9 bankruptcy process during the Bond Buyer’s California Public Finance Conference here.

Four California cities have filed for bankruptcy since 2008, including three this year, and only Vallejo, which filed in 2008, has emerged from the process, so there isn’t much precedent to work with.

One problem is the Chapter 9 process is so different from Chapter 7 and 11 procedures that govern corporate bankruptcies, where more of a track record does exist, said panelist Christopher Klein, the U.S. bankruptcy judge presiding over the Stockton case.

In Chapter 7 and 11, corporations can voluntarily file for relief, Klein said. A municipality, on the other hand, has to prove it’s entitled to relief. Instances exist where judges have ruled that cities did not qualify to file for bankruptcy, Klein said.

The judge has a lot less power to direct the city on how to handle its finances through the Chapter 9 bankruptcy than it would a corporation, Klein said, because municipalities receive the same immunity from the federal government, because of issues of sovereignty, that exists for states under the constitution.

The one similarity for municipalities that exists to corporate bankruptcies is that the theme should be “let’s make a deal,” Klein said. In cases where litigation as opposed to mediation becomes the general rule, bankruptcies become much more costly than they need to be, he said.

Panelist Emaunel Grillo, partner with law firm Goodwin Procter, said he is concerned that if the bankruptcy process goes smoothly for the current trifecta of California cities in bankruptcy -- Mammoth Falls, San Bernardino and Stockton – that other cities across the country could follow suit, he said.

Moderator Lewis Feldman, chair of Goodwin Procter’s Los Angeles office, said during an interview prior to the conference that investors are looking at ways to help cities work through their issues by providing intermediate financing, which was confirmed by one of the panelists in his remarks.

“The thing we are looking at is:  Are distressed investors going to pay more in the marketplace,” said William Nolan, senior managing director with FTI Consulting. “Are there going to be viable opportunities where one-time issues need to be resolved?”

As much as people consider municipal bankruptcy a stigma, some cities have no choice because they can’t generate additional revenue because people have moved away, Nolan said.

“If real estate prices stay down, you can’t just raise them to generate revenue,” he said.

If the issues facing the state continue to snowball, more people could be moving away, according to Feldman.

“They say in California land is free, people just pay for the weather,” he said. “I don’t know how much people going to be willing to pay for the weather if their cities, counties and educational systems are crumbling.”

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Bankruptcy California
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