SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: AB 506 HEARING: 9/7/11
AUTHOR: Wieckowski FISCAL: No
VERSION: 9/2/11 TAX LEVY: No
LOCAL GOVERNMENT BANKRUPTCY
Authorizes a local government to petition for bankruptcy
protection if it either participates in a neutral
evaluation process or declares a fiscal emergency.
Background and Existing Law
Federal bankruptcy law for public agencies (Chapter 9)
gives government debtors time to come up with repayment
plans, providing them a breathing spell from creditors'
collection efforts. Only a municipality, which federal law
defines as a political subdivision, public agency, or
instrumentality of a state, can initiate a Chapter 9
proceeding. The municipality must be insolvent and desire
to effect a plan to adjust its debts. To qualify as
insolvent, a municipality must demonstrate that it:
Has obtained the agreement of creditors holding at
least a majority of the amount of the claims of each
class that such entity intends to impair under a plan
in a case under Chapter 9; or,
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; or,
Is unable to negotiate with creditors because
negotiation is impracticable; or,
Reasonably believes that a creditor may attempt to
obtain a transfer that is avoidable under federal
Unlike private bankruptcy law (Chapter 11), municipal
bankruptcy law must respect the states' sovereign powers.
Consequently, the states can control their local agencies'
access to federal bankruptcy protection. Like 11 other
states, California grants its local public agencies the
AB 506 -- 9/2/11 -- Page 2
broadest possible access to federal bankruptcy available.
The state statutes broadly authorizing bankruptcy filings
by local governments were first enacted in 1939 (SB 338,
Phillips, 1939) and codified in 1949 (SB 768, Cunningham,
1949). In 2001, after studying the state statutes
authorizing bankruptcy filings by local public entities,
the California Law Revision Commission recommended
revisions to conform the statutes to changes in federal
bankruptcy law and to reaffirm the intent of the statute to
provide the broadest possible access to municipal debt
relief under federal law. Legislators approved the
Commission's recommendations the following year (SB 1323,
Because one municipality's bankruptcy may have a negative
effect on other local governments' borrowing power, some
states limit or prohibit their local governments to access
federal protections. Local governments in 22 states do not
have access to municipal bankruptcy, while 16 other states
impose some conditions on municipal bankruptcy filings.
The conditions imposed by other states range from a
requirement that a local entity's legislative body must
pass an ordinance or resolution before filing for
bankruptcy to a requirement that a state commission grant
approval before a local government may file for bankruptcy.
After the 1994 Orange County bankruptcy, the Legislature
tried to establish state oversight for municipal bankruptcy
filings. The bill passed, but Governor Pete Wilson vetoed
it (SB 349, Kopp, 1996). The Law Revision Commission's
2001 study also considered proposals to require prefiling
approval by the Governor or a governmental committee, but
did not recommend any substantive reforms. Last year, AB
155 (Mendoza, 2010) would have required either the approval
of a state commission or the completion of a state audit
before a local public entity could file for bankruptcy.
That bill died on the Senate Floor.
In 2008, the City of Vallejo filed a Chapter 9 bankruptcy
petition. The City subsequently asked the bankruptcy court
for permission to reject collective bargaining agreements
with four unions representing city employees. Vallejo
recently ended its bankruptcy after more than three years.
In response to the length, cost, and consequences of
Vallejo's bankruptcy and the potential for additional
AB 506 -- 9/2/11 -- Page 3
municipal bankruptcy filings, labor unions and others want
local officials to participate in a neutral alternative
dispute resolution process before filing for bankruptcy.
Assembly Bill 506 authorizes a local public entity to file
a petition and exercise powers pursuant to applicable
federal bankruptcy law if it either:
Participates in a neutral evaluation process, or
Declares a fiscal emergency.
I. Neutral evaluation process
. AB 506 authorizes a local
public entity to initiate a neutral evaluation process if
it is, or likely will become, unable to meet its financial
obligations when those obligations are due or become due.
The bill defines "local public entity" as any county, city,
district, public authority, public agency, or other entity,
without limitation, that is a municipality as defined in
federal bankruptcy law, or that qualifies as a debtor under
any other federal bankruptcy law applicable to local public
entities. The bill specifies that a "local public entity"
does not include a school district.
