and the
Citizens Economic Research Foundation

Vallejo Times Herald
September 5, 2008

Judge rules Vallejo meets bankruptcy requirements
Decision sets stage for battle over employee contracts
By Jessica A. York

A federal judge ruled Friday that Vallejo is eligible for municipal bankruptcy protection, setting the stage for a major battle over possible dissolution of city employee union contracts.

The decision came less than a week after the close of a month-long court clash between the city and union attorneys.

"It's done, we won," said Vallejo bankruptcy attorney Marc Levinson. "We expected to win and we did ... It doesn't mean that we're out of the woods."

City insolvency challengers, including the Vallejo Police Officers Association, International Association of Firefighters and the International Brotherhood of Electrical Workers, had argued that the city did not meet the legal requirements for bankruptcy protection. U.S. Chief Judge Michael McManus soundly rejected that contention in a 52-page ruling.

"In our view, Vallejo has a lot of work to put it's financial house in order," said union bankruptcy attorney Dean Gloster, echoing a later press release pointing at "years of bad decisions by Vallejo city councils and their top managers."

With bankruptcy protection, the city may adjust its debts without immediate reprisal from its creditors. Months of mediated negotiations on the employee contracts, at nearly $79 million projected in 2008-2009 - resulted in police and fire employee concessions. A three-month concession plan from city employees, forged in an effort to stave off bankruptcy at least until June 30, was extended when the city filed for bankruptcy on May

Hint of a likely Chapter 9 bankruptcy filing came earlier this year after city officials warned that the city had spent more than it was receiving in revenue, and would run out of money before the end of the year - without drastic steps.

The city council unanimously voted on May 6 to approve the bankruptcy filing, in anticipation of a nearly $17 million deficit. City officials said that unexpectedly decreased 2007-2008 fiscal year revenues and increased costs pushed the city into bankruptcy.

"Considering the city's falling revenues, its prior years of operating deficits and the program cuts and deferrals those deficits have necessitated, continuing to shoulder the contractual obligations under the existing collective bargaining agreements ... with the unions makes projecting a realistic balanced 2008-2009 general fund budget exceedingly difficult and unlikely," McManus wrote in his ruling.

Three of the city's four employee unions, including its police, fire and non-management workers, challenged the city's insolvency. They claimed that the city could accept a short-term union deal of pay raise cutbacks and other concessions, and loan itself money from it's other city funds in order to avoid bankruptcy this year. McManus stated that nearly all of the cash and investments identified by the unions' attorneys are restricted by law or grant language and are unavailable.

McManus said he wasn't swayed by testimony from the unions' key and only witness, Harvey M. Rose Associates principal partner Roger Mialocq.

Mialocq "damaged his credibility" when admitting he agreed to assess the city's budget because he felt that the "city's bankruptcy petition would harm his other clients," McManus wrote.

McManus also commended testimony from Assistant City Manager Craig Whittom and Assistant Finance Director Susan Mayer as being "much more helpful and credible" than Mialocq's.

City officials said at the time they were only interested in long-term solutions that would eradicate the pending deficit and begin to rebuild the city's reserves.

On Monday, attorneys will meet in U.S. Bankruptcy Court, Eastern District in Sacramento to set a schedule on the city's request to reject its existing employee contracts outside of bankruptcy.

Copies of the ruling are available on-line at . Under "search site" look for City of Vallejo.

The Bond Buyer
September 9, 2008

Federal Court: Vallejo Officially Bankrupt
By Andrew Ward

SACRAMENTO - A U.S. federal court ruled late Friday that Vallejo, Calif., is bankrupt, ending a battle over its solvency and forcing the city and its creditors to begin negotiating a plan to adjust the city's debts.

Vallejo, a city of 117,000 about 30 miles northeast of San Francisco, filed for protection from creditors under Chapter 9 of the federal bankruptcy code on May 23, becoming the biggest municipal bankruptcy since Orange County, Calif., in 1994. The city began the current fiscal year with no reserves and a projected $17 million deficit.

"The city was insolvent as of the date the petition was filed," said Michael McManus, chief judge of the U.S. Bankruptcy Court for the Eastern District of California, in a written ruling. "With no reserves and a multi-million dollar deficit, the general fund would not have sufficient funds and cash flow to pay its debts as they become due."

