This document provides an overview and summary of municipal fiscal crises in California. It discusses the large unfunded pension liabilities faced by state and local governments, guidance for elected officials on proactively addressing fiscal issues, the purpose and advantages of declaring a fiscal emergency or filing for Chapter 9 bankruptcy protection. It also introduces the presenters, who are legal and financial experts on municipal restructuring.

1. Municipalities In Crisis:
Options Short Of Last Resort
February 27, 2013
Presented by:
David S. Kupetz, Partner, SulmeyerKupetz
dkupetz@sulmeyerlaw.com
Dean G. Rallis Jr., Partner, SulmeyerKupetz
drallis@sulmeyerlaw.com
Robert Tormey CPA, CTP, CIRA
bob@roberttormey.com
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2. California Cities in Crisis:
• Presenters
• Current Circumstances
• Guidance for Elected and Appointed Officials
• Constructive Use of Fiscal Emergency
• AB 506 Advantages
• Purpose and Power of Chapter 9
• Filing Chapter 9
• Status of Pension Obligations: San Bernardino and Stockton
• Chapter 9 Precedents
• Conclusions
• Precedents Summary
• Questions and Comments
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3. Dean Rallis
 For over 30 years, Dean Rallis has focused his practice
in the areas of business reorganization, corporate
insolvency, commercial and bankruptcy litigation, as
well as the acquisition of assets and businesses in
bankruptcy court and out-of-court workouts. He has
functioned as lead counsel for debtors, creditors (both
secured and unsecured), creditors‟ committees and
purchasers in the bankruptcy, restructure and
liquidation of companies, and represented Tri-City
Mental Health Center in its successful chapter 9
municipal debt adjustment case.
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4. David Kupetz
 David Kupetz specializes in troubled transactions, crisis avoidance
consultation, workouts, restructurings, reorganizations, bankruptcies, receiverships,
assignments for the benefit of creditors, municipal debt adjustment, and other non-
bankruptcy insolvency proceedings. He represents debtors (in restructurings and
workouts and in chapter 11 reorganization cases), secured creditors, unsecured
creditors' committees, assignees for the benefit of creditors, buyers/sellers of
businesses/assets in distressed circumstances and other entities in insolvency and
bankruptcy situations.
 Practicing law at SulmeyerKupetz for over 25 years, David has substantial
experience in municipal debt adjustment matters, and speaks and writes extensively
on the subject. SulmeyerKupetz represented the Ventura Port District and Tri-City
Mental Health Center in their successful Chapter 9 municipal debt adjustment
cases, the Orange County Transportation Authority in connection with the Orange
County Chapter 9 case, and a group of cities that were creditors in the Chapter 9
case of Desert Hot Springs. In recent years, SulmeyerKupetz has represented a
number of local public entities in out of court negotiations with
creditors, workouts, and restructurings that have allowed them to avoid Chapter 9.
The firm has also represented other governmental entities in connection with
Chapter 9 cases.
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5. Robert Tormey, CPA
• Bob Tormey is a Certified Public Accountant and Crisis Manager who specializes in
highly leveraged situations, crisis situations and turn-arounds.
• He has acted as financial advisor to Lenders, lender's counsel, equity stakeholders
and as interim management to debtors and has significant expertise in for profit
education, municipal finance, aerospace manufacturing, business services, and
acquisitions integration.
• Bob holds and MBA from the Johnson School of Cornell University and a BA from
Loyola University of Los Angeles. He is also a member of the Turn Around
Management Association and the Association of Certified Insolvency and
Restructuring Advisors.
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6. Current Circumstances - Federal
• The Simpson Bowles Commission, i.e. the National Commission on Fiscal Responsibility and
Reform was a Presidential Commission created in 2010 by President Obama to identify
"…policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability
over the long run.
• The Commission‟s report was released on December 1, 2010.
• The Commission‟s report was supported by over 60% of the members (11 out of 18), and an
equal number of Democrats and Republicans; however, the report did not reach the 14-vote
threshold required to formally endorse the blueprint and have it sent to Congress.
• The Government took no action on the Commissions recommendations.
• Proponents of the plan praised it for hitting all parts of the federal budget and for putting the
national debt on a stable and then downward path.
• Prominent supporters include JP Morgan Chase CEO Jamie Dimon, Democratic Leader Nancy
Pelosi, and Republican Senator Tom Coburn.
• On August 5, 2011, Standard and Poor‟s lowered the credit rating of the United States
Government to AA+, the first time the credit rating of the United States has ever been lowered.
• On March 1, 2013, the United States begins the process of sequestration as a result of an inability
to arrive at a legislative solution to its fiscal crisis.
6Robert Tormey