AB 506 requires a local public entity to initiate the
neutral evaluation by providing notice by certified mail of
a request for neutral evaluation to all interested parties.
The bill requires interested parties to respond within 10
business days of receipt of notice of the local public
entity's request for neutral evaluation.
AB 506 defines "interested party" as a trustee, a committee
of creditors, an affected creditor, an indenture trustee, a
pension fund, a bondholder, a union that, under its
collective bargaining agreements, has standing to initiate
contract or debt restructuring negotiations with the
municipality, or a representative selected by an
association of retired employees of the public entity who
receive income from the public entity convening the neutral
AB 506 defines "creditor" as either of the following:
An entity that has a claim against a municipality
that arose at the time of or before the commencement
AB 506 -- 9/2/11 -- Page 4
of the neutral evaluation process and whose claim
represents at least $5 million or comprises more than
5% of the local public entity's debt or obligations,
whichever is less.
An entity that may have a claim against the
municipality arising out of rejection of an executory
contract or unexpired lease in a Chapter 9 case and
whose claim represents at least $5 million or
comprises more than 5% of the local public entity's
debt or obligations, whichever is less.
The bill allows a local public entity to invite holders of
contingent claims to participate as interested parties in
the neutral evaluation if the local public entity
determines that the contingency is likely to occur and the
claim may represent $5 million or comprise more than 5% of
the local public entity's debt or obligations, whichever is
AB 506 requires the local public entity and all interested
parties participating in the neutral evaluation process to
negotiate in good faith.
The bill requires the local public entity and interested
parties to provide a representative of each party to attend
all neutral evaluation sessions. Each party's
representative must have the authority to settle and
resolve disputes or be in a position to present any
proposed settlement or plan of readjustment to the parties
participating in the neutral evaluation.
AB 506 requires the parties to maintain the confidentiality
of the neutral evaluation process. The bill prohibits
parties from disclosing statements made, information
disclosed, or documents prepared or produced, during the
neutral evaluation process, at the conclusion of the
neutral evaluation process, or during any bankruptcy
proceeding unless either:
All persons that conduct or otherwise participate
in the neutral evaluation expressly agree in writing,
or orally, to disclosure of the communication,
document, or writing.
The information is deemed necessary by a judge
presiding over a bankruptcy proceeding pursuant
federal bankruptcy law to determine eligibility of a
municipality to proceed with a bankruptcy proceeding.
AB 506 -- 9/2/11 -- Page 5
AB 506 prohibits a neutral evaluation from lasting for more
than 60 days following the date the evaluator is selected,
unless the local public entity or a majority of interested
parties want to continue and agree to an extension.
AB 506 requires an end to the neutral evaluation process
must end if any of the following occur:
The parties execute an settlement agreement.
The parties reach an agreement or proposed plan of
readjustment that requires the approval of a
The neutral evaluation process has exceeded 60 days
following the date the neutral evaluator was selected,
the parties have not reached an agreement, and the
parties do not agree on extension of the neutral
evaluation process past the initial 60 day time
The neutral evaluator confirms that a neutral
evaluation was initiated by the local public entity
but that no interested parties participated.
The fiscal condition of the local public entity
deteriorates to the point that the municipality
declares a fiscal emergency.
The bill specifies that if the 60 day time period for
neutral evaluation has expired, including any extension
agreed to by the local public entity, and the neutral
evaluation is complete with differences resolved, the
neutral evaluation shall be concluded. If the neutral
evaluation process does not resolve all pending disputes
with creditors, the local public entity may file a petition
and exercise powers pursuant to applicable federal
bankruptcy law if, in the opinion of the governing board of
the local public entity, a bankruptcy filing is necessary.
AB 506 requires the local public entity to pay 50% of the
costs of neutral evaluation, including but not limited to
the fees of the evaluator, and the creditors must pay the
balance, unless otherwise agreed to by the parties.
II. Neutral evaluator selection and removal
. AB 506
requires the interested parties who agree to participate in
the neutral evaluation to select the neutral evaluator to
oversee the neutral evaluation process. The interested
parties must facilitate all discussions in an effort to
AB 506 -- 9/2/11 -- Page 6
resolve their disputes.