The ruling means that the city is officially bankrupt. The case will proceed to arguments on Vallejo's motion to overturn its collective bargaining agreements, as well as negotiations with creditors on a plan to adjust its debts. Vallejo has $53 million of variable-rate debt outstanding at the time of the filing. It has since paid down $7 million, using unspent proceeds. The majority of the rest is held by Union Bank of California, the liquidity provider. The city, in its pendency plan, said it would not pay more than 6% on that debt.

Unions for city police, firefighters, and other workers fought the bankruptcy filing, arguing that the city understated its resources and overstated its obligations in its bankruptcy filing to find a way out of its labor contracts.

McManus rejected their arguments and suggested he sees little possibility that the unions' contracts will be able to survive the bankruptcy.

"Given that the labor costs are a majority of the city's general fund expenditures, it is clear from the evidence that achieving solvency will require, among other things, serious consideration of economic concessions from the city's labor groups," McManus said in his ruling.

The city has pushed hard to speed the bankruptcy proceedings, calling the unions' objections a waste of time and money, but McManus gave the unions as much time as they wanted to make their case against the bankruptcy.

Vallejo budgeted $2 million for bankruptcy expenses for this entire fiscal year, but it spent $1.1 million in just the first month and a half of the proceedings, according to Joann West, the city's public information officer.

The city workers - represented by the Vallejo Police Officers Association, the International Association of Firefighters, and the International Brotherhood of Electrical Workers - hired one of California's best-known budget analysts to review the city's books and suggest ways to return to solvency.

McManus lambasted the testimony by Harvey M. Rose Associates principal Roger Mialocq as lacking credibility because the budget analyst admitted that he took the case in part because he was worried about the impact of a municipal bankruptcy on the interest rates his other clients would have to pay.

Still, McManus said Mialocq's testimony showed that even the unions' own consultant couldn't balance the city budget without rejecting labor contracts. The unions had asked the judge to consider the city's solvency in light of $10 million in concessions they offered, not their contracts.

He refused.

"The court rejects the unions' argument that the city is not an eligible debtor under Chapter 9 based on the existence of the unions' offer," McManus wrote. "Insolvency is determined based on the city's obligations as of the petition date as those obligations actually exist, not as they could exist under hypothetical circumstances."

The judge also rejected union suggestions that the city had extra money outside the general fund that it could use to offset bankruptcy, agreeing with city assistant finance director Susan Mayer that those funds can only be tapped for short-term loans that can be repaid within a year. That wasn't possible this year because the city couldn't pass a balanced budget, he said.

To a large degree, the ruling returns the city and its unions to the position they were in before the bankruptcy - facing each other over a negotiating table. The employee unions had offered the city a temporary $10 million salary reduction, while the city was pushing for permanent changes in contracts, including removal of minimum staffing requirements for its police and fire departments.

Both sides seem to have gotten the message that it's time to negotiate a settlement.

"We are willing to continue working with city officials to craft a comprehensive plan that restores Vallejo's financial stability and allows us to continue providing vital services to the people of our community," the unions said in a statement released by their lawyer, Dean Gloster, of Farella, Braun & Martel in San Francisco. "We reiterate this $10 million offer."

The city also issued a statement calling for renewed negotiations.

"While past attempts to negotiate modifications to collective bargaining agreements to ensure long-term solvency have been unsuccessful, the city is hopeful that the labor associations will reengage and the parties will be able to agree on modifications to the labor agreements that provide such long-term solvency," Vallejo officials said in a press release.

September 9, 2008

Vallejo Decision Delayed For 3 Months
Vallejo Police and Fire Granted Stay of Execution

By Ron York, President

In a move that caught most people, including me, by surprise, Bankruptcy Judge Michael McManus continued the hearing for the City of Vallejo's motion to reject the union contracts until December 2, 2008. The civil minutes of yesterday's hearing said only "HEARING CONTINUED TO 12/2/08 at 09:00 AM Request of Parties". That is all we know because nobody is talking. I was convinced that yesterday's hearing would be a slam dunk for the city, with union attorney Dean Gloster having to stay after school, but I misjudged that.

A surprising thing is the lack of interest in yesterday's proceedings by the local press and the hysterical bloggers. Apparently, Friday's victory by the city was enough to satisfy everyone's anger and outrage. If we had known this sooner, the whole bankruptcy process could have been avoided. The presidents of the police and fire unions could have been given a public flogging in front of city hall and everyone would have went home feeling vindicated.