7. Current Circumstances - California
• The Little Hoover Commission, officially, the Commission on California State Government
Organization and Economy, is an independent California state oversight agency that investigates state
government operations.
• Two years ago, in its February 2011 report, entitled “Public Pensions for Retirement Security,” the
Commission made the following determinations:
• Pension costs will crush government: the Math doesn‟t work, the system lacks discipline, oversight and
accountability.
• State and local governments need the authority to restructure future, unearned retirement benefits for
their employees. The Legislature should pass legislation giving this explicit authority to state and local
government agencies. This legislation may entail the courts having to revisit prior court decisions.
• Failure to seek this authority will prevent the Legislature from having the tools it needs to address the
magnitude of the pension shortfall facing state and local governments. The situation is dire.
• The pension reform measure signed into law in September by Gov. Jerry Brown, AB 340 left current
employees alone, focusing instead on new hires. Government officials will have to wait until 2018 to
negotiate with public employee unions to reform pensions for current employees. In short, the advice of
the Little Hoover Commission was ignored.
7Robert Tormey

8. Current Circumstances - California
• The California State Controller‟s office estimates the pension underfunding as of 2010 as
only $128 Billion.
• However, according to the Little Hoover Commission, as of 2010, the 10 Largest Public
Pension funds in California faced a combined shortfall of as much as $240 Billion.
• As of February 2013, the California Public Policy Center has released a study entitled
„Public Retirement Systems Annual Report for 2010” which calculates California‟s total
unfunded pension liability using the new criteria proposed by Moody‟s Investor Services for
adoption in 2014. The CPPC estimates the underfunded amount to be $326 Billion.
• UnionWatch has estimated both the pension underfunding and the related retirement
healthcare plan underfunding as approaching $872 Billion.
• The Government Accounting Standards Board, the GASB, plans to require municipalities to
disclose the unfunded pension liabilities on their balance sheets beginning in 2014. In that
year, auditors are expected to opine as to whether the municipality can be considered a
going concern with such liabilities under GASB 67 and 68.
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Robert
Torney

9. • Maintain flexibility
• Avoid fiscal crisis
• Preserve general fund liquidity
• Identify unrestricted fund balances held in other funds
• Investigate opportunities to reduce service levels and headcount
• Negotiate plans with Unions for alternative delivery and service
consolidation approaches to further reduce costs
• Insist on multi-year forecasts for all funds
• Complete a “prospective insolvency” analysis
9Robert Tormey
Guidance for Elected Officials

10. Guidance for Elected Officials
• Analyze costs of services and opportunities for generating fees
• Evaluate cost recovery opportunities that might result in additional
revenue to aid in the restoration of needed services
• Poll voters to gauge support for augmenting existing revenue sources
• Consider debt restructuring – outside of court, if possible
• Negotiate benefit reductions with existing employees
• Implement two-tier benefit plans for new employees
• Outsource and consolidate services with other agencies and JPA‟s
10Robert Tormey

11. Guidance for Elected and Appointed Officials
Watch Closely for Warning Signs
• Resignation of accounting personnel (San Bernardino)
• Interfund borrowings - (Compton)
• General fund below threshold levels (Montebello)
• Prospective insolvency analysis (Vallejo)
• Fiscal problems facing local school district(s) at FCMAT website
• Pension obligation bonds issued or proposed (Fresno, Oakland)
• Unrealistic budget projections – i.e., budgets which "assume"
growth in revenue
11Robert Tormey

12. Constructive Use of Fiscal Emergency
• Constitutional
– In order to raise taxes outside of a regularly scheduled election.
• Contract Impairment – Case Law Precedent
– Blaisdell, 290 U.S. 473 (1937) & Sonoma County, 23 Cal.3d. 296 (1979)
• Requires actual emergency
• Temporary
• Benefits the Public Interest
• Appropriately tailored to the emergency
– United States Trust Co. of N.Y., 431 U.S. 1 (1977)
• Reasonable and necessary to serve an important public purpose
• Statutory –AB 506
12David S. Kupetz

