Journal of
Corporate
Renewal
June
2014
SEP TEmbEr 29-oC TobEr 1, 2014
WES Tin Harbour CaSTLE
Toron To, on Tario
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agreements it believed were financially
untenable. Negotiations with the
unions were crucial, as Vallejo could
not address its bond debt until it was
able to accurately forecast its labor
costs. Despite a series of negotiations
with the unions, no long-term solution
was reached. Ultimately, the city filed
its Chapter 9 petition, and the unions
challenged Vallejo's eligibility, asserting
that the municipality had failed to meet
all five of Section 109(c)'s requirements.
However, the trial court held, and the
Bankruptcy Appellate Panel affirmed,
that the city was indeed insolvent, as it
entered the year with no cash reserves.
Further, the court held that Vallejo was
not required to pillage its component
agencies in violation of covenants,
grant restrictions, and accounting
principles to keep its general fund
solvent. The court held that such actions
would have left Vallejo even more
distressed in the future and would not
resolve the financial issues at hand.
The unions also asserted that had
Vallejo accepted their last offer, the
city could have operated for another
year. However, the court found
that the last offer did not represent
a solution but rather created yet
another deficit in the future.
Creditors also challenged whether
Stockton was truly insolvent and
questioned whether the insolvency
had been manufactured by the city.
The court noted that Stockton proved
at trial significant deficits over the next
two years that could not be paid, in
violation of California laws requiring
balanced budgets. Nevertheless, the
court looked to "service insolvency"
and "budget insolvency" in holding
that the city was truly insolvent.
Service insolvency is determined by
evaluating a city's ability to respond
to and provide basic community
services, such as fire, police, etc.
Stockton had decimated its police
force to the extent that officers only
responded to in-progress crimes.
Crime rates had soared. For the court,
this was the paradigm of insolvency.
The city's budget insolvency focused on
the need to find extra revenue to offset
decades-long revenue shortages. In
California, citizens must vote to increase
tax rates, which was unlikely to occur,
in the city's opinion, at that time. The
objecting creditors rested their argument
on the fact that no tax increase was
put to the voters prepetition. However,
the court held that prepetition votes on
tax increases were not necessary, as
confirmation of a plan of adjustment
involves voter approval if taxes are to
be increased, where appropriate.
The most visible municipality filing, that
of Detroit, was also ripe with eligibility
issues. The court’s 150-page opinion
covered a wide variety of issues, but
highlighted the importance of some
of the same issues that were raised
in these earlier Chapter 9 cases.
For example, similar to its counterpart
in Stockton, the court looked at
Detroit’s ability to provide services to
its residents. In fact, the court noted
that while the city’s disastrous and
razor edge finances, tumbling credit
rating, and lack of liquidity may have
established insolvency under Section
101( 32)(C), it was the service insolvency
that was most striking and disturbing
to the court. The court specifically
found the testimony of the city's police
chief, who described the “deplorable”
condition of police services and lack of
any improvement in the near future,
to be powerful and compelling.
One of the more interesting aspects of
the eligibility issue was that while the
court rejected the “ludicrous” conspiracy
theory put forth by objectors, it also
noted that some facts in the record at
least lent credence to the objectors’
allegation that Detroit’s filing was
in bad faith. For example, the city
did not have a clear idea of assets,
income, cash flow, or liabilities.
However, that evidence was insufficient
to declare the filing in bad faith, and
the court found that Detroit’s obsolete
accounting and bookkeeping systems
were likely to blame for this lack of
crucial information. Further, the
court noted that while a bankruptcy
filing for the entirety of 2013 was
a “forgone conclusion,” merely
waiting too long to file a petition
does not constitute bad faith.
Avoiding Bankruptcy
Of course, not all municipalities are
eligible to file Chapter 9, nor should they
be. Only those facing serious budgetary
and service insolvency issues are likely to