If at any time during the neutral evaluation process the
local public entity and a majority of the representatives
of the interested parties participating in the neutral
evaluation wish to remove the neutral evaluator, AB 506
allows the local public entity or any interested party to
request that the neutral evaluator be removed. If the
local public entity and the majority of the interested
parties agree that the neutral evaluator should be removed,
the parties must select a new neutral evaluator.
If a neutral evaluator is informed of any facts that a
reasonable individual would consider likely to create a
potential or actual conflict of interest, AB 506 requires
the neutral evaluator to disclose these facts in writing to
the local public entity and all interested parties involved
in the neutral evaluation. If any party to the neutral
evaluation objects to the neutral evaluator, that party
must notify all other parties, including the neutral
evaluator, within 15 days of receiving the notice from the
neutral evaluator, the neutral evaluator must withdraw, and
a new neutral evaluator must be selected.
III. Neutral evaluator requirements
. AB 506 requires that
a neutral evaluator must have experience and training in
conflict resolution and alternative dispute resolution and
must meet at least one of the following qualifications:
At least 10 years of high-level business or legal
practice involving bankruptcy or service as a United
States Bankruptcy Judge.
Professional experience or training in municipal
finance and one or more of the following issue areas:
o Municipal organization.
o Municipal debt restructuring.
o Municipal finance dispute resolution.
o Chapter 9 bankruptcy.
o Public finance.
o California constitutional law.
o California labor law.
o Federal labor law.
AB 506 provides that a neutral evaluator:
Must be impartial, objective, independent, and free
AB 506 -- 9/2/11 -- Page 7
Cannot act with partiality or prejudice based on
any participant's personal characteristics,
background, values or beliefs, or performance during
the neutral evaluation process.
Must avoid a conflict of interest, or the
appearance of a conflict of interest, during the
neutral evaluation process and must 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.
Cannot, before the neutral evaluation process,
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 mediation.
Must conduct the neutral evaluation process in a
manner that promotes voluntary, uncoerced
decisionmaking in which each party makes free and
informed choices regarding the process and outcome.
Cannot impose a settlement on the parties.
Must use his or her best efforts to assist the
parties to reach a satisfactory resolution of their
May make oral or written recommendations for
settlement or plan of readjustment to a party
privately or to all parties jointly.
Must inform the local public entity and all parties
of the provisions of Chapter 9 relative to other
chapters of the bankruptcy codes. This instruction
must highlight the limited authority of United States
bankruptcy judges in Chapter 9, such as the lack of
flexibility available to judges 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.
May request documentation and other information
from the parties that the neutral evaluator believes
may be helpful in assisting the parties to address the
obligations between them. This documentation may
include the status of funds of the local public entity
that clearly distinguishes between general funds and
special funds, and the proposed plan of readjustment
prepared by the local public entity.
AB 506 -- 9/2/11 -- Page 8
Must provide counsel and guidance to all parties,
shall not be a legal representative of any party, and
shall not have a fiduciary duty to any party.
May, in the event of a settlement with all
interested parties, assist the parties in negotiating
a prepetitioned, preagreed plan of readjustment in
connection with a potential Chapter 9 filing.
IV. Fiscal emergency declaration
. As an alternative to
the neutral evaluation process, AB 506 authorizes a local
public entity to file a petition and exercise powers
pursuant to federal bankruptcy law if the local public
entity declares a fiscal emergency and adopts a resolution
by a majority vote of the governing board.
The resolution must:
Be adopted at a noticed public hearing.
Include findings that the financial state of the
local public entity jeopardizes the health, safety, or
well-being of the residents of the local public
entity's jurisdiction or service area, absent the
protections of Chapter 9.
Make findings that the public entity is or will be
unable to pay its obligations within the next 60 days.
Before declaring a fiscal emergency and adopting a
resolution, the local public entity must place an item on
the agenda of a noticed public hearing on the fiscal
condition of the entity to take public comment.