First, I must admit that I am more concerned with the ramifications of what occurs in Vallejo than with Vallejo in particular. I do care about Vallejo. I fully understand what Roger Mialocq meant when he had to address this same reality of a larger interest. There is more at stake here than just the unions in Vallejo. I do not see myself as Joan of Arc, but I do believe that my station in life requires that I always be mindful of public safety everywhere. The proceedings in the Sacramento court will have an impact nationwide.

What is the effect of yesterday's action? The most important result is that the momentum has been taken out of the freight train that was about to run over public safety collective bargaining. By December, it will be hard for the opposition to regain the momentum. If you are a Vallejo police officer, firefighter or just a supporter, stay off of those blogs and bulletin boards - all of them. There is no such thing as a "private blog." Quit talking about the case. If you work for the City of Vallejo, do your job - including only using city computers and telephones for the purpose they are intended. Joe Tanner's right in the broad sense. To the unions, take that horrible website down and stop making public statements. Put a muzzle on your attorneys. Lawyers are lawyers, not public relations spokesmen. Hire a real public spokesman. Everybody needs to "shut up." Read that little card you have in your pocket:

"You have the right to remain silent. Anything you say can and will be used against you in a court of law."

To the members of the unions, you need to remove the obstacles that stand in your way of having public support. Regardless of what you may want to believe, "you ain't got it." The strange relationship between the fire department and the firefighters union reminds me of an old song about a guy who married his grandma and became his own grandpa.

To the rest of you police officers and firefighters that are not employees of the City of Vallejo, you had better start developing a strategy for dealing with the Vallejo Syndrome - now. What are you going to do when the topic of bankruptcy and voiding your collective bargaining agreement begins being discussed. I hope you do not start spewing venom like the guys in Vallejo did and continue to do. You better have a plan - one that actually has a chance of succeeding. Are you listening Gary and Duluth?

To the national police unions: It is up to you to lead the battle. A global strategy and operation center needs to be established. Forget about issuing incendiary press releases that castigate those who are not in line with your views. Stop telling the world about how the other police unions are horrible. Mend your fences. If you want your organization to be the "number one" police union, take the lead on this. Other organizations that are ambivalent about whether they are agents of collective bargaining, primarily NAPO and PORAC, now is a good time to make your declaration.

Police and fire have relied too long on inherent public support, while either avoiding or fumbling public relations efforts. The morticians have done a better job of P.R. than public safety. We live in a rapidly changing society where almost any information is available immediately. This has lead to a society that is cynical and immune to gratuitous rhetoric. If your script looks like it was written by Joseph Goebbels, you're toast.

Think about what I have said. I did not write it to make you happy, but rather to awaken you.

The Bond Buyer
September 12, 2008

Cease-Fire in Vallejo?
City, Unions Willing to Negotiate

By Andrew Ward

VALLEJO, Calif. - Vallejo and its public employee unions say they're willing to negotiate a settlement to end the city's three-and-a- half-month old Chapter 9 bankruptcy case.

There are tentative signs that they might mean it.

"The city has invited us to sit down and talk," said detective Mat Mustard, vice president of the Vallejo Police Officers Association. "We plan to do that."

Vallejo police fought the city's bankruptcy along with the International Brotherhood of Electrical Workers and the International Association of Firefighters. Mustard said workers are willing to reconsider city demands after a federal judge ruled last week that Vallejo is bankrupt and hinted that the unions may lose their contracts in bankruptcy.

For their part, city officials said they would still prefer to solve the conflict before it does further damage to Vallejo's long-term access to capital markets, and its ability to recruit and retain workers.

"This is a more opportune time to negotiate a settlement than there has ever been," said Mayor Osby Davis, adding that earlier negotiations quickly degraded into arguments over solvency. "We don't have to have that discussion anymore," he said.

The city and the unions went through many rounds of unsuccessful negotiations before the bankruptcy. In March, they reached an interim agreement that delayed the bankruptcy filing, but they failed to reach a permanent agreement to reduce the city's labor costs and avoid bankruptcy. The talks broke off entirely after their court battle began.

The adversaries refused this week to discuss their precise negotiating positions, and court testimony made it clear that they disagree on some key issues. They also have to agree to move past many months of acrimony. Union leaders and city officials hardly even looked at each other when they met in bankruptcy court in Sacramento.

