SACRAMENTO - Vallejo, Calif., has made its case for filing Chapter 9 bankruptcy, and U.S. District Bankruptcy Court Chief Judge Michael McManus wants to hear more.

Union lawyers yesterday asked the judge to dismiss the city's case after six days of testimony from city officials. The city employee unions said the city has neither proven it is insolvent nor shown it negotiated in good faith to avoid bankruptcy.

McManus declined to rule on the motion and told the unions to present their case against the bankruptcy, forcing the unions to call their own expert witnesses to try to debunk the testimony of Vallejo's management.

The question before the judge is whether the city is really bankrupt. It's the first major decision of the trial, and until McManus decides whether the city belongs in bankruptcy court, the case cannot move on to contentious issues like the rejection of labor contracts and renegotiating the terms of the city's debts.

Vallejo is the biggest U.S. municipality to seek bankruptcy protection since Orange County, Calif., in 1994. Its biggest unsecured creditors are its workers - who had contracts that promised pay raises the city now says it can't afford - and retirees, who are owed almost $220 million in unfunded pension and retirement health benefits.

The city also owed about $53 million to bondholders at the time of its bankruptcy filing on May 23. Union Bank of California, which was the letter of credit bank on $47 million of Vallejo variable-rate demand obligations, is the largest holder because it called the debt after the city filed bankruptcy.

McManus has to decide if the city can afford to pay its obligations as they come due - in other words whether it is solvent, and whether it negotiated in good faith to avoid bankruptcy. That will require a couple of key decisions about the city's finances and the bankruptcy code, including how broadly to construe the city's available resources and its obligations.

On the question of resources, the city says it is bankrupt because it depleted its reserves last year and faced a projected $17 million deficit in the current fiscal year.

The unions counter that the city has $116 million of unreserved money outside its general fund. It says much of that money could be transferred or loaned to the general fund if the city weren't trying to avoid its debts.

"Vallejo is not insolvent," said union bankruptcy attorney Dean Gloster, of Farella Braun + Martel LLP. "There are places they can go to get money."

The city can't tap that money because it is "locked up under state law," grants, and other contracts that limit how it can be spent, argued city bankruptcy attorney Marc Levinson, of Orrick, Herrington & Sutcliffe LLP, characterizing the union's call to raid other funds as a "shell game."

The two sides also disagree on how the judge should measure the city's obligations.

"The city has no cash reserves and couldn't have paid its bills on July 11 or anytime in the fiscal year" if it hadn't declared bankruptcy, Levinson told the court, citing the date at which city financial projections showed that Vallejo would miss a payroll payment for the first time.

The unions retorted that the city could pay its bills if it would just accept pay concessions offered by workers, who agreed to cut their pay by about $10 million this year to help avoid the bankruptcy. City officials testified that they declined the offer because it was temporary.

Levinson argued that the court should consider the city's legal obligations - not the union offers - in determining solvency, but even if McManus considers the union offers, he shouldn't construe solvency so narrowly as to require the city to accept an offer that buys a year of solvency in exchange for a deeper hole the next year.

"There's no way that the city could have accepted the union's offer," Levinson said. "The city falls over a financial cliff in the out-years if it accepts the union offer."

Those arguments came at the end of the city's case supporting its bankruptcy filing. The unions hoped to end the proceedings there, contending the city hadn't proved it belonged in bankruptcy.

The judge decided not to rule on that matter one way or the other. Instead, he ordered the unions to put on their case before he would make any decision.

Gloster said the unions only intended to call one witness, Roger Mialocq, a principal with Harvey M. Rose Associates LLC of San Francisco. Mialocq, whose firm serves as the independent budget analyst for the San Francisco and Santa Clara County boards of supervisors, prepared a report for the unions earlier this year, suggesting ways that Vallejo could balance its books.

Testimony began late Thursday morning and continued at press time. The trial is expected to resume today.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.