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california legislation > AB 506

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Date of Hearing: May 18, 2011

Felipe Fuentes, Chair

AB 506 (Wieckowski) - As Amended: March 31, 2011

Policy Committee:Local

Urgency: No State Mandated Local Program:
No Reimbursable:


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

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.


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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).


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

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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

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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

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

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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