Vol 6 (2009) - Issue 6

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Bankruptcy Appellate Panel Upholds Municipality’s Eligibility for Chapter 9 Bankruptcy Protection: In re City of Vallejo, California

Introduction

On 26 June 2009, the Bankruptcy Appellate Panel of the Ninth Circuit (the ‘BAP’) affirmed the ruling of the United States Bankruptcy Court of the Eastern District of California (the ‘Bankruptcy Court’) and held that the City of Vallejo, California (‘Vallejo’) had satisfied the eligibility requirements of chapter 9 of title 11, United States Code (the ‘Bankruptcy Code’) and thus was eligible to utilise the Bankruptcy Code to restructure its financial obligations. Vallejo’s eligibility under chapter 9 had been challenged by a number of Unions3 representing a majority of the city’s work force. In upholding the Bankruptcy Court ruling, the BAP concluded that Vallejo had satisfied the requirements of Bankruptcy Code section 109, in that the municipality had established that it (i) was insolvent upon commencement of the case, (ii) desired to implement a restructuring plan and (iii) was unable to negotiate with creditors because such negotiations were impracticable. The BAP determined that the Bankruptcy Court had erred in concluding that Vallejo had engaged in good faith negotiations with creditors regarding the terms of a restructuring plan – based on the fact that Vallejo had failed to negotiate the terms of a specific plan – but found that such error was harmless since Vallejo had been able to establish the alternative requirement of showing creditor negotiation to have been impracticable. As a result, Vallejo will be able to proceed with its financial restructuring under Bankruptcy Court protection.

Background

As reported in International Corporate Rescue, Volume 5, Number 5, on 23 May 2008 (the ‘Petition Date’), Vallejo filed a petition under Bankruptcy Code section 109, thereby becoming the largest city in California history to seek bankruptcy protection. Despite concerted efforts to achieve a balanced budget, Vallejo faced a substantial budget deficit, due to excessive labour costs and pension obligations, coupled with declining revenues tied to a depressed real estate market. Negotiations with creditors, including the Unions, proved unsuccessful, leaving Vallejo no viable option other than a bankruptcy filing.

Approximately one month after the Petition Date, the Unions filed an objection to Vallejo’s chapter 9 petition and statement of qualifications under Bankruptcy Code section 109(c), asserting therein that (i) Vallejo did not satisfy chapter 9’s eligibility requirements and (ii) Vallejo had filed the case in bad faith. After a protracted evidentiary hearing, the Bankruptcy Court denied the motion to dismiss and held that Vallejo was eligible for chapter 9 relief. The Unions filed a timely notice of appeal and the matter was assigned to the BAP.