13. AB 506
• Adopted after the City of Vallejo filing
• Promotes mediation with key creditors before Chapter 9
• Requires either a
– Completion of a 60 day neutral evaluation (mediation) process, or
– A declaration of fiscal emergency
• Stockton first California city to use evaluation process
• San Bernardino declared fiscal emergency and filed Chapter
9 without the neutral evaluation process
• Costs of process to be shared between debtor and creditors
13Dean G. Rallis

14. AB 506 - Advantages
• Signals seriousness of fiscal circumstances to all stakeholders
• Allows "confidential" negotiations out of court and without scrutiny of
Brown Act disclosures
• May help manage or avoid potential embarrassment and scandal factors
as information can be disclosed to stakeholders in confidential fashion
• Opportunity to shape perceptions of liquidity and feasibility
• If agreement can be reached with some or all key creditors, Chapter 9
may be avoided or made more efficient if still necessary
14Dean G. Rallis

15. Purpose & Power of Chapter 9
• Provides a framework for eligible governmental entities to restructure
debt
• Was drafted solely for municipalities
• Allows insolvent local public entities to remain viable
• Similar to Chapter 11, main benefits of Chapter 9
are:
o The automatic stay; and
o Adjusts debts through a plan
• The Goal of a Chapter 9 Case is Confirmation of a
Plan of Debt Adjustment
15David S. Kupetz

16. Purpose & Power of Chapter 9
• The bankruptcy court cannot interfere with the municipality's ability to
continue its operations or dictate what type of services or level of
services the governmental entity may provide.
• Municipalities are permitted to adjust burdensome contractual
relationships under the power to reject executory contracts and
unexpired leases, subject to court approval.
• Municipalities may also reject collective bargaining agreements
(Vallejo and Orange County) or potentially retiree benefit plans.
16David S. Kupetz

17. Purpose & Power of Chapter 9
• Creditors cannot expect that all excess funds go to the payment of
their claims under a Chapter 9 plan.
• The Municipality must retain sufficient funds from which to
operate, make necessary improvements and maintain its facilities
and assets, and continue to fulfill its governmental responsibilities.
17David S. Kupetz

18. Filing Chapter 9 - Last Resort
 AB 506 process is completed before filing.
 Sale of assets or new bonds, raising taxes, assessments, and
fees, and other alternatives have been exhausted.
 All opportunities to reduce costs and increase revenues have been
examined.
 Consensual debt restructuring, debt moratoriums, and debt
adjustment potential solutions have been explored, or have proven
impossible to arrive at through consensual negotiation (Stockton).
 Municipal dissolution or merger has been considered.
18David S. Kupetz

19. Filing Chapter 9 - Last Resort
Eligibility for Chapter 9
• Chapter 9 has significant eligibility requirements
• Requirements
– Municipality
– Specifically authorized by State Law
– Must be determined to be „Insolvent‟
19Dean G. Rallis

20. Filing Chapter 9 - Last Resort
Prospective Insolvency
• Bridgeport almost required cities to fail.
• In Vallejo, the bankruptcy judge (McManus) determined
Vallejo was „prospectively insolvent‟:
o The City's General Fund will begin fiscal year 2008-09
with no reserves, and possibly with a negative balance;
o Absent the Chapter 9 case, the General Fund would
operate at a multi-million dollar deficit in fiscal year
2008-09, with projections by the City ranging from a
$10 million to $17 million deficit;
20Dean G. Rallis

21. Filing Chapter 9 - Last Resort
Eligibility for Chapter 9 – Cont.
• Desires to effect a plan to adjust debt
• Obtain agreement, negotiate in good faith, unable to
negotiate, or reasonably believe creditor may
attempt to obtain a preference
21Dean G. Rallis

22. Status of Pension Obligations:
San Bernardino and Stockton
• San Bernardino –
– City suspended postpetition contributions to CalPERS
– CalPERS filed opposition to City‟s eligibility for Chapter 9
• Asserting (i) City cannot demonstrate desire to effect a
plan to adjust its debts because City had not come
forward with a plan and (ii) Chapter 9 petition was not
filed in good faith because City did not negotiate with
creditors before filing
– Matter is still pending
22David S. Kupetz

