BILL ANALYSIS Ó AB 506 Page 1 Date of Hearing: May 18, 2011 ASSEMBLY COMMITTEE ON APPROPRIATIONS Felipe Fuentes, Chair AB 506 (Wieckowski) - As Amended: March 31, 2011 Policy Committee: Local GovernmentVote:5-3 Urgency: No State Mandated Local Program: No Reimbursable: SUMMARY This bill 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. 2)Requires the California Debt and Investment Advisory Commission (CDIAC) to adopt mediation guidelines relating to local public entity bankruptcy. Establishes qualifications for a mediator. 3)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. 4)Prohibits the local public entity that is in mediation from filing a petition if either the mediator believes settlement is possible or the mediator finds the local government has not participated in good faith. FISCAL EFFECT AB 506 Page 2 1)Costs to the California Debt and Investment Advisory Commission of approximately $250,000 to develop program guidelines, develop qualifications for mediators and carry out other duties related to mediation. 2)State exposure to legal challenges and related fiscal pressures, potentially in the hundreds of millions of dollars (see comment #4). COMMENTS 1)Purpose. 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. 2)Bankruptcy background . Federal law regarding municipal bankruptcy rose out of the financial crises of the 1930s. 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. 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 (Ackerman), Chapter 94, Statutes of 2002 became law. This bill was sponsored by the California Law Revision Commission (CLRC), accomplished the specific authorization as required under federal law. 3)Chapter 9. According to the U.S. Courts, "the purpose of Chapter 9 is to provide a financially-distressed municipality AB 506 Page 3 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. 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. The local public entity must be insolvent, have the desire to develop and implement 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. 1)CDIAC . CDIAC under the purview of the State Treasurer's office, currently collects data on municipal finance, and provides information and technical assistance to local public agencies and their finance professionals on debt issuance. The Commission is comprised of the State Treasurer, as Chair, and the State Controller, the Governor, two members each from the Senate and Assembly, and two local government officials with expertise in debt issuance. 2)Does the bill create a major new state obligation ? State liability is of particular concern given the broad authority granted to CDIAC by the bill to deny access to bankruptcy. The mediator, who is operating under state guidelines, also has significant authority, including blocking a bankruptcy filing if the mediator determines the local entity is not operating in good faith. A similar concern was expressed in Governor Wilson's 1996 veto of SB 349 (Kopp), a bill with similar gatekeeping provisions in 1996. The veto message stated that state interference "could raise questions of the liability of the state to creditors of the public agency if eligibility for bankruptcy is denied." 3)Impact of bankruptcy. The statewide implications of local AB 506 Page 4 bankruptcies can vary tremendously, depending on the specific circumstances surrounding the filing. While a bankruptcy by a major municipality due to general economic circumstances may affect investors' perception of credit risk for the state as whole, bankruptcies due to circumstances unique to the municipality - such as a large court judgment, fraud or investment losses, would have less significant statewide impacts. If investors were to see mediation as a barrier to protecting their interests, that view could negatively affect perceptions of credit risk within the state. 4)Amendments. The bill raises significant questions. a) Who will appoint the mediator? b) Who will pay for mediation? c) How long will the mediation process take? d) What happens if the local public entity or other stakeholders involved in the mediation process want to request a different mediator? e) What happens when the mediator denies the entity from seeking bankruptcy and the entity defaults? f) Why is CDIAC, an entity with no experience with mediation, the administrative entity rather than the Attorney General? 1)Opposition. 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. The League of California Cities argues that this bill is a state intrusion into local affairs. They are concerned it creates obstacles rather than assisting municipalities and the AB 506 Page 5 state commission will not be a neutral forum. They are also concerned about mediation being convening by a stakeholder concerned about the financial condition of the municipality and argue that this intrusion by the state into local affairs may be unconstitutional. Analysis Prepared by : Roger Dunstan / APPR. / (916) 319-2081