Vallejo bankruptcy: trend or lost cause?

UPDATE: Vallejo is mentioned in a Wall Street Journal story about cities considering “disincorporation” to deal with their financial woes. To see story, click here.

A year after the City of Vallejo drew nationwide attention by filing for bankruptcy the outcome is far from clear.

The bankruptcy looked to some like a way for hard-pressed local governments to escape expensive labor contracts, which guarantee public employee pensions.

Officials in a number of California cities talked publicly, with varying degrees of seriousness, about following Vallejo’s lead as the economy slid into a deep recession, busting budgets as tax revenue fell.

An alarmed statewide firefighters organization sponsored legislation, AB 155 by Assemblyman Tony Mendoza, D-Norwalk, that would require cities to get approval from a commission in Sacramento before declaring bankruptcy.

The giant Public Employees Retirement System, with its 2,000 local pension systems, had an attorney make filings in the bankruptcy suit. The CalPERS board is receiving closed-door briefings on the progress of the case.

A Vallejo retirees committee, filing in the suit through its own city-paid attorney, fears that any contracts overturned in bankruptcy court could affect retiree benefits, including the mounting costs of health care.

Union officials said that in contract negotiations some management representatives bring up the prospect, directly or indirectly, of the city being forced to “do a Vallejo” if the unions do not make concessions.

In a first-of-its-kind ruling last March, U.S. Bankruptcy Judge Michael McManus in Sacramento determined that labor contracts can be overturned in Chapter 9 municipal bankruptcies.

McManus said that Congress, rejecting a proposal by U.S. Rep. Howard Berman, D-Los Angeles, declined to adopt protections given to private-sector labor contracts in Chapter 11 corporate bankruptcies.

But McManus has made it clear that he does not want to overturn the Vallejo contracts. He has ordered mediation for the last two unsettled contracts: electrical workers on June 2 and firefighters on June 3.

The mediator is an apparent judicial heavyweight with much experience in bankruptcy issues, Elizabeth L. Perris, chief judge of the U.S. Bankruptcy Court in Oregon.

Vallejo settled contracts earlier this year with the powerful police union and a small union representing managers and others. If mediation settles the electrical worker and firefighter contractors, McManus will not have to pull the trigger on his ruling.

His determination that labor contracts can be overturned in municipal bankruptcies will go into the books. But his opinion will not have been implemented, nor tested on appeal to see if other judges read the law the same way.

There are some signs that the Vallejo City Council’s view of bankruptcy may be changing.

The settlement of the firefighter and manager contracts were opposed by two council members, Stephanie Gomes and Joanne Schivley, who said costs were not cut enough.

The city manager, Joe Tanner, an advocate of the bankruptcy, is leaving with a $390,000 severance package. He was ousted by a council faction whose campaigns were funded by police and fire unions, Gomes was quoted as saying this week.

Whether the councils is now more likely to settle the remaining two contracts remains to be seen.

Another way the Vallejo bankruptcy could end is with a ruling by a U.S. Bankruptcy Court appellate panel in Los Angeles that Vallejo was not eligible for bankruptcy.

The city said it began the current fiscal year last July with $77.9 million in estimated general fund revenue, less than its $79.4 million cost for labor. By January the revenue estimate had dropped to $72 million.

But the unions argue in their appeal that the city had an additional $116 million in special funds restricted for water, transportation and other purposes. McManus ruled that the city was bankrupt because the special funds cannot relieve the general fund.

“We are frankly confident that the Bankruptcy appellate panel is looking at it extremely closely and is close to reversing that decision,” Kelly Woodruff, an attorney for the unions, told an Assembly committee hearing the AB 155 bankruptcy bill last month.

Woodruff said the appellate panel asked for supplemental information that she thinks supports the union’s argument. The panel began deliberating on April 23 and a decision is expected soon.

The bill requiring state approval of municipal bankruptcies by the California Debt and Investment Advisory Commission was approved by the Assembly labor committee, despite opposition from cities and counties.

But the bill was placed on the “suspense” file in the Assembly appropriations committee, awaiting an uncertain fate along with other measures that could cost the red ink-ridden state money.

An analysis said the bill, unless amended, could leave the state facing “hundreds of millions of dollars” of legal liabilities. If bankruptcy is delayed or denied for cities, their creditors might then turn to the state.

In a story in the Vallejo Times-Herald last weekend on the first anniversary of the bankruptcy, Councilwoman Gomes is quoted as saying that the bankruptcy was painful but necessary.

“The city saved $17 million in just the first year, and $19 million going into the second year,” Gomes said in the story.

The councilwoman is apparently referring to a “pendency plan” imposed under bankruptcy. The city froze salaries and benefits, avoiding raises called for by contracts, and cut staffing and services.

The attorney for the unions, Woodruff, argues that the savings are illusory because the city will face claims for the pay and benefits whether the contracts are overturned or remain in force.

“Councilwoman Gomes, frankly, doesn’t get it,“ said Woodruff. “They are on the hook for it either way.“

Woodruff said that even if the contracts are overturned, a bankruptcy “plan of adjustment” to help the city balance its books would require a vote of the creditors, which includes the unions.

“The city has messed up horribly,” said Woodruff. “It has spent $4 million to $5 million in attorney fees. That is money that could have been used to pay police and pave streets.”

Meanwhile, a newspaper that covers public finance, The Bond Buyer, looked at a half dozen California cities rumored to be considering bankruptcies and found none ready to follow Vallejo at this point.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Posted 21 May 09

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