AB 506: California Sees The Most Dramatic Change In Municipal Bankruptcy In The Past Sixty Years

Originally published in PublicCEO.com 27 March 2012

The financial restructuring plan that the Stockton city's elected leaders approved in February has renewed the interest in our state's new municipal bankruptcy laws. After much angst and wrangling the California Legislature passed AB 506 last fall, making it Government Code §§53760 et seq. As a result, the landscape of municipal bankruptcy saw the most dramatic change in more than sixty years.

The United States Bankruptcy Code has always provided that a municipality did not have an unfettered right of access to the bankruptcy process. Some type of state authorization has always been required. However, prior to Jan. 1 the grant was general in nature and the decision to file was largely left to the local municipality. While the decision remains with the local governing board, that decision is constrained by new requirements as prerequisites to filing a Chapter 9.

Now, any entity wishing to file must do either of the following:

Show that it has participated in a "neutral evaluation process." Declare a "fiscal emergency" adopted by a majority vote of the governing board. Neutral Evaluation

"Neutral evaluation" is controlled by Government Code §53760.3. It requires the use of an independent third party "mediator" who is disinterested and qualified. Those qualified are bankruptcy judges or bankruptcy lawyers with at least 10 years of practice. Alternatively, individuals with significant experience in the municipal and labor areas may also be qualified.

Interestingly, only creditors who have or may have claims exceeding $5 million or whose claims exceed five percent of the public entities debt (whichever is less) qualify as "creditors" who are invited to participate in this "neutral evaluation process." This serves the practical purpose of limiting the number of parties to the negotiation/mediation process. Too many parties would make it simply too cumbersome and unmanageable.

However, the definition of "interested parties" or parties who may participate in the mediation process is much more expansive and includes, among others, bondholders, unions, representatives of retired employees and others who hold, or may hold, a stake in the outcome of the mediation/evaluation process. The public entity has the option of inviting those with contingent claims that fit the same monetary parameters of a "creditor."

The process is initiated by giving notice to all interested parties who must respond within...