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california legislation > AB 506

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ASSEMBLY THIRD READING
AB 506 (Wieckowski)
As Amended May 27, 2011
Majority vote

LOCAL GOVERNMENT 5-3 APPROPRIATIONS 12-5

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|Ayes:|Alejo, Bradford, Campos, |Ayes:|Fuentes, Blumenfield, |
| |Davis, Hueso | |Bradford, Charles |
| | | |Calderon, Campos, Davis, |
| | | |Gatto, Hall, Hill, Lara, |
| | | |Mitchell, Solorio |
| | | | |
|-----+--------------------------+-----+--------------------------|
|Nays:|Smyth, Knight, Norby |Nays:|Harkey, Donnelly, |
| | | |Nielsen, Norby, Wagner |
| | | | |
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SUMMARY : Prohibits a local public entity from exercising powers
pursuant to applicable federal bankruptcy law unless the local
public entity has participated in a neutral evaluation process,
as specified, and certain criteria have been met through that
process. 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 a neutral evaluation process and received a good faith
certification from the neutral evaluator, 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 neutral
evaluator has certified in writing that the parties have
participated in the neutral evaluation process in good
faith pursuant to provisions of this bill; or,

c) The local public entity initiated the neutral evaluation
process and interested parties did not participate in the








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neutral evaluation process as specified in provisions of
this bill, and has disclosed documents arising from the
neutral evaluation process as specified.

2)Prohibits the local public entity from filing a petition and
exercising powers under 1) above
if the neutral evaluator determines a local entity has failed to
participate in the neutral evaluation process in good faith.

3)Specifies that a failure to participate in good faith
includes, but is not limited to, the failure to provide
accurate and essential financial information, the failure to
attempt to reach settlement with all interested parties to
avert bankruptcy, or evidence of manipulation to delay and
obstruct a timely agreement.

4)Provides that the California Debt and Investment Advisory
Commission (CDIAC), when requested by a local public entity or
a neutral evaluator, shall serve as a neutral third party to
provide technical assistance in any neutral evaluation process
conducted pursuant to provisions of the bill.


5)Allows a local public entity to initiate the neutral
evaluation process and provides that a neutral evaluator shall
oversee the neutral evaluation process and shall facilitate
all of the following requirements:

a) The local public entity shall make complete disclosure
of all documentation necessary to clearly demonstrate
whether the local public entity is solvent, including, but
not limited to, financial reports, expenditures, assets,
and any other relevant documentation;

b) The local public entity and any interested party shall
make present information to each other, which shall
include, but is not limited to, the status of funds of the
local public agency that clearly distinguishes between
general funds and special funds;

c) The local public entity and any interested party shall
present its proposed plan of readjustment; and,

d) The local public entity and any interested party shall








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negotiate in good faith.

6)Provides that the neutral evaluation process shall be
confidential and is subject to specified provisions contained
in the Evidence Code.

7)Allows a local public entity to initiate a neutral evaluation
process 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.

8)Provides that the neutral evaluation process will be conducted
through an alternative dispute resolution program within the
state and in accordance with provisions of the bill.

9)Provides that the role of the neutral evaluator shall be to
assist all interested parties in reaching an equitable
settlement to avert a Chapter 9 filing.

10)Provides that the neutral evaluator may consult with
alternate dispute resolution service providers, CDIAC, the
Executive Office for U.S. Trustees, retired bankruptcy judges,
or other appropriate entities in establishing and
administering the neutral evaluation regarding issues that are
not confidential.

11)Requires a neutral evaluator to meet all of the following
qualifications:

a) At least 10 years of high level business or legal
practice involving bankruptcy;

b) Experience and training in conflict resolution and
alternative dispute 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
law, and municipal finance dispute resolution, provided
through an alternative dispute resolution program within
the state.

12)States that the neutral evaluator shall be impartial,








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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 the neutral evaluation process.

13)Requires the neutral evaluator to avoid a conflict of
interest or the appearance of a conflict of interest during
and after a neutral evaluation and requires the neutral
evaluator 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.

14)Requires, prior to neutral evaluation, that the neutral
evaluator shall not establish another relationship with any of
the parties in a manner that would raise questions about the
integrity of the neutral evaluation, except that the neutral
evaluator may conduct further neutral evaluations regarding
other potential local public entities that may involve some of
the same or similar constituents to a prior neutral
evaluation.

15)Requires the neutral evaluator to conduct the neutral
evaluation in a manner that promotes voluntary, uncoerced
decisionmaking in which each party makes free and informed
choices regarding the process and outcome.

16)Prohibits the neutral evaluator from imposing a settlement on
the parties and requires the neutral evaluator to use his or
her best efforts to assist the parties to reach a satisfactory
resolution of their disputes.

17)Allows, subject to the discretion of the neutral evaluator,
the neutral evaluator may make oral or written recommendations
for settlement or plan of readjustment to a party privately or
to all parties jointly.


18)Specifies that the neutral evaluator 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








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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.


19)Requires the neutral evaluator to request from the parties
documentation and other information that the neutral evaluator
believes may be helpful in assisting the parties to address
the obligations between them.


20)Allows, in the event a complete settlement of all or some
issues in dispute is not achieved within the scheduled neutral
evaluation session or sessions, the neutral evaluator, at the
neutral evaluator's discretion, to continue to communicate
with the parties in an ongoing effort to facilitate a complete
settlement in order to avoid a Chapter 9 filing.


