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The Bankruptcy Fight: The Unions Strike Back

Rick Roeder       June 7, 2009

In March, California bankruptcy judge Michael McManus affirmed that the City of Vallejo need only meet broad requirements in order to give the City discretion to break labor contracts pursuant to entering bankruptcy. He affirmed that Congress did not impose limits on invalidation of union contracts under Chapter 9. McManus’ interpretation was broader than the initial intent of Chapter 9 bankruptcy: to allow a government entity the ability to restructure debt.

While Chapter 9 is a federal statute, the law also recognizes states’ rights pursuant to the 10th Amendment. Thus, each state is allowed latitude as to if and how Chapter 9 is implemented. There are 22 states which do not allow bankruptcy filings by governmental subdivisions. 16 states allow filings with certain oversight and conditions. 12 states broadly allow such filings. Since 1949, California has been in the last category.

Our April Ramble (“California’s Latest Earthquake: National Fault Lines”) made two predictions that have already proven true:

  • There will be a lively, ongoing debate as to whether collective bargaining agreements fall under Chapter 9’s domain.

  • Do not expect public safety unions to go quietly into the night. Their union might dwarfs all others. I expected a bare knuckle fight to ensue.

On June 3, the passage of Assembly Bill 155 by a 47-25 vote (see for related video on the Bill’s introduction in January) was a rapid and strong response despite opposition by the League of California Cities and the California State Association of Counties. Local governments would need approval from the nine-member California Debt and Investment Advisory Committee before filing for bankruptcy protection. Not surprisingly, the measure received scant Republican support. The Committee consists of the state’s treasurer and controller, the governor or his finance director, two local government finance officers and two members apiece from the Assembly and Senate. The Committee would be empowered to determine whether “sufficient steps” have been taken to reduce the negative consequences of proposed bankruptcy relief.

The April Ramble made a third prediction: the bankruptcy fight would enrich lawyers. Assuming that this bill gets through the California State Senate, as I expect, consider this prediction as being well on its way to becoming true. Imagine how many ways the term “sufficient steps” could be interpreted! The Assembly Appropriations Committee warned that the bill could potentially expose the state to legal challenges and huge potential liability for allowing or barring local governmental entities from filing for bankruptcy protection.

In most states, there is a looming conflict of interest in the state getting overly involved with bankruptcy considerations of governmental subdivisions. The state often is a big source of revenue for such subdivisions and issues numerous mandates as to services that such subdivisions must provide. For example, the biggest revenue source for California’s 58 counties is Sacramento. The League of Women Voter’s Guide to Government indicates that Counties receive 31% of their revenues from the state. In California, the linkage between the state and the Counties has been closer since 1978’s passage of Proposition 13: Prop 13 redirected property tax revenues that previously had been earmarked to local entities.

Numerous bankruptcy filings will likely have the impact of undermining the collective bargaining process – which supposedly is done in good faith. However, many entities spent freely and permitted pension benefit levels reach unprecedented heights during the past decade. How many entities are truly between a rock and a hard place? Will the Obama administration provide large enough bailout funds to forestall dramatic actions? What role will the expensive and embarrassing prospect of bankruptcy filings have on the collective bargaining process and negotiated contracts? Stay tuned!

Rick Roeder. FSA

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