. AB 506 defines numerous terms used in the
VI. Findings and declarations
. AB 506 contains extensive
legislative findings and declarations supporting the need
to establish a neutral evaluation process for
municipalities in fiscal distress. As constitutionally
required by Proposition 59 (2004), AB 506 also includes
legislative findings and declarations regarding the
necessity of maintaining the confidentiality of neutral
State Revenue Impact
AB 506 -- 9/2/11 -- Page 9
1. Purpose of the bill
. Because local and state finances
are inextricably linked, the state has a direct interest in
the fiscal health of its local governments. A municipal
bankruptcy can have statewide repercussions, including
higher borrowing costs for other local entities and the
state. The state also has a compelling interest in
ensuring the validity and enforceability of contracts
negotiated through the collective bargaining process, which
forms the foundation for positive and stable labor
relations. These state interests justify a state role in
prescribing conditions under which local entities may seek
Chapter 9 protection. The neutral evaluation authorized by
AB 506 helps local officials find alternative strategies to
address short-term fiscal challenges in ways that avoid the
broad and lasting spillover effects of municipal
bankruptcy. By providing an opportunity for good faith
negotiation over a restructuring plan, the neutral
evaluation process expedites the Chapter 9 process for
local entities that eventually file for bankruptcy. AB 506
offers municipalities facing financial distress a faster,
cheaper, better alternative to the path recently taken by
Vallejo and protects the interests of a broad coalition of
stakeholders who are affected by municipal bankruptcies.
2. What's changed
? Local officials have used municipal
bankruptcy protection sparingly during the 70 years that it
has been available to local public entities in California.
Only three general purpose governments have filed for
municipal bankruptcy protection: Orange County (1994), the
City of Desert Hot Springs (2001), and the City of Vallejo
(2008). Since 1991, 24 local public entities have filed
for bankruptcy; more than half were small health care
districts. This recent average of fewer than two municipal
bankruptcy filings per year from among the thousands of
local public entities in California may reflect the
substantial, inherent disadvantages of resorting to
bankruptcy. High legal costs, damaged credit ratings, and
a lasting stigma that can deter investment and growth in a
community all weigh heavily against a decision to petition
for bankruptcy protection. Despite the Great Recession and
additional state-imposed burdens on local finances, the
AB 506 -- 9/2/11 -- Page 10
Sierra Kings Health Care District is the only California
local government that has filed for bankruptcy protection
in the three years since Vallejo entered bankruptcy.
Vallejo's experience is a cautionary tale, encouraging
fiscally distressed local governments to find alternative
approaches to fiscal restructuring. The Committee may wish
to consider whether the recent frequency and purpose of
municipal bankruptcy filings justify making any changes to
the state's long-standing municipal bankruptcy statute.
3. Whose choice
? Unlike earlier versions of the bill, AB
506 doesn't give a local public entity any role in
selecting a neutral evaluator. Instead, the interested
parties agreeing to participate in the neutral evaluation
process must select the neutral evaluator. The Committee
may wish to consider whether AB 506 should require a local
public entity and participating interested parties to
select a neutral evaluator through a process in which they
both participate. Why should creditors, unions, and
retired employees pick a neutral evaluator without local
4. Extension tension
. AB 506's provisions for extending
the neutral evaluation process beyond the 60-day limit are
ambiguous. The bill requires that the neutral evaluation
must not last more than 60 days unless the local public
a majority of interested parties want to
continue. However, it also appears to require that the
neutral evaluation process must end after 60 days, allowing
a local public entity to file a bankruptcy petition, unless
the local public entity and a majority of interested
parties agree to an extension. The Committee may wish to
consider whether AB 506 should allow either a local public
a majority of participating interested parties to
extend a neutral evaluation by up to 30 additional days and
a local public entity and a majority of
participating interested parties to agree to extend a
neutral evaluation process beyond 90 days.
5. Nowhere to run
. AB 506 requires a local public entity
to place an item on a public meeting agenda and take public
comment before it acts on a resolution declaring a fiscal
emergency in anticipation of possibly petitioning for
bankrupt-cy. If a board of supervisors puts that item on
its agenda, other local agencies would rush to withdraw
funds they had invested in the county treasury. To prevent
AB 506 -- 9/2/11 -- Page 11
possible runs on county investment pools, the Committee may
wish to consider whether AB 506 should allow a county to
require a five-day notice for withdrawals from the county
treasury when the county's board of supervisors places an
item on its agenda in compliance with AB 506.
