BILL ANALYSIS Ó AB 506 Page 1 Date of Hearing: May 4, 2011 ASSEMBLY COMMITTEE ON LOCAL GOVERNMENT Cameron Smyth, Chair AB 506 (Wieckowski) - As Amended: March 31, 2011 SUBJECT : Local government: bankruptcy: mediation SUMMARY : Establishes a process for mediation to be administered by the California Debt and Investment Advisory Commission, and prohibits a local public entity from exercising powers pursuant to applicable federal bankruptcy law unless the local public entity has participated in mediation proceedings and specified criteria have been met through those mediation proceedings. Specifically, this bill : 1)Prohibits a local public entity, as defined, from filing a petition and exercising powers applicable to federal bankruptcy law unless the local public entity has participated in mediation and received a good faith certification from the mediator, and requires one of the following to apply: a) The local public entity has reached an out-of-court agreement with all interested parties regarding a plan of adjustment pursuant to provisions of this bill; b) The local public entity and the interested parties were unable to reach an out-of-court agreement and the mediator has certified in writing that the parties have participated in mediation in good faith pursuant to provisions of this bill; or, c) The local public entity initiated the mediation proceeding and interested parties did not participate in the mediation as specified in provisions of this bill. 2)Prohibits the local public entity from filing a petition and exercising powers under 1) above if either of the following occur: a) The mediator determines that solvency or effective debt restructuring can be achieved through settlement with all interested parties and that a settlement can be reached through further mediation; and, AB 506 Page 2 b) The mediator determines that a local public entity has failed to participate in good faith mediation, which includes, but is not limited to, the failure to provide accurate and essential financial information, the failure to attempt to reach a settlement with all interested parties to avert bankruptcy, or evidence of manipulation to delay and obstruct a timely agreement. 3)Requires the California Debt and Investment Advisory Commission (CDIAC) to adopt mediation guidelines relating to local public entity bankruptcy and specifies that CDIAC may consult with Judicial Arbitration and Mediation Services, the Executive Office for U.S. Trustees, retired bankruptcy judges, or other appropriate entities in adopting the guidelines. 4)Allows a local public entity to initiate a mediation when the local public entity is or is likely to become unable to meet its financial obligations when those obligations are due or become due and owing. 5)Provides that mediation will be conducted through an alternative dispute resolution program within the state and in accordance with mediation guidelines adopted by CDIAC. 6)Provides that the role of the mediator shall be to assist all interested parties in reaching an equitable settlement to avert a Chapter 9 filing. 7)Provides that the mediator may consult with the Judicial Arbitration and Mediation Services, the Executive Office for U.S. Trustees, retired bankruptcy judges, or other appropriate entities in establishing and administering the mediation. 8)Requires a mediator to meet all of the following qualifications: a) At least 10 years of high level business or legal practice involving bankruptcy; b) Experience in conflict resolution; and, c) Completion of a mandatory training program in municipal organization, municipal debt restructuring, Chapter 9 bankruptcy, public finance, taxation, California constitutional law, California labor law, federal labor AB 506 Page 3 law, and municipal finance dispute resolution, provided through an alternative dispute resolution program within the state. 9)States that the mediator shall be impartial, objective, independent, and free from prejudice, and shall not act with partiality or prejudice based on any participant's personal characteristic, background, values or beliefs, or performance during mediation. 10)Requires the mediator to avoid a conflict of interest or the appearance of a conflict of interest during and after a mediation and requires the mediator to make a reasonable inquiry to determine whether there are any facts that a reasonable individual would consider likely to create a potential or actual conflict of interest. 11)Requires, prior to mediation, that the mediator shall not establish another relationship with any of the parties in a manner that would raise questions about the integrity of the mediation, except that the mediator may conduct further mediations regarding other potential local public entities that may involve some of the same or similar constituents to a prior mediation. 12)Requires the mediator to conduct the mediation in a manner that promotes voluntary, uncoerced decisionmaking in which each party makes free and informed choices regarding the process and outcome. 