Vol 5 (2008) - Issue 5

Article preview

The Municipality Strikes Back: In re City of Vallejo, California

Introduction

On 23 May 2008, the City of Vallejo, California (‘Vallejo’), became the largest city in California history to seek protection under chapter 9 of the title 11, United States Code (the ‘Bankruptcy Code’). The Bankruptcy Code is somewhat unusual among insolvency statutes in that it affords municipalities the opportunity to restructure their debts through a federally sanctioned proceeding, the rules governing which are found in Bankruptcy Code chapter 9. Burdened by excessive labour costs and pension obligations, and faced with declining revenues – driven largely by a depressed real estate market – Vallejo faced a substantial budget deficit. Negotiation with labour unions proved fruitless, and efforts to trim other costs and boost revenue were insufficient. Unable to increase real estate taxes without voter approval, and unable to borrow funds due to its inability to adopt a balanced budget, Vallejo had little choice but to file for bankruptcy protection.

The labour unions challenged this decision, arguing that Vallejo failed to meet the qualifications for filing chapter 9 in that (i) it was not insolvent and (ii) it had not negotiated with the unions in good faith to achieve a consensual adjustment of its debts. In a recent ruling that has received considerable attention, the United States Bankruptcy Court for the Eastern District of California (the ‘Bankruptcy Court’) overruled these objections and held that the City of Vallejo was eligible for protection under chapter 9 of the Bankruptcy Code. As a result, Vallejo will be afforded an opportunity to formulate a chapter 9 plan. Assuming that Vallejo is able to muster sufficient creditor support, Vallejo will be able to use the Bankruptcy Code to implement a financial restructuring.

Chapter 9 overview

Chapter 9 of the Bankruptcy Code is the chapter governing the adjustment of debts of a municipality, and offers protection for a municipality that is insolvent. Chapter 9 is divided into three subchapters. The first subchapter contains definitions and other general provisions, the second deals with administration of chapter 9 cases, and the third addresses the chapter 9 plan process, including the filing, modification and confirmation of a plan, the effect of confirmation, and the continuing jurisdiction of the court following plan confirmation.

To be eligible for chapter 9 protection, the filing entity must satisfy the statutory criteria of Bankruptcy Code section 109(c).