In re City of Vallejo

• Decision Date: 26 June 2009
• Docket Number: Bankruptcy No. 08-26813.,BAP No. EC-08-1244-JuMkMo.
• Citation: 408 B.R. 280
• Parties: In re CITY OF VALLEJO, Debtor. International Association of Firefighters, Local 1186; Vallejo Police Officers' Association; International Brotherhood of Electrical Workers Local 2376, Appellants, v. City of Vallejo; Union Bank, N.A.; Wells Fargo Bank, N.A., Appellees.
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit

408 B.R. 280

In re CITY OF VALLEJO, Debtor International Association of Firefighters, Local 1186; Vallejo Police Officers' Association; International Brotherhood of Electrical Workers Local 2376, Appellants, v. City of Vallejo; Union Bank, N.A.; Wells Fargo Bank, N.A., Appellees.

BAP No. EC-08-1244-JuMkMo.

Bankruptcy No. 08-26813.

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Submitted on April 23, 2009.

Filed June 26, 2009.

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Katherine Thomas, Washington, DC, Marc A. Levinson, Norman C. Hile, Sacramento, CA, for Debtor.

Robert T. Matsui, Sacramento, CA, for trustee.

Before: JURY, MARKELL, and MONTALI, Bankruptcy Judges.

OPINION

JURY, Bankruptcy Judge.

After months of fiscal manipulations to increase its worsening cash flow and ultimately unsuccessful negotiations with its labor unions, the City of Vallejo ("Vallejo") filed a chapter 9 bankruptcy petition.¹ Vallejo asserted it was insolvent and otherwise met the eligibility requirements under § 109(c).

Appellants², some of Vallejo's unions, appeal the bankruptcy court's order that Vallejo was eligible to file under chapter 9.

We conclude that, based on admissible evidence, the bankruptcy court correctly found that Vallejo was insolvent. In addition, we hold that the record supports the bankruptcy court's finding that Vallejo desired to effectuate a plan under § 109(c)(4). We determine that the bankruptcy court erred in concluding that Vallejo satisfied § 109(c)(5)(B) by employing an incorrect legal standard. This error, however, was harmless because the bankruptcy court's finding that the provisions of § 109(c)(5)(C) were met was correct and this alternative finding satisfies the statutory eligibility requirements. Accordingly, we AFFIRM.³

I. FACTS

On paper, Vallejo appeared financially sound in July 2007. Its audited financial statement (called a Comprehensive Annual Financial Report ("CAFR")) for the fiscal year that ended on June 30, 2007,⁴ showed nearly $1 billion in total assets and $624.5 million in net assets in excess of liabilities. Its financial statement also reported $211 million of cash and investments as of June 30, 2007, of which nearly $137 million was characterized as "unrestricted" and "available for operations".⁵

Vallejo's use of general labels like "unrestricted" and "available for operations" failed to convey restrictions on many of the underlying funds. Consequently, the CAFR's snapshot of Vallejo's financial health was initially misleading. Closer examination revealed that much of Vallejo's surplus cash and investments belonged to funds that were restricted by law or grant to specific uses and could not be used for operational costs.

The evidence presented at trial showed that Vallejo held most of its unrestricted funds in its General Fund, which could be used for any purpose, including operations and labor costs such as the salaries of firefighters or city electricians. The General Fund shouldered most of the costs of municipal services and was the purse of last resort.

In prior fiscal years, Vallejo used its General Fund reserves to cover shortfalls in other funds. For that reason, the General Fund had suffered multimillion dollar deficits in the prior three fiscal years. By the end of the 2007-2008 fiscal year, the reserves were exhausted. Vallejo projected the General Fund deficit at $17 million for the 2007-2008 fiscal year, with labor costs alone outstripping its revenues. It also projected that the General Fund would bleed into a deficit of $22.7 million by November 2008.

The record also shows that Vallejo estimated its General Fund revenues would be about $77.9 million in the 2008-2009 fiscal year ($5.3 million less than the prior fiscal year) as a result of falling sales taxes, real property taxes, and motor vehicle license fees, among others. Conversely, Vallejo estimated that its General Fund expenditures for the upcoming 2008-2009 fiscal year would be $95 million ($7 million more than in the 2007-2008 fiscal year).

Vallejo prepared a new budget projection shortly before filing its petition based on a $1.4 million infusion and an absence of union contracts. Despite the liberal assumptions employed, the 2008-2009 fiscal year General Fund deficit remained at over $10 million.

Due to the deficits, the General Fund could not borrow funds from other, restricted, city funds for periods less than a year because city funds could not borrow money from other city funds unless the city had a balanced budget or a demonstrated ability to repay the borrowed money within the fiscal year. The General Fund also could not borrow from private credit markets because it had no reserves and insufficient cash flow to pay back loans. As a result, Vallejo was unable to pay General Fund obligations in the 2008-2009 fiscal year. In the end, due to an inability to borrow, Vallejo's fiscal situation became bleak.⁶

Vallejo searched for ways to improve its financial situation, but various state laws limited its ability to generate new revenues.⁷ It considered a number of proposals, including increasing the garbage franchise fees, selling surplus real estate, charging a fee for false 911 calls, and filing claims with the State of California. Vallejo concluded, however, that the proposed revenue enhancements provided only insignificant new revenues, were too costly or speculative to implement immediately, or provided one-time boosts at best.

The timing for receiving the bulk of revenues was also problematic. Vallejo's primary source of revenue was property taxes, and these were received only twice a year, in April and December. Additionally, many of Vallejo's funds that relied on federal or state grants had to spend the money before seeking reimbursement. Thus, many of Vallejo's funds operated at a deficit for parts of the year.

Vallejo also began to cut expenses. Since 2003, Vallejo eliminated eighty-seven employee positions and severely reduced or eliminated numerous community services such as infrastructure programs. In the 2007-2008 fiscal year, Vallejo cut about $10 million in funding for programs and services not mandated by contract.

Next, Vallejo attempted to address its largest liability, labor costs, which it projected to make up $79.4 million of its $95 million expenditures in 2008-2009 fiscal year. Accordingly, Vallejo opened discussions with the Unions to alter their collective bargaining agreements ("CBAs") in November 2007.

In March 2008, after negotiating for several months, Vallejo and the Unions agreed to temporary modifications of the CBAs.⁸ The modifications would be effective through the end of Vallejo's 2007-2008 fiscal year, terminating on June 30, 2008. The savings and a one-time $2.4 million transfer from nonrestricted funds permitted Vallejo to avoid projected insolvency through June 30, 2008.

In the interim, Vallejo and the Unions agreed to mediate a long-term solution. The parties met with a mediator eleven times, corresponded informally and exchanged several written proposals between March and mid-May 2008. No agreement was reached.

Vallejo also began discussions with Union Bank, N.A. ("Union Bank") in March 2008. As the holder of $47 million in Vallejo's bonds, Union Bank was Vallejo's largest single creditor. Union Bank also acted as the Indenture Trustee for the holders of three other bond issuances.⁹

The parties discussed lowering the interest rate on the bonds. Customarily, Union Bank would not support these changes unless Vallejo provided a multi-year cash flow projection. Vