A recent decision in the municipal bankruptcy case of the City of Vallejo may make chapter 9 a more appealing option for municipalities that are struggling financially. A district court in California has held that a chapter 9 debtor may reject collective bargaining agreements under section 365 of the Bankruptcy Code and that federal law preempts state labor law requirements for determining whether a public employee labor agreement may be rejected. See Int’l Bhd. of Elec. Workers v. City of Vallejo (In re City of Vallejo), 432 B.R. 262 (E.D. Cal. 2010) (affirming In re City of Vallejo, 403 B.R. 72 (Bankr. E.D. Cal. 2009)).
Because Congress did not incorporate into chapter 9 section 1113 of the Bankruptcy Code, which requires chapter 11 debtors to satisfy certain procedural and substantive prerequisites before rejecting collective bargaining agreements, the district court held that municipalities are required to satisfy the less stringent procedural requirements under section 365 of the Bankruptcy Code, as articulated by the Supreme Court in NLRB v. Bildisco & Bildisco, 456 U.S. 513 (1984). See Int’l Bhd., 423 B.R. at 267-68, 272. Under the Bildisco standard, a debtor can reject a labor agreement under section 365 if the debtor establishes that the agreement burdens the bankruptcy estate, the equities favor rejection, and the debtor made reasonable efforts to negotiate a voluntary modification but its efforts would not be likely to produce a prompt and satisfactory solution. Id. at 270 (citing Bildisco, 465 U.S. at 526). In contrast, section 1113 of the Bankruptcy Code enables a debtor to reject a collective bargaining agreement only if the debtor makes a proposal to the authorized representative of the employees covered by the agreement, the authorized representative has refused to accept the debtor’s proposal without good cause, and the balance of the equities clearly favors rejection of the agreement. 11 U.S.C. § 1113. In addition, the district court found that the Bankruptcy Code’s broad grant of power to debtors to reject contracts preempted negotiation requirements under state labor law. Int’l Bhd., 423 B.R. at 268-70, 272.
The ability to reject collective bargaining agreements without meeting the more rigorous statutory process imposed in chapter 11 cases is significant. It can enhance municipalities’ leverage in prebankruptcy contract negotiations with unions and, therefore, make chapter 9 (or, at least, the prospect of it) a more attractive restructuring option for a municipality.
In response to the Vallejo case, California lawmakers unsuccessfully proposed to restrict municipalities’ ability to file for chapter 9 bankruptcy protection. California Assembly Bill 155, which was introduced in 2009 but failed to pass in August 2010, would have required California municipalities to obtain approval from the California Debt and Investment Advisory Commission, comprised of nine state and local officials, before filing for federal bankruptcy protection under chapter 9 (although municipalities could adopt a resolution to override the Commission’s findings). California’s proposed legislation raises the issue of whether other state legislatures will seek to amend state laws that generally authorize municipalities to file under chapter 9 in order to prevent municipalities from filing petitions for the sole purpose of rejecting collective bargaining agreements. Indeed, the district court noted that “[i]f California had desired to restrict the ability of its municipalities to reject public employee contracts in light of state labor law, it could have done so as a pre-condition to seeking relief under Chapter 9.” Id. at 272. That is, a municipality might be required to comply with state labor law before it would be authorized to be a chapter 9 debtor; however, the Vallejo court makes clear that, once authorized to be a debtor under chapter 9, state labor law restrictions on a municipality’s rejection of its collective bargaining agreements would be preempted by federal law.
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