Still, they are starting negotiations for the first time since the bankruptcy filing, and outside bankruptcy experts - and their own lawyers - say they have strong incentives to negotiate a solution that will end an increasingly costly trial. Both Vallejo and its unions face significant risks in continuing the case.

"Bankruptcy is like 'Deal or No Deal,' " said James Spiotto, a lawyer and municipal bankruptcy expert at Chapman and Cutler in Chicago, who is not involved in the case. "No deal, you get the judge to decide."

U.S. Bankruptcy Judge Michael McManus has given the city and its workers time to talk before asking him to settle their differences. Earlier this week, he scheduled hearings on a city motion to reject its collective bargaining agreements. He's not going to hear arguments on the request until December.

McManus, chief judge for the Eastern District of California in Sacramento, gave workers a strong incentive to negotiate with renewed realism - a decisive defeat. He not only rejected their contention that Vallejo was feigning insolvency, he also made it clear that workers shouldn't expect their contracts to survive a bankruptcy proceeding and that he didn't find their star witness credible.

"Given that the labor costs are a majority of the city's general fund expenditures, it is clear from the evidence that achieving solvency will require, among other things, serious consideration of economic concessions from the city's labor groups," McManus wrote in a 52-page ruling last Friday.

The unions have an option of appealing the ruling, but Spiotto said the judge's ruling was "thorough" and squared with established law on municipal bankruptcy.

Labor bankruptcy lawyer Dean Gloster, of Farella Braun & Martel in San Francisco, said the unions haven't decided whether to appeal.

An appeal would add to mounting legal bills on both sides of the case. Mustard estimated the unions have spent more than $1 million. The city budgeted $2 million for bankruptcy costs for this entire fiscal year and spent $1.1 million in just the first month and a half of the proceedings, before the current fiscal year even began, according to Joann West, the city's public information officer.

That's not a trivial amount of money in a city with a general fund budget of less than $90 million and municipal market debt of about $47 million.

The indirect costs of bankruptcy may be higher, and they've fallen largely on the residents of the city.

Vallejo has lost many police officers since the case began. The working-class city sits in one of the richest regions in the country. Nearby cities, such as San Francisco and Oakland, are offering signing bonus to experienced Vallejo cops who will jump ship.

"Police officers are marketable, and they're leaving," Mustard said. He said the city has lost five officers in the week since the ruling and the police force could shrink to 100 by the end of the year from 140 in 2007. "Over the course of a year, they'll lose a third of their police force," he said.

As always, the city and its unions dispute the precise figures, but they agree that the department has fewer officers than it needs. They also agree that crime is increasing. The police chief told the City Council that he doesn't have enough staff to do his job. The city has stopped investigating most property crimes.

Even the strongest proponents of Vallejo's bankruptcy acknowledge that there are limits to the cuts they can impose on workers if it expects to continue to provide city services in such a competitive labor market.

"We have to offer a fair, competitive wage," said Councilwoman Stephanie Gomes, who was an early proponent of bankruptcy and one of the public safety unions' toughest adversaries in local debates, though she says public safety advocates have exaggerated the bankruptcy's impact on crime.

"Crime is going up because the economy is weak," she said.

By anyone's estimate, Vallejo sits near the epicenter of the Bay Area's housing crisis. The Vallejo-Fairfield metropolitan area suffers the eighth-highest mortgage foreclosure rates in the nation, according to RealtyTrac.

Again, it's impossible to tell how much of the real estate market is suffering due to the bankruptcy case and how much underlying fundamentals are causing the pain.

Bankruptcy advocates point out that the bankruptcy is an attempt to solve the city's financial problems, which would help the local housing market in the long term.

"Anytime you try to make profound changes, it's painful," Gomes said.

Opponents point out that the uncertainty around future tax rates, crime, and the level of city services can't improve the marketability of local homes.

"I have heard a couple of anecdotal reports about people who chose not to buy here because of the bankruptcy, but for the most part, that doesn't appear to be the case," said Lori Collins, a Vallejo realtor and president of the Solano County Association of Realtors

She said she discloses the bankruptcy filing to buyers, but she has seen volume pick up recently because "prices have come way down here."