21)Requires the neutral evaluator to provide counsel and
guidance to all parties and specifies that the neutral
evaluator shall not be a legal representative of any party and
shall not have a fiduciary duty to any party.


22)Allows, in the event of a settlement with all interested
parties, the neutral evaluator to assist the parties in
negotiating a prepetition, preagreed plan of readjustment in
connection with a potential Chapter 9 filing.


23)Requires the neutral evaluator to maintain the
confidentiality of all the information obtained by the neutral
evaluator in the neutral evaluation process, unless otherwise
agreed to by the parties.

24)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 neutral
evaluator, and allows the neutral evaluator to request the
submission or exchange of memoranda on issues, including the
underlying interests, and the history of the parties' prior
negotiations.








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25)Allows information that a party wishes to keep confidential
to be sent to the neutral evaluator in a separate
communication clearly marked "CONFIDENTIAL."

26)Requires each interested party to provide at least one
representative to attend all neutral evaluation 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.

27)Requires the local public entity to provide a representative
who shall represent the local public entity's interest in the
neutral evaluation and who shall be in a position to propose
any settlement or plan of readjustment to the governing body
of the local public entity.

28)Allows an interested party to be represented by legal
counsel, but must inform all parties of the representation.

29)Requires the parties to maintain the confidentiality of the
neutral evaluation process and prohibits the parties from
disclosing statements made, information disclosed, or
documents prepared or produced during the neutral evaluation
process as specified in provisions of the Evidence Code
related to mediation, unless all parties consent in writing to
the disclosure.

30)Requires the neutral evaluation process 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 neutral evaluator certifies in writing that one or
more of the parties has not participated in good faith,
that no resolution has been reached, and that further
efforts at the neutral evaluation process would not
contribute a resolution of the parties' dispute;








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d) The neutral evaluator certifies in writing that the
parties have participated in good faith but the parties
have reached an impasse and further efforts at the neutral
evaluation process would not contribute to a resolution of
disputes; or,

e) The neutral evaluator certifies in writing that a
neutral evaluation was initiated by the local public
entity, but that no interested parties participated.

31)Adds a new section that defines terms related to provisions
of the bill.

32)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 the
California Constitution Article I, Section 3 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.

33)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 Section 59125) to
file a petition and exercise powers under applicable federal
bankruptcy law as provided by Section 53760.









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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 : According to the Assembly Appropriations
Committee:

1)Costs to the California Debt and Investment Advisory
Commission of approximately $100,000 to develop program
guidelines, develop qualifications for neutral evaluators and
carry out other duties related to the neutral evaluation
process.

2)State exposure to legal challenges and related fiscal
pressures, potentially in the hundreds of millions of dollars.

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








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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;

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








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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
authorizing bankruptcy filings by local governments were
codified in 1949 and those provisions were not amended until
SB 1323 (Ackerman) 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) of 1995 and AB 2 X2 (Caldera) of 1995
would have granted the broadest authority permissible under
federal law by adopting the federal definition of
"municipality;"

b) AB 29 X 2(Archie-Hudson) of 1995 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) of 1995 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 State Treasurer, State
Controller and Director of the Department 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








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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
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








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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.

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 İfor
municipalities to file a petition under federal bankruptcy
law]."

RECENT LEGISLATION









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6)The Legislature saw two municipal bankruptcy bills in the
2009-10 legislative session,
AB 155 (Mendoza) and SB 88 (DeSaulnier) Chapter 304, Statutes of
2000 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 but no longer included provisions relating to
municipal bankruptcy.

7)For both AB 155 and SB 88, the authors argued that a municipal
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 (Wieckowski) 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 a local
government go through a neutral evaluation process first, and
then 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 the neutral process
and receive a good faith certification from the neutral
evaluator. 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 neutral evaluator certify that all parties acted
in good faith; or, c) the local public entity would need to
initiate the neutral evaluation process but have interested
parties not participate in the neutral evaluation.

The bill also prohibits a local public entity from filing a








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petition for Chapter 9 if the neutral evaluator determines
that a local entity has failed to participate in the neutral
evaluation process in good faith. The bill defines the
failure to participate in good faith to include, but not be
limited to, the failure to provide accurate and essential
financial information, the failure to attempt to reach
settlement with all interested parties to avert bankruptcy, or
evidence of manipulation to delay and obstruct a timely
agreement.

The provisions of the bill allow a local public entity to
initiate the neutral evaluation process when the local public
entity is or is likely to become unable to meet its financial
obligations. The bill provides that the neutral evaluation
must be conducted through an alternative dispute resolution
program within the state and in accordance with the provisions
of the bill that allow CDIAC to serve as a neutral third party
and provide technical assistance in any neutral evaluation
process.

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 İthe 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) above). 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 Legislature may wish to consider whether the bill's








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neutral evaluation process is duplicative of what is already
required for local governments before they can file a
bankruptcy petition for Chapter 9 protection.

11)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 an evaluation
process does not make sense and prohibits districts from being
granted the automatic stay protection under Chapter 9.

The Legislature 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 the neutral evaluation process
will have little to no impact.

12)As noted in Governor Wilson's veto of SB 349 (Kopp) of 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








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distressed municipality." The Legislature may wish to
consider whether this bill creates some sort of unintended
state liability.

13)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
İVallejo'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."

14)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
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."


Analysis Prepared by
: Debbie Michel / L. GOV. / (916)
319-3958

FN: 0001135









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