SAN FRANCISCO - The lawyers representing Vallejo, Calif., in its Chapter 9 bankruptcy case have a message for municipalities considering bankruptcy: It's no get-out-of-debt-free card.
"Municipalities feeling financial stress should work as hard as possible, accepting as much pain as they and their constituents, creditors, and employees can endure, to avoid" bankruptcy, said Orrick, Herrington & Sutcliffe LLP public finance lawyer John Knox and bankruptcy lawyer Marc Levinson in a pamphlet titled "Municipal Bankruptcy: Avoiding and Using Chapter 9 in Times of Fiscal Stress."
The 37-page pamphlet and marketing brochure is a plain-English explanation of the major legal criteria for municipal bankruptcy, the costs and benefits of bankruptcy, and strategies for righting a municipality's finances before or during a Chapter 9 case.
Knox and Levinson have advised Vallejo on the biggest, most contentious municipal bankruptcy since Orange County, Calif.'s 1994 filing. Levinson is the lead bankruptcy counsel, while Knox has advised Vallejo and other near-bankrupt California municipalities on financial workouts.
The first lesson they draw is that a bankruptcy that aims to fix long-term structural budget imbalance is painful in terms of lost access to credit, service reductions and tax increases that will be necessary to exit bankruptcy, high legal costs and lost economic development.
"While bankruptcy clearly provides certain benefits for municipalities that cannot otherwise solve their fiscal problems, it is no panacea and comes with some significant downsides," they wrote.
One key benefit of bankruptcy is protection from immediate actions by creditors, which gives a municipality the "breathing space" needed to renegotiate debts, they said. Bankruptcy also allows a municipality to discard contracts that are truly unsupportable. Vallejo is currently asking the courts to allow it to reject its labor contracts.
But even those benefits come with a cost. A municipality has to pay damages for rejecting contracts, and it must eventually agree to a plan to adjust its debt with creditors or risk getting tossed out of bankruptcy court.
Still, they said local governments really can use Chapter 9 to put themselves on a sustainable path if local leaders are committed to reducing costs, increasing revenues, and preparing for the future, particularly their future return to the municipal bond market.
"While it is unavoidable that access to the capital markets after a bankruptcy will be more expensive and limited than it normally would be, it is not certain that the fact of a bankruptcy will be a permanent or even long-term problem," particularly if bond investors are made whole in the bankruptcy, they said.
Market access will be easier with a sustainable, believable resolution, they said.
Such a happy ending requires the creation of a credible new budget that raises revenues, reduces costs and builds "adequate rainy day reserves," the support of stakeholders who will have to make the painful plan work, a debt restructuring that limits risks such as variable-rate exposure, and the flexibility to cut services and increase fees to maintain balance in the future, they said.