BILL ANALYSIS SB 88 Page 1 SENATE THIRD READING SB 88 (DeSaulnier) As Amended September 4, 2009 Majority vote SENATE VOTE : Vote not relevant SUMMARY : Prohibits a local public entity, as defined, from exercising its rights under applicable federal bankruptcy law unless granted approval by the California Debt and Investment Advisory Commission (CDIAC), and specifies procedures in which the local public entity may override a decision of denial by CDIAC. Specifically, this bill : 1)Allows a local public entity, if CDIAC approves, to file a petition and exercise powers pursuant to applicable federal bankruptcy law (chapter 9). 2)Requires CDIAC, upon request of a local public entity, to advise, and if deemed appropriate by CDIAC, grant approval to the local public entity to exercise its right pursuant to chapter 9. 3)Provides that if CDIAC denies a local public entity's request the governing body of a local public entity may do either of the following: a) Reapply to CDIAC, which includes adopting another resolution and submit documentation to address the deficiencies identified by CDIAC; or, b) Hold a public hearing to override the decision adopted by CDIAC and adopt a resolution to declare the public entity's intent to exercise authority pursuant to applicable federal bankruptcy law. 4)Requires, at the public hearing to override the decision by CDIAC, the governing body to make public findings about the necessity to override the decision of CDIAC. 5)Provides that if the governing body votes to exercise its authority to file chapter 9 and makes findings to that effect, both CDIAC's findings and the local public entity's findings shall be submitted along with any filing of a petition for bankruptcy. SB 88 Page 2 6)Requires, when requesting approval to file chapter 9, a local public entity to submit to CDIAC all of the following: a) A resolution or ordinance adopted by that governing body at a public hearing held pursuant to the Ralph M. Brown Act that does both of the following: i) Requests authority through state law to petition the federal bankruptcy court for financial relief under the provisions of chapter 9 in federal law; and, ii) Acknowledges that the state's fiscal and financial responsibilities are not changed by the application or CDIAC's decision. b) A thorough analysis of the entity's request to petition under the provisions of chapter 9 in federal law; in addition to any other information it may provide, the entity shall do all of the following: i) Demonstrate that it is or will be unable to pay its undisputed debts; ii) Demonstrate that it has exhausted all options to avoid seeking relief under chapter 9; and, iii) Detail a specific plan for restoring the soundness of entity's financial plans. c) An itemization of creditors that may be impaired or may seek damages as a result of the proposed plan. d) Evidence of irreparable harm that may result during the 30-day evaluation period, and the 15 days allotted for a hearing. 7)Requires CDIAC, upon receipt of the information listed in 6) above, to evaluate the information presented within five days, to notify the public entity of one of the following results: a) Approval of the request; or, b) CDIAC intends to proceed with a further evaluation based on a finding that the local public entity did not provide SB 88 Page 3 sufficient evidence. 8)States that if CDIAC determines that it will proceed with a further evaluation, CDIAC shall publish its evaluation within 30 business days. 9)Provides that if CDIAC does not respond to the request within five days of receipt of the request, the request shall be deemed approved. 10)Requires CDIAC staff to specifically evaluate the extent to which the local public entity has done the following: a) Demonstrated that it has exhausted other remedies; b) Demonstrated that it has taken sufficient steps to reduce the negative consequences of the proposed bankruptcy relief; c) Has anticipated the transfer of service responsibility to other governments or parties and to what extend the entity has documented the consequences for the transfer of municipal and other government services; d) Documented the likely effect a successful petition will have on state and local finances, including the impact on credit access and debt service; and, e) Has proposed a remedy that it is appropriate and proportionate to the entity's fiscal problems. 11)Requires CDIAC, after it conducts and publishes its evaluation, to conduct a hearing and publish a decision within 15 days of, but not less than 10 days after the publication of the staff evaluation; and requires that the hearing on the application shall be held in convenient proximity of the entity filing the application. 12)Specifies that CDIAC shall, in a recorded vote on the date of the hearing, approve or deny the request of the local public entity. 13)Requires CDIAC to adopt specific findings that address the deficiencies of the application, if the application is denied. SB 88 Page 4 14)Requires that the hearing held by CDIAC be subject to the provisions of the Bagley-Keene Open Meeting Act. 15)Requires, after CDIAC receives an application from a local public entity, the executive director to record costs incurred by CDIAC to make and publish the evaluation and conduct the public hearing; and requires the director to report the costs to CDIAC at the next regularly scheduled CDIAC hearing. 16)Allows the executive director of CDIAC, upon denial of the request, to assess a fee on the requesting entity to cover some or all of the costs associated with making the findings and conducting the hearing. 17)Requires that fee revenue be deposited in the CDIAC Fund. 18)Allows CDIAC to propose regulations pursuant to this bill. 19)Declares that in enacting this bill, the state assumes no new or additional fiscal responsibilities for local entities that may apply to CDIAC. 