As Dr. Seuss once famously wrote (Marvin K. Mooney, Will You Please Go Now), "THE TIME HAS COME, THE TIME IS NOW". Good faith efforts to bargain with Chapter 9 of the Bankruptcy Code in the foreground must begin now if we want to emerge from this financial crisis.
On June 14, 2010, Judge John A. Mendez of the United States District Court for the Eastern District of California upheld a California Bankruptcy Court order permitting the City of Vallejo, California to reject a collective bargaining agreement with the International Brotherhood of Electrical Workers. International Brotherhood of Electrical Workers, Local 2376 v. City of Vallejo, No. 2:09-cv-02603-JAM. This decision is significant in that there is now a federal district court case that supports Chapter 9 of the Bankruptcy Code as a viable option for financially strapped municipalities. In order to reject a collective bargaining agreement under Section 365 in a Chapter 9 Bankruptcy, the debtor must show that: (1) the agreement in question burdens the estate; (2) the equities balance in favor of rejecting the labor contract; and (3) reasonable efforts to negotiate a voluntary modification have been made and are not likely to produce a prompt and satisfactory solution. We can only wait and see whether this district court decision will persuade other municipalities to take advantage of Section 365 in a Chapter 9 Bankruptcy.
Another California city, San Diego, may find comfort in the City of Vallejo district court opinion, and utilize the bankruptcy code to re-work its pension obligations. Writing for Bloomberg, Joe Mysak reports that San Diego's pension plan is short $2.2 billion, and is short $1.3 billion for health care. Like the City of Vallejo, San Diego can use Chapter 9 of the bankruptcy code as leverage to negotiate with public employee representatives in an effort to compromise on the pension obligations.
In the meantime, the financial woes of state and local governments throughout the country are heating up. Illinois is facing a $13 billion budget deficit, and its bond ratings were downgraded this month by Moody's and Fitch Ratings. Illinois stands with California as the lowest rated municipal bond state in the country. Morton High School District 201, in Cicero, Illinois, is faced with a $94.8 million debt and projects a deficit of an additional $30 million by the year 2015. This could force a bankruptcy in two or three years unless budgetary reforms are implemented. The District is awaiting $4 million in payment from the State of Illinois and has suggested budget cutting by reducing graduation requirements from 22 credits to 20. They also will eliminate seven full time administrators, 65 full time teaching position and 11 certified state positions for the year 2011-12. The Local Morton District Union for teachers opposes the proposal. The students are the real parties in jeopardy. The school district intends to create fewer classes, larger class sizes and fewer teachers which will "dumb down" the student body in the Morton District. This District could take advantage of a Chapter 9 filing and re-structure its debt, but would need to seek the approval and recommendation of the Illinois Financial Planning and Supervision Commission. Unlike California, Illinois does not have a statute that specifically authorizes a municipal Chapter 9 filing.
Rhode Island is also in dire straights. Central Falls, Rhode Island raised the white flag and obtained a receiver to control its finances. Rhode Island is one of nearly half of the United States that does not permit a Chapter 9 filing. With the appointment of a receiver, contracts can be re-written, pension benefits can be cut, and debts can be restructured. In essence, the receiver has the power to achieve the same goals as a Chapter 9 filing would achieve. The receiver still needs to obtain court approval to reject a collective bargaining agreement or union contract, but so does a Chapter 9 debtor.
In light of the California district court opinion, maybe the City of Harrisburg, Pennsylvania will finally seek bankruptcy relief. The Harrisburg City Controller recently met with representatives of a German bank to discuss the city's mounting budget deficit, which is now up to $7,000,000. The City Controller expressed what has been his longstanding view – the City should seek Bankruptcy protection. Under Pennsylvania law, the City would need to submit its Chapter 9 petition to the State Department of Internal Affairs for written approval before filing. There is no evidence to suggest that the City would not obtain the required approval.
The theme of "the time has come, the time is now" is readily apparent. The various municipalities and employee groups, including the unions, must now come together to try to cut costs and renegotiate obligations. Although Chapter 9 of the Bankruptcy Code has rarely been used, now may be the time when we see its use, or the threat thereof, increase with rapid popularity. The prospect of having collective bargaining agreements and other executory contracts completely rejected and re-written will likely be motivation for unions and other employee representatives to negotiate and seek and equitable compromise. Even for states that do not permit Chapter 9 filings, such as Rhode Island, financially strapped municipalities will find a way to re-structure their debts if creditors refuse to cooperate. The lesson to be learned from the California district court case is that unions and other creditors should negotiate with local governments rather than run the risk of being wiped out by a Chapter 9 filing.
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