6. You say tomato
. Because the September 2 amendments
make the bill's neutral evaluation process nearly identical
to a traditional mediation process, local governments want
to be able to refer to a "neutral evaluation" as a
"mediation" and refer to a "neutral evaluator" as a
"mediator." The Committee may wish to consider whether AB
506 should specify that the terms neutral
evaluation/neutral evaluator can be used interchangeably
with the terms mandatory mediation/mediator.
7. End game
. AB 506 requires a neutral evaluation process
to end if a neutral evaluator confirms that a local public
entity initiated a neutral evaluation but no interested
parties participated. However, if no interested parties
participate, a neutral evaluator would never be selected,
making impossible for any neutral evaluator to confirm the
interested parties' failure to participate. The Committee
may wish to consider amending AB 506 to require that a
neutral evaluation process ends if no interested parties
respond to a local public entity within 10 days of a local
public agency's initiating a neutral evaluation.
8. Technical fixes
. To clarify that AB 506 requires a
neutral evaluator, not the interested parties, to be
responsible for facilitating discussions in an effort to
resolve disputes, the Committee may wish to consider
amending the bill to strike the word "shall" on page 11,
line 16. Additionally, the committee may wish to consider
amending AB 506 to correct the bill's section numbers on
pages 17 and 21.
9. Take two
. The Senate Governance & Finance Committee
heard testimony on AB 506 at its July 6, 2011 hearing. At
that hearing, the Committee voted to amend the bill to
remove its substantive provisions and refer it to the
Senate Rules Committee. On August 15, new substantive
language relating to municipal bankruptcy was amended into
AB 506, which the Senate Rules Committee then referred to
the Senate Appropriations Committee. The Senate
Appropriations Committee voted 6-3 to pass AB 506 to the
AB 506 -- 9/2/11 -- Page 12
Senate Floor, with additional amendments. Because the
September 2 floor amendments rewrote AB 506, the Senate
Rules Committee referred AB 506 back to the Senate
Governance & Finance Committee under Senate Rule 29.10.
Assembly Local Government Committee: 5-3
Assembly Appropriations Committee:12-5
Support and Opposition
: California Professional Firefighters; California
Conference Board of The Amalgamated Transit Union;
California Conference of Machinists; California Dispute
Resolution Council; California Labor Federation; California
Official Court Reporters Association; California Nurses
Association; California Teamsters Public Affairs Council;
Estero Municipal Improvement District; International
Longshore and Warehouse Union; Police Officers Research
Association of California; Professional and Technical
Engineers; IFPTE Local 21; United Food and Commercial
Workers Region 8 States Council; Unite Here!; Utility
Workers Union of America, Local 132.
: Association of California Healthcare
Districts; California Chamber of Commerce; California
Contract Cities Association; California Special Districts
Association; California State Association of Counties;
Howard Jarvis Taxpayers Association; League of California
Cities; Long Beach Area Chamber of Commerce; Los Angeles
County Business Federation; Marin County Council of Mayors
and Councilmembers; Regional Council of Rural Counties;
Urban Counties Caucus.
Cities of: American Canyon; Antioch; Apple Valley;
Atherton; Azusa; Bellflower; Beverly Hills; Burlingame;
Campbell; Ceres; Clayton; Cloverdale; Culver City;
Danville; Diamond Bar; Encinitas; Fontana; Foster City;
Fountain Valley; Fresno; Goleta; Gustine; Half Moon Bay;
Healdsburg; Hermosa Beach; Highland; Huron; Lakewood;
Lathrop; Livingston; Lodi; Long Beach; Los Altos Hills;
Madera; Merced; Monterey Park; Moreno Valley; Mountain
View; Murrieta; Newman; Norwalk; Pasadena; Pinole;
AB 506 -- 9/2/11 -- Page 13
Placentia; Rancho Cucamonga; Red Bluff; Redding; Redwood
City; Santa Clara; Santa Rosa; Signal Hill; South San
Francisco; Stockton; Sunnyvale; Tracy; Tulare; Upland;
Vista; Wasco; West Hollywood; Whittier; Yucaipa.
Counties of: Monterey; Orange; Sacramento; Santa