13)Prohibits the mediator from imposing a settlement on the parties and requires the mediator to use his or her best efforts to assist the parties to reach a satisfactory resolution of their disputes 14)Allows, subject to the discretion of the mediator, the mediator may make oral or written recommendations for settlement or plan of readjustment to a party privately or, if the parties agree, to all parties jointly. AB 506 Page 4 15)Specifies that the mediator has a duty to instruct and inform the local public entity and all parties of the limitations of Chapter 9 relative to other chapters of the bankruptcy codes and requires that this instruction highlight the limited authority of United States bankruptcy judges in Chapter 9 such as the lack of flexibility available to judges to reduce or cram down debt repayments and similar efforts not available to reorganize the operations of the city, that may be available to a corporate entity. 16)Requires the mediator to request from the parties documentation and other information that the mediator believes may be helpful in assisting the parties to address the obligations between them. 17)Allows, in the event a complete settlement of all or some issues in dispute is not achieved within the scheduled mediation session or sessions, the mediator to, at the mediator's discretion, continue to communicate with the parties in an ongoing effort to facilitate a complete settlement in order to avoid a Chapter 9 filing. 18)Requires the mediator to provide council and guidance to all parties and shall not be a legal representative of any party and shall not have a fiduciary duty to any party. 19)Allows, in the event of a settlement with all interested parties, the mediator to assist the parties in negotiating a prepetition, preagreed plan of readjustment in connection with a potential Chapter 9 filing. 20)Requires the mediator to maintain the confidentiality of all the information obtained by the mediator in mediation, unless otherwise agreed to by the parties. 21)Requires parties to exchange all documents including current financial information and projections addressing future financial obligations affecting the local public entity or that may hinder a resolution of the issues before the mediator, and allows the mediator to request the submission or AB 506 Page 5 exchange of memoranda on issues, including the underlying interests, and the history of the parties' prior negotiations. 22)Allows information that a party wishes to keep confidential to be sent to the mediator in a separate communication clearly marked "CONFIDENTIAL." 23)Requires each interested party to provide at least one representative to attend all mediation conferences, and states that each party's representative shall have authority to settle and resolve disputes or shall be in a position to present any proposed settlement or plan of readjustment to the governing body or membership for approval and implementation. 24)Requires the local public entity to provide a representative who shall represent the local public entity's interest in the mediation and who shall propose any settlement or plan of readjustment to the governing body of the local public entity. 25)Allows an interested party to be represented by legal counsel, but must inform all parties of the representation. 26)Requires the parties to participate in the mediation in good faith, and allows the mediator to request that a substitute representative be appointed, if the mediator determines that a representative of one or more of the parties is not participating in good faith. 27)Requires the parties to maintain the confidentiality of the mediation and prohibits the parties from disclosing statements made, information disclosed, or documents prepared or produced during the mediation process as specified in provisions of the Evidence Code related to mediation, unless all parties consent in writing to the disclosure. 28)Requires mediation to end if any of the following occur: a) The parties execute an agreement of settlement; b) The parties reach an agreement or proposed plan of readjustment that requires the approval of a bankruptcy judge; c) The mediator certifies in writing that one or more of the parties has not participated in good faith, that no AB 506 Page 6 resolution has been reached, and that further efforts at mediation would not contribute a resolution of the parties' dispute; d) The mediator certifies in writing that the parties have participated in good faith but the parties have reached an impasse and further efforts at mediation would not contribute to a resolution of disputes; or, e) The mediator certifies in writing that a mediation was initiated by the local public entity, but that no interested parties participated. 29)Adds a new section that defines terms related to provisions of the bill. 30)States that the Legislature finds and declares that certain sections contained in the bill impose a limitation on the public's right of access to the meetings of public bodies or the writings of public officials and agencies pursuant to Section 3 of Article I of the California Constitution, and provides that the reason to demonstrate the interest protected by this limitation and the need for protecting that interest is to facilitate the process to avoid municipal bankruptcy; therefore, it is necessary to provide for secure documents. 31)Makes other legislative findings and declarations. 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 59125) to file a petition and exercise powers under applicable federal bankruptcy law as provided by Section 53760. AB 506 Page 7 4)Defines the term "municipality" as a political subdivision or public agency or instrumentality of a state, in federal law (11 U.S.C. § 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. FISCAL EFFECT : Unknown COMMENTS : MUNICIPAL BANKRUPTCY 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; 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; AB 506 Page 8 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. 