23. San Bernardino
• CalPERS filed motion for relief from automatic stay to
pursue debt collection action in state court
– Asserting City‟s failure to make contributions violated
state law (including Public Employees‟ Retirement
Law, California Labor Code, and California
Constitution)
– CalPERS contended automatic stay not apply to it
because it is an arm of the state exercising its police
power
23David S. Kupetz

24. San Bernardino
– To extent stay applies, CalPERS argued cause for
relief because City had failed to comply with
applicable state law and failed to pay postpetition
administrative expenses
– Court denied CalPERS motion for relief from stay
without issuing written opinion
24David S. Kupetz

25. San Bernardino
• Capital Market Creditors (Indenture
Trustee, Bondholder, and Bond Insurer) opposed relief
sought by CalPERS, asserting:
– City‟s insolvency caused by rising employee salaries
and benefits coupled with declining revenues
– CalPERS is seeking to bully the City into providing
CalPERS with special treatment
25David S. Kupetz

26. Stockton
• City has not suspended payments to CalPERS
• City defaulted on bond payments
• Bond Creditors have filed objection to City‟s eligibility for Chapter 9
• Primarily arguing, among other things, that (i) City did not negotiate with
CalPERS, its single largest unsecured creditor, and negotiation was not
impracticable, and (ii) City‟s decision not to negotiate with CalPERS was
tainted by conflicts of interest, made without due care, and thus not made in
good faith
• Matter still pending
• CalPERS is opposing relief sought by Bond Creditors
26David S. Kupetz

27. Chapter 9 Precedents – Stockton (478 B.R. 8)
– Federal bankruptcy power of the Supremacy Clause of the U.S. Constitution
trumps the contracts clause in the California state constitution.
– Stockton suspended payment of retired employees‟ health
care benefits.
– Retirees contended these were vested contractual rights.
– Court found the Bankruptcy Clause of the U.S. Constitution
eclipses the Contracts Clause
– Authorizes Congress to make laws that impair contracts.
27David S. Kupetz

28. Chapter 9 Precedents – Stockton
– Federal bankruptcy power trumps California law.
– Accordingly, while a state cannot make a law impairing the
obligation of contract, Congress has properly done so in the U.S.
Bankruptcy Code.
– Moreover, the goal of the Bankruptcy Code is adjusting the
debtor-creditor relationship. The court determined that, even if
the retirees held vested property interests, "the shield of the
Contracts Clause crumbles in the bankruptcy arena.“
– The court held "although the City's unilateral interim reduction of
retiree health benefit payments may lead to tragic hardships . . .
before their claims are redressed in a chapter 9 plan of debt
adjustment, the motion for injunctive relief must be denied."
28David S. Kupetz

29. Chapter 9 Precedents – Stockton
(2013 Bankr. LEXIS 533)
 Debtor’s Freedom to Act during Pendency
 Debtor does not need court approval to settle claims.
 Stockton settled a damages lawsuit and requested court rule
that it was precluded from approving or disapproving the
settlement.
 Creditors argued city required to seek Court approval.
 Court determined its approval was prohibited without debtor
consent.
 Court indicated the debtor‟s actions are subject only to review
in connection with plan of debt adjustment.
29Dean G. Rallis

30. Chapter 9 Precedents
• Collective Bargaining Agreements May be Rejected –
Vallejo and Orange County Cases
• Jefferson County Decisions re Section 928 and Automatic
Stay
o special/pledged revenues and necessary operating
expenses
o automatic stay and extension of stay to protect
municipal officials and representatives
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31. Observations
– Vallejo – „Prospective Insolvency‟ (i.e. looking forward) will likely be
the test for eligibility. This has significant implications as GASB 67 &
68 are enforced in 2013 and 2014. The insolvency of an increasing
number of municipalities will be apparent.
– Stockton - Federal bankruptcy power trumps California constitution.
Contracts can be impaired in bankruptcy.
– San Bernardino – CalPERS vested contract rights and sovereignty
arguments will likely fail when tested.
– Stockton - Debtor municipalities have broad powers to act during
pendency without court involvement.
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32. Observations
• Despite California‟s resolution of current year deficit staggering
unfunded obligations remain.
• Legislative initiatives fall short of what is required.
• Negotiations are not accomplishing enough.
• Stockton‟s test of mediation under AB 506 inconclusive – no
confirmable plan emerged.
• Ballot initiatives in San Diego and San Jose quickly challenged in
court.
• California municipal obligations will increasingly require restructuring.
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