California Chapter 9: Next Up, City of Atwater?

on October 10, 2012 ·

Posted in Chapter 9

Contributed by Will Hueske

In July, we at the Weil Bankruptcy Blog noted the high number of chapter 9 filings by California municipalities this year – three have been filed since June and a fourth, the City of Compton, is ailing and considering bankruptcy.  See Weil Bankruptcy Blog entry, The Summer California Went Bankrupt, by Will Hueske, July 25, 2012.  This summer trend appears to be continuing into the fall, with the City of Atwater struggling to stay afloat and recently taking steps toward a chapter 9 filing.

As we have discussed previously on the Weil Bankruptcy Blog, in 2011, the California General Assembly adopted Assembly Bill 506, now codified at Cal. Gov’t Code § 53760, which imposed state law eligibility requirements for a municipality to file a bankruptcy petition, in addition to the requirements of section 109(c) of the Bankruptcy Code.  Under California law, a municipality contemplating a chapter 9 filing must engage in a formalized mediation or “neutral evaluation process” with creditors and an independent arbiter for 60-90 days processing may file a petition.  See Weil Bankruptcy Blog entry, The Politics of Municipal Bankruptcy, by Debora Hoehne, Dec. 2, 2011.  If the health and safety of a municipality’s residents would be compromised by waiting 60-90 days and the municipality will be unable to pay its obligations in the next 60 days, an “emergency off-ramp” mechanism is available, whereby a municipality may avoid the neutral evaluation process by voting to declare a fiscal emergency.

On Wednesday, October 3, the Atwater city council held a public meeting and voted to declare a common law fiscal emergency, which gives the city the power to terminate otherwise fixed contracts, including collective bargaining agreements. The city plans to meet on October 22 to vote on a declaration of an A.B. 506 fiscal emergency, which would clear the path for a chapter 9 filing without the 60-90 day neutral evaluation process.

Located in central California’s Merced County with a population of approximately 28,000, Atwater has suffered from the same structural financial challenges as dozens of other municipalities across the nation.  The combined effects of an aging population, increased costs of retiree healthcare, and depressed revenues and property values following the 2007-08 housing collapse have left Atwater with a $3.3 million deficit for the 2012-2013 fiscal year.  According to its proposed 2012-2014 budget report, the city currently suffers from a 21% unemployment rate, and housing prices remain depressed, 40% lower than their peak in 2007.  Also cited are the anticipated impacts from the statewide termination of redevelopment agencies, which until February of this year had contributed to municipal revenues and property values by financing development in blighted areas.  In order to fill state budget gaps, however, the agencies were dissolved, leaving already struggling communities with even less outside investment.

In addition to these structural challenges, Atwater recently invested $5 million to construct a new wastewater treatment plant in order to comply with stricter state water regulations.  Repayment of the bonds sold to finance the project has left the city severely strapped for cash at a time when revenues are already slim.  Given these adverse budget conditions, on September 28, Fitch lowered Atwater’s debt rating to a non-investment grade BB.  These circumstances are not unique to Atwater; as the city acknowledged in its budget report, “Although some regions of California are showing signs of recovery, the Central Valley is lagging behind.”

Atwater has attempted to avoid bankruptcy, most recently by announcing plans to lay off over 25% of its public safety and other municipal employees and demanding a 15% salary cut from remaining employees.  Similar cuts were taken by San Bernardino and Stockton, two other California municipalities currently in chapter 9 cases, but ultimately were insufficient to prevent bankruptcy filings by those cities.

Since its adoption last year, the “emergency off-ramp” provision of California’s A.B. 506 law has been used once, by the City of San Bernardino, whereas the 60-90 day neutral evaluation process was employed by the Town of Mammoth Lakes and the City of Stockton prior to their chapter 9 filings.  If the City of Atwater votes to declare an A.B. 506 fiscal emergency on October 22, the city will be representing that it will be unable to pay its obligations in the next 60 days and another two or three months of negotiations with creditors would put the health and safety of its residents in jeopardy.  Under such circumstances, if the case of San Bernardino is any example, the City of Atwater would appear poised to become the fourth California municipality in chapter 9 bankruptcy this year.  The Weil Bankruptcy Blog will continue to follow developments in these cases, as well as analyze the use of the A.B. 506 scheme and its effect on the outcomes of these California bankruptcies.

11 USC Sec. 109
Sec. 109. Who may be a debtor
    . . . (c) An entity may be a debtor under chapter 9 of this title if and only if such entity -
    (1) is a municipality;
    (2) 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 under such chapter;
    (3) is insolvent;
    (4) desires to effect a plan to adjust such debts; and     (5)(A) 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 a case under such chapter;
    (B) has negotiated in good faith with creditors and has failed to obtain 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 a case under such chapter;
    (C) is unable to negotiate with creditors because such negotiation is impracticable; or
    (D) reasonably believes that a creditor may attempt to obtain a transfer that is avoidable under section 547 of this title.

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