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 AB 506 Page 9 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. 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. The California Law Revision Commission (CLRC) studied AB 506 Page 10 California's municipal bankruptcy statute and released their report 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, the 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. 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. 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. AB 506 Page 11 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 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 Ýfor municipalities to file a petition under federal bankruptcy law]." RECENT LEGISLATION 6)The Legislature saw two municipal bankruptcy bills in the 2009-10 legislative session, AB 155 (Mendoza) and SB 88 (DeSaulnier), following on the heels of the City of Vallejo bankruptcy filing in May of 2008. Both bills would have prohibited a local public entity from exercising its rights under applicable federal bankruptcy law unless granted approval by CDIAC, and would have specified procedures in which the local public entity could override a decision of denial by CDIAC. AB 155 died on the Senate Third Reading File and SB 88 was chaptered with other provisions not relating to municipal bankruptcy. 7)For both AB 155 and SB 88, the authors argued that a municipal AB 506 Page 12 bankruptcy filing has 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. PROPOSED LAW 8)AB 506 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. Instead of full and unfettered access, this bill requires that a local government go through a mediation process first, and that local government can only file a petition for Chapter 9 if certain conditions are met. First, the local public entity would need to participate in mediation proceedings and receive a good faith certification from the mediator. Second, the local public entity would need to have one of the following happen: a) Reach an out-of-court agreement with all interested parties regarding a plan of adjustment; b) Be unable to reach an out-of-court agreement but have the mediator certify that all parties acted in good faith; or, c) The local public entity would need to initiate the mediation proceeding but have interested parties not participate in the mediation. The bill also prohibits a local public entity from filing a petition for Chapter 9 if either of the following occurs: a) The mediator determines that solvency or effective debt restructuring can be achieved through settlement with all interested parties and that a settlement can be reached through further mediation; or b) The mediator determines that a local public entity has failed to participate in good faith mediation. Additionally the bill requires CDIAC to administer the mediation process and adopt guidelines for mediation. The provisions of the bill allow a local public entity to initiate a mediation when the local public entity is or is likely to become unable to meet its financial obligations, and provides that the mediation shall be conducted through an alternative dispute resolution program within the state and in accordance AB 506 Page 13 with mediation guidelines adopted by CDIAC. 9)The author argues that the state has a vested interest in protecting taxpayers from the effects of an ill-advised bankruptcy and believes that this bill will help local public entities and elected officials make the most responsible decisions for the communities they represent. Additionally, the author notes that "in the absence of clear standards or oversight, local elected officials considering bankruptcy and the communities impacted by such a bankruptcy have little guidance about whether Ýthe bankruptcy] is merited or necessary." The author argues that under current law, there is nothing to prevent a frivolous bankruptcy petition or one that is politically motivated. 10)In order for a bankruptcy petition to be accepted by the court for a Chapter 9 filing, certain conditions must be met by the local public entity (see Comment #1). The local public entity must be insolvent, have the desire to effect a plan to adjust debts, and must attempt to negotiate in good faith with creditors, as long as such negotiation is not impracticable. In situations where the local public entity has not met these conditions, the court can reject the bankruptcy petition. The Committee may wish to consider whether the bill's mediation process is duplicative of what is already required for local governments before they can file a bankruptcy petition for Chapter 9 protection. 