20)Specifies that the bill shall only apply to a local public entity on or after the effective date of the bill. 21)Provides that if a member of CDIAC is also employed as a local government finance officer by an entity requesting approval, the Treasurer shall replace that member, for purposes of the application of the local government that also employs the member, with a person employed by a city, county, or city and county, within the state, experienced in the issuance and sale of municipal bonds and nominated by associations affiliated with these agencies, to preside over that application. 22)Defines "local public entity" to mean any city, county, city and county, district public authority, public agency, or other entity that is a "municipality" within the meaning of federal bankruptcy law applicable to local public entities. 23)Makes findings and declarations relating to municipal bankruptcies. SB 88 Page 5 EXISTING LAW : 1)Allows a local public entity in California to file a petition and exercise powers pursuant to applicable federal bankruptcy law, without any statewide approval or pre-conditions. 2)Defines a "local public entity" as a county, city, district, public authority, public agency, or other entity, without limitation, that is a municipality as defined in paragraph (40) of Section 101 of Title 11 of the United States Code, or that qualifies as a debtor under any other federal bankruptcy law applicable to local public entities. 3)Allows a legislative body authorized to conduct a proceeding pursuant to this chapter (Government Code Section 59125) to file a petition and exercise powers under applicable federal bankruptcy law as provided by Section 53760. 4)Defines the term "municipality" as a political subdivision or public agency or instrumentality of a state, in federal law (11 U.S.C. Section 101 (40)). 5)Allows the Superintendent of Public Instruction to assume control of a school district that becomes insolvent to ensure the district's return to fiscal solvency. COMMENTS : MUNICIPAL BANKRUPTCY 101 UNDER FEDERAL LAW 1)The list of eligibility requirements for a "municipal debtor" in federal law under chapter 9 is contained in 11 U.S.C Section 109(c) and specifies the following: First, an entity may be a debtor under chapter 9 only if such entity: a) Is a municipality; b) Is specifically authorized, in its capacity as a municipality or by name, to be a debtor under such chapter by state law, or by a governmental officer or organization empowered by state law to authorize such entity to be a debtor; SB 88 Page 6 c) Is insolvent; d) Desires to effect a plan to adjust such debts; and, e) Has obtained the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in case under such chapter: i) Has negotiated in good faith with creditors and it has obtained the agreement of creditors holding at least a majority in amount of the claims of each class that the municipality intends to impair under a plan of adjustment of claims; ii) Is unable to negotiate with creditors because such negotiation is impracticable; or, iii) Reasonably believes that a creditor may attempt to obtain a transfer that is avoidable under section 547 of this title. A municipality must meet all of these conditions for the bankruptcy petition to be accepted by the court. 1)According to the U.S. Courts, "the purpose of chapter 9 is to provide a financially-distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts. Reorganization of the debts of a municipality is typically accomplished either by extending debt maturities, reducing the amount of principal or interest, or refinancing the debt by obtaining a new loan." Chapter 9 provides a municipal debtor with two primary benefits: a) a breathing spell with the automatic stay; and, b) the power to readjust debts through a bankruptcy plan process. The process enables municipalities to continue to provide essential public services while allowing them to adjust their debts. 2)Federal law regarding municipal bankruptcy rose out of the financial crises of the 1930s. Chapter 9 federal law was created in 1934 and after several revisions, was made a permanent part of the Bankruptcy Act in 1946, and incorporated into the new Bankruptcy Code in 1978. SB 88 Page 7 In 1994, Congress amended the Bankruptcy Code to require that municipalities be "specifically authorized" under state law to file a petition under chapter 9 - this was an express invitation to the states to revisit the types of local agencies that could seek federal relief. SB 1323 (Ackerman), Chapter 94, Statutes of 2002, sponsored by the California Law Revision Commission (CLRC), accomplished this by bringing state law in line with the "specific authorization" as required under federal law. CALIFORNIA'S RESPONSE TO CHAPTER 9 3)In response to the federal creation of chapter 9, the California Legislature enacted bankruptcy authorization for municipalities in 1934. The general state statutes authorizing bankruptcy filings by local governments were codified in 1949 and those provisions were not amended until SB 1323 became law in 2002. There were several attempts in the 1990s to streamline California law with federal law requiring specific authorization: a) SB 1274 (Killea, 1995-1996) and AB X2 2 (Caldera, 1995-1996) would have granted the broadest authority permissible under federal law by adopting the federal definition of "municipality;" b) AB X2 29 (Archie-Hudson, 1995-1996) would have provided authority for a municipality as defined by federal law to file "with specific statutory approval of the Legislature" and required the plan for adjustment of debts under Bankruptcy Code Section 941 to be "submitted to the appropriate policy committees of the Legislature prior to being submitted to the United States Bankruptcy Code;" and, c) SB 349 (Kopp, 1995-1996) would have modernized the obsolete references and adopted the "municipality" definition language in federal law. The bill would have established a Local Agency Bankruptcy Committee" to determine whether to permit a municipality to file a chapter 9 petition, and the committee would have contained the Treasurer, Controller and Director of Finance. The bill passed the Legislature, but was vetoed by then-Governor Wilson. SB 88 Page 8 These bills were introduced mainly in response to the Orange County bankruptcy filing in 1994. According to a study done by the Public Policy Institute of California on the Orange County bankruptcy, "the financial difficulties leading to the bankruptcy were the direct result of an enormous gamble with public funds taken by a county treasurer who was seriously under-qualified to deal in the kinds of investments he chose." At that time, Orange County and its investment pool - which suffered nearly $1.7 billion in investment losses - filed for bankruptcy protection on December 6 in two separate cases. The bankruptcy judge ruled that only the county, and not the investment pool, could file for bankruptcy. 