Question

include a firm, government, or municipality that experienced bankruptcy

Post an entry that includes the owing:

• 2-4 sentences about What happened?  

• What financial management led to the bankruptcy.  Focus on financial decisions or strategies rather than external factors

• 2-4 sentences explaining the Implications for others

• financial risk and return, monetary costs and benefits for investors and stakeholder related to the firm, government, or instituion

• 2 financial vocabulary terms with definitions

Answer 1

The initial step in trying to avoid bankruptcy is to clearly and dispassionately assess the underlying problem or problems that are pushing the municipality in that direction. The degree of self awareness and transparency among municipalities can vary widely, and for some, one of the main problems may be simply getting a good handle on the real drivers of financial stability and solvency. Not being financial managers, we will leave it to those more qualified to get into the technical details, but suffice it to say that if a municipality cannot identify in clear terms the specific factors that are driving revenues down and/or expenses up, it has some serious homework to do before venturing into a workout, let alone into bankruptcy court. Municipalities that have been pushed to the brink of, or into, bankruptcy, generally experienced one or both of two types of fiscal problems. The first is a large and extraordinary one-time financial hit that cannot be absorbed by the budget or covered out of reserves. This could be a sudden and catastrophic investment loss or a large judgment rendered against the municipality. In each case, these significant one-time liabilities forced the municipality into seeking bankruptcy protection

The second kind of fiscal problem is a structural operating deficit that continues long enough to burn through reserves and is not resolved byrevenue increases or spending cuts quickly enough for the municipality to avoid running out of cash as it attempts to meet necessary and fixed expenses such as debt service and payroll. Such was the case with Vallejo, Stockton, Detroit and San Bernardino. A municipality with this type of problem could be pushed over the edge by a relatively small one-time expense or drop in revenues, as it may have little or no cushion available to absorb even a modest setback. For example, the City of Vallejo, which had spent down its reserves in order to meet its obligations over a period of several years, became insolvent as a result of California’s economic slowdown and the concomitant drop in real estate and sales tax revenues, combined with significant employee salary and benefit cost increases dictated by collective bargaining agreements. The City of Stockton suffered even greater losses due to the burst of the housing bubble, and in addition to unsustainable labor and legacy costs, faced public debt with payment obligations structured to escalate in the future. Unfortunately, the COVID-19 pandemic has the potential to be the straw that breaks the back of a municipality already struggling with a structural operating deficit. Indeed, the consequences of the pandemic may turn out to be a unique, third such driver of municipal bankruptcy, combining elements of both an extraordinary onetime financial hit with the potential for longer-term structural deficits should revenue losses as a result of associated economic and social dislocations be prolonged while needs, and associated costs, escalate. In general, fiscal stress related to one-time problems can be resolved by financing cure costs over a long enough period so that those costs can be absorbed in the budget over time. And while bankruptcy protection may be necessary to buy time to consummate such a financing and delay disruptive collections efforts or the forced liquidation of collateral, all efforts should be made to convince creditors to be patient and not to cause the municipality to incur the significant costs associated with a bankruptcy filing. Fiscal stress related to ongoing structural deficits and lack of reserves is much more difficult to tackle because a financing will have little impact on solving the underlying structural problem. In fact, this tactic will likely make things worse by “kicking the can down the road” and increasing the overall costs to the municipality. In these circumstances, painful cuts in service levels, employee compensation and other expenses may be required, as well as increased revenues through higher taxes or fees. Bankruptcy protection may 4 Orrick Municipal Bankruptcy: Avoiding and Using Chapter 9 in Times of Fiscal Stress be needed to avoid immediate sanctions for breaching contracts, including labor agreements, missing debt service payments or failing to provide required levels of service.

Once the municipality’s management has identified and quantified the underlying fiscal problems, it must recognize that a key ingredient to solving them is to clearly and transparently communicate the nature and scope of the challenges to all potentially impacted stakeholders so that they are able to understand and acknowledge the problems. Managers and political leaders should insist on clear and open disclosure of the financial data and related facts, and they should make sure that stakeholders both receive all relevant information and data, and that they have an opportunity to ask questions and offer solutions. All reasonable suggestions to solve the problems should be investigated and taken seriously. The ins and outs of labor negotiations are far beyond the scope of this pamphlet, but if payroll costs or benefits are a key component of the municipality’s fiscal stress, it will be necessary to engage labor law advisors to assist in resolving these problems. In most states, laws applicable to public employee labor agreements place numerous restrictions on revising such agreements, even if the impact thereof is pushing the municipality toward bankruptcy. However, if all parties realize that failure to modify extant agreements would likely land the municipality in bankruptcy court, they should be willing to work very hard to achieve consensual modification of burdensome agreements. Although bankruptcy may provide more flexibility in dealing with labor agreements by enabling the municipality to reject an agreement, bankruptcy is not necessarily a “silver bullet” with respect to such matters, so every effort should be made to reach an agreement that provides a workable arrangement for the municipality prior to the decision to file. Negotiations continue after the bankruptcy filing as well. For example, in the City of Vallejo case, agreement was reached with one safety union after the bankruptcy filing and with another safety union even after the ruling of the bankruptcy court authorizing rejection was affirmed on appeal. Similarly, creditors such as banks, bondholders and credit enhancers may be willing to restructure long-term debt in order to avoid forcing a municipality into bankruptcy. Attempts should be made to approach these stakeholders with clear and transparent information in order to reach some accommodation. Often an intermediate step in such a restructuring is a forbearance agreement under which the creditors agree not to declare a default and/or take remedial action against the municipality for a specified period while the parties attempt to reach a negotiated settlement. Finally, the officers and elected officials of the ailing municipality must make the hard decisions about ongoing projects and programs that may have to be postponed, scaled back or cancelled in order to free up cash. These are often painful political choices, but the looming possibility of a bankruptcy filing can serve as a catalyst to reach consensus on these difficult issues.