11)According to Judicial Arbitration and Mediation Services (JAMS), "mediation" is defined as "a process wherein the parties meet with a mutually selected impartial and neutral person who assists them in the negotiation of their differences." JAMS specifies the following about the role of the mediator: "Mediation leaves the decision power totally and strictly with the parties. The mediator does not decide what is 'fair' or 'right,' does not assess blame nor render an opinion on the merits or chances of success if the case were litigated. Rather, the mediator acts as a catalyst between opposing interests attempting to bring them together by defining issues and eliminating obstacles to communication, while moderating and guiding the process to avoid confrontation and ill will. The mediator will, however, seek concessions from each side during the mediation process." AB 506 Page 14 While this bill requires mediation for a local public entity and interested parties in order to "assist all interested parties in reaching an equitable settlement to avert a Chapter 9 filing," it is important to note that mediators are not usually responsible for making determinations. This bill, however, gives a mediator involved in bankruptcy mediation the ability to determine if solvency or effective debt restructuring can be achieved through settlement with all interested parties. This bill also gives the mediator the power to determine whether the mediator thinks a settlement can be reached through further mediation. The Committee may wish to consider whether the authority given to mediators under the provisions of the bill is too far-reaching and changes the typical role a mediator would play. 12)This bill treats all forms of local governments - cities, counties, and special districts - the same, even though there is wide variation among these entities and how they are funded, the services they provide, and the different ways that they function and are governed. According to the Urban Counties Caucus (UCC), in opposition to the bill, counties provide many mandated programs on behalf of the state or federal government. UCC raises the point that counties often have fiscal issues related to payment deferrals or a lack of payments from the state or federal government. In a situation where there is a court case, run on the bank, or decreased payments from the state or federal government, the provisions of the bill do not allow for the types of emergency situations that could occur for counties. According to the California Special Districts Association (CSDA) and the Association of California Healthcare Districts (ACHD), in opposition, special districts have never entered Chapter 9 because of a disputed labor contract. Rather, certain types of special districts, like healthcare districts, have typically used Chapter 9 because of low Medi-Cal reimbursements or a court judgment that the district could not afford. In these situations, going through a mediation process does not make sense and prohibits districts from being granted the automatic stay protection under Chapter 9. AB 506 Page 15 The Committee may wish to consider whether these types of situations for local governments warrant the inclusion of emergency process provisions in the bill to allow local governments to have access to the automatic stay of protection under Chapter 9 in cases where mediation will have little to no impact. 13)The bill's provisions are silent on the following issues. The Committee may wish to ask the author: 1) Who will appoint the mediator? 2) Who will pay for mediation? 3) How long will the mediation process take? 4) What happens if the local public entity or other stakeholders involved in the mediation process want to request a different mediator? 1)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." The Committee may wish to consider this bill creates some sort of unintended state liability. 2)The California Professional Firefighters, writes that the "2008 bankruptcy filing by the City of Vallejo has only serviced to further devastate a struggling community, including local businesses that were already feeling the adverse impact of a stagnant economy." As well, "Upon ÝVallejo's bankruptcy filing] the city's bond interest rates converted to their maximums and the city's filing claimed a deficit of approximately $12 million, and Vallejo's litigation costs have escalated to over $9.5 million, thereby further encumbering an already dried-up general fund budget." 3)Support arguments: According to the California Labor Federation, in support, "in the absence of clear standards or oversight, local elected officials considering bankruptcy and the communities impacted by such a bankruptcy have little AB 506 Page 16 guidance about whether it is merited or necessary." Additionally, "the state has a vested interest in protecting taxpayers from the effects of an ill-advised bankruptcy, and all major creditors, workers, retirees, and investors have a stake in reaching a fair resolution without resorting to bankruptcy, as do local elected officials." Opposition arguments: The California Chamber of Commerce, in opposition, writes that the "business community's concern is three-fold: Debts and contracts remain unpaid as the local government entity simply will not function or is dissolved; the local entity will raise fees, assessments and taxes on the community's residents and businesses at a time when jobs need to be created and the economy stimulated; the state - already facing a cash crisis and budget deficit - steps in to take over the provision of services, putting further strain on the budget that other Californians and businesses will have to pay for. REGISTERED SUPPORT / OPPOSITION : Support California Labor Federation California Nurses Association California Professional Firefighters Opposition Association of California Healthcare Districts California Chamber of Commerce California Special Districts Association California State Association of Counties Howard Jarvis Taxpayers Association League of California Cities Regional Council of Rural Counties Urban Counties Caucus Analysis Prepared by : Debbie Michel / L. GOV. / (916) 319-3958