4)Currently, California state law authorizes federal bankruptcy filing by a "local public entity" - "a county, city, district, public authority, public agency, or other entity, without limitation, that is a municipality as defined in paragraph (40) of Section 101 of Title 11 of the United States Code, or that qualifies as a debtor under any other federal bankruptcy law applicable to local public entities". As referenced, federal law defines "municipality" as a political subdivision or public agency or instrumentality of a state (11 U.S.C. 101 (40)). However, the California Law Revision Commission notes that the definitions in state and federal law create some ambiguity as to what exactly falls under the definition of "municipality" and can therefore seek financial relief through the chapter 9 bankruptcy process. According to the 2001 report produced by the California Law Revision Commission, there is some debate about how broad the definition of "municipality" and "local public entity" is - it may be that the definition includes anything from library districts, parking districts, public cemetery districts, community service districts and the like. The Legislature may wish to discuss whether there is a legitimate statewide interest in preventing these small local government entities from filing for bankruptcy. BANKRUPTCY PRACTICES IN OTHER STATES 5)The 10th amendment to the United States Constitution says that "the powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved SB 88 Page 9 to the States respectively, or to the people," otherwise known as the sovereign rights of the states. In the context of municipal bankruptcy filing, it is up to each state to decide whether to empower its municipalities to utilize federal bankruptcy laws. Other states approach authorization for municipalities in various ways - some explicitly authorize municipalities and provide unlimited access, or explicitly authorize certain types of municipalities, some states are silent, one state expressly prohibits municipalities from filing, and yet others have their own state pre-conditions, processes or "gate-keeping" requirements. Those states comparable to California in terms of population, like Texas and Florida, provide explicit authorization for municipalities in their state statutes. The state of New York allows a municipality or its emergency financial control board to file any petition within any United States district court or court of bankruptcy and explicitly notes in the statute that "nothing contained in this title shall be construed to limit the authorization granted by this section [for municipalities to file a petition under federal bankruptcy law]." For those states with preconditions or "gatekeeping" provisions, the following is a sample of the wide range of state statutes: Iowa : Permits "a city, county, or other political subdivision" to become a chapter 9 debtor only if it is rendered insolvent as a result of debt (a defined term in the state statute) involuntarily incurred. Michigan : Requires notice to be given to the local emergency financial assistance loan board and authorization from the emergency financial manager. Montana : Applies to a "local entity." The local entity's legislative body must pass an ordinance or resolution declaring that it meets all eligibility requirements found in 109 of the federal Bankruptcy Code. New Jersey : Applies to "any county, municipality, school district or other political subdivision of this State." The SB 88 Page 10 political subdivision must get the approval of the municipal finance commission before filing the petition. Also, the governing body of the political subdivision must pass an ordinance authorizing the filing by a not less than two-thirds vote of all the members elected to the governing body. The municipal finance commission must approve the plan of adjustment before the political subdivision files it with the court and the commission must approve in writing each payment for attorneys, agents, committees, or other representatives of creditors. North Carolina : Applies to "any taxing district, local improvement district, school district, county, city, town, or village." The local unit must get the approval of the Local Government Commission of North Carolina, which oversees local government debt and financial management. PROPOSED LAW 6)This bill places conditions on how and when a municipality could seek chapter 9 relief under federal bankruptcy law. Current law authorizes municipalities to file a petition under the federal bankruptcy process without any prior state approval or pre-conditions to filing. This bill creates "gatekeeper" provisions by granting a state entity - CDIAC - the authority to allow or disallow a municipality from exercising its rights to file a petition under federal chapter 9. This bill mandates that a local public entity that is seeking to file chapter 9 go to CDIAC for approval. Under the provisions of the bill, the entity would be required to submit certain paperwork to CDIAC in order for CDIAC to evaluate the entity's request. The provisions of the bill also place a time limit for CDIAC to approve or deny the request, and provide for certain factors that CDIAC would be required to use to evaluate the entity's request. If CDIAC denies the local public entity's request, the bill provides the entity an opportunity to override CDIAC's decision, or to re-file their request. This bill also contains public noticing requirements for both CDIAC and the local public entity, in the event that the entity decides to override the decision adopted by CDIAC in a public meeting. CDIAC's denial findings and the local public entity's override findings would be submitted along SB 88 Page 11 with any filing of a petition for bankruptcy to the federal bankruptcy court. 