In the capital markets, the damage increases the longer the city is in bankruptcy and the more damage it does to its municipal creditors, said Spiotto, who has been working on municipal credit defaults and bankruptcies for almost three decades.

Vallejo officials have said they want to minimize the impact of the bankruptcy on bondholders and on Union Bank of California, the letter-of-credit bank on $47 million of the city's $53 million of outstanding variable-rate certificates of participation at the time of the bankruptcy filing.

The city has since repaid about $7 million of the debt by returning unspent bond proceeds to lenders, but it has also unilaterally capped the interest rate it will pay on its outstanding debt at 6%. The bank rate on the bonds is indexed to the prime rate, plus a penalty of one to three percentage points, which increases the longer the bank holds the bonds.

Vallejo doesn't want to permanently forgo access to the funds that will be necessary to develop the city's economy and infrastructure.

Mayor Davis understands the damage that does to the city's long-term prospects. He served as a legal counsel on some of Vallejo's outstanding issues, and he wants to see it take advantage of its ample natural assets in any turnaround.

Vallejo is working to redevelop its downtown waterfront and the former Mare Island Naval Shipyard, which closed in 1996. Developers are restoring historic structures and building thousands of new homes on the island, in addition to parks, mixed-use developments, and the Touro University, a school of osteopathic medicine. It's the sort of project that could expand the city's tax base over the long term.

Locals often bemoan their city's untapped potential. "The p-word," as Gomes calls it, is easy to see in Vallejo.

The city sits just south of the Napa Valley wine country, nestled between rolling, undeveloped hills and the San Francisco Bay. It has rich and poor sections and below-average incomes for the wealthy region. But its strengths include ethnic diversity, relatively affordable housing, a charming but underutilized downtown, and some of the best weather in the notoriously cold and foggy Bay Area.

With three months until the next hearing, the two sides have plenty of time to negotiate.

"It's always preferable to cut an acceptable deal and get out of bankruptcy because it does put a stigma on them," said David Dubrow, a lawyer at Arent Fox in New York. Dubrow, who represented letter of credit banks in Orange County, Calif.'s 1994 bankruptcy, is not involved with the Vallejo case.

The city continues to incur damage claims that it will have to pay to creditors for any contracts they break in bankruptcy. While lawyers say those claims will have to be paid off in "itty-bitty bankruptcy dollars" - that is, with a significant haircut - Vallejo can avoid those expenses if it negotiates a settlement that allows them to dismiss the case.

While none of those economic incentives makes a settlement certain, the city and the unions did get a clearer view of the each other's negotiating position in the bankruptcy hearings.

"If they can cut a good enough deal, it's in the interests of the city to get out relatively quickly," Dubrow said. "But from the city's point of view, they already went into bankruptcy, so they've got to clean up their problem. You've got to hit your bottom line or it's not worth coming out."

The unions offered the city $10.6 million in pay cuts before the filing. In court, Vallejo officials said they couldn't take the offer because it was temporary. Union lawyers said workers were hesitant to offer more out of fear the city would take the concessions and file for bankruptcy anyway, undercutting workers' bankruptcy damage claims.

As Mustard sees it, the city wouldn't accept the union concessions for four reasons:

= The unions offered temporary pay cuts, not permanent ones.

= The unions demanded contract extensions in exchange for pay concessions.

= The unions refused to give up minimum staffing requirements for the police and fire departments.

= The parties failed to agree on limits on the amount of paid leave union leaders can take for union business.

"I don't disagree that it's the time for compromise," Mustard said. "If they stay on those four topics, I'm optimistic that we can come to a resolution. If they step outside of that box, I'm unsure if we're going to be able to do anything." He suggested the city may have bigger goals than solvency, including rewriting work rules and revising retirement benefits.

For its part, Vallejo won't say how hard it will press its newfound advantage. Gomes and Davis - the two officials who agreed to talk on the record - would not say what the city's negotiating stance would be. Its offer will be determined by the whole City Council and won't be made in public.

Both men said they would push for a settlement that includes a resolution of Vallejo's biggest debt, an unfunded $135 million retiree health care liability. The city offers employees retirement health benefits after just five years of service. That wasn't a key issue in earlier negotiations, according to testimony at the bankruptcy trial.

If Vallejo wants to solve that problem now, it may prevent any quick settlement of the case. The court says the unions don't represent the holders of retiree health claims, and it's not yet clear who will.

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