7)CDIAC, under the purview of the State Treasurer's office, currently collects data on municipal finance, conducts research, and provides information and technical assistance to local public agencies and their finance professionals. Since CDIAC has expertise in the financial health of local governments, it makes sense to put the review process in their hands. CDIAC's Board is comprised of the State Treasurer as Chair, and other members including the State Controller, the Governor, two members each from the Senate and Assembly, and two local government officials with expertise in debt issuance. 8)The California Law Revision Commission produced a report studying California's municipal bankruptcy statute in 2001. CLRC recommended that the Legislature revise the state law to conform to the federal provisions and what resulted was SB 1323 by Senator Ackerman. However, CLRC's report only suggested that California law be updated to provide explicit authority for municipalities, per the federal statute requiring states to have explicit authorization. The report did not recommend any other substantive policy changes or pre-conditions, or "gate-keeping" in order to access the federal bankruptcy process, and instead, the report noted that "there does not appear to be any general agreement on the best approach to reform, or even as to the need for additional protections or controls." The California State Legislature has a long history, dating back to the Orange County bankruptcy filing in 1994, of debating access to federal municipal bankruptcy laws every few years (see Comments under 3) and 4) above, and ultimately in 2002, made the decision to seek the broadest authority for municipal bankruptcies that exists under federal law. 9)Supporters of the topic argue that a municipal bankruptcy filing will have repercussions in terms of credit rating and spillover effects that will raise borrowing costs for other California municipalities and the state. Arguably, a municipal bankruptcy, depending on the size of the entity, could potentially affect other local agencies and the state as a whole. Supporters argue that the state government should have the opportunity to consider whether bankruptcy is the SB 88 Page 12 best approach to the problem, since municipal affairs are of interest to the state and should not be left to the sole discretion of the municipality. 10)The issue of state liability is of great concern. As noted in Governor Wilson's veto of SB 349 (Kopp) in 1996, state interference in municipal bankruptcy "could raise questions of the liability of the state to creditors of the public agency if eligibility for bankruptcy is denied. State denial of access to chapter 9 may create the implication that the state has assumed responsibility for the debts of the distressed municipality." 11)Opposition to this topic note that it is an unwarranted and unjustified intrusion on local control and that the determination to pursue protection under federal bankruptcy law should be left to the discretion of the local agency. Opposition to this topic believe that changes to current law, like what is being proposed in this bill, undercut local authority by giving the state the right to intervene in local decisions. Voters elect their local representatives and expect that their local elected officials know best about the municipality's financial condition, which will vary from jurisdiction to jurisdiction based on unique local needs. 12)The chapter 9 process under federal law has rarely been used - only three filings by cities and counties since the adoption of the state Bankruptcy Code in 1949 - Orange County in 1994 (See Comment #4), the City of Desert Hot Springs in 2001 because of a judgment against the city, and the City of Vallejo in May of 2008. 13)In a March 13, 2009, memorandum, Michael McManus, the U.S. Bankruptcy Judge assigned to the Vallejo case, addressed whether chapter 9 of the Bankruptcy Code permits municipality to reject collective bargaining agreements with its public employee unions. He found that "if a municipality is authorized by the state to file a chapter 9 petition, it is entitled to fully utilize 11 U.S.C. 365 (Section 365) to accept or reject its executory contracts" and that "unexpired collective bargaining agreements are executory contracts subject to rejection under Section 365." 14)This bill is substantially similar to AB 155 (Mendoza), which SB 88 Page 13 was heard on the Assembly Floor June 3, 2009. However, there are a number of major changes between the version heard on the Assembly Floor and this bill, including: a) The addition of language allowing a local public entity to hold a public hearing to override the decision adopted by CDIAC, if CDIAC denies the local public entity from seeking relief under chapter 9; b) The addition of language that specifies a timeline for CDIAC to respond to a local public entity seeking to file under chapter 9; c) The deletion of language that would allow CDIAC, if a request to file was approved, to limit the nature and extent of relief provided through chapter 9 to the local public entity, including limiting changes to a contract, prohibition of the abrogation of contracts, and limiting the amount of relief to ensure the protection of debt service payments. Analysis Prepared by : Debbie Michel / L. GOV. / (916) 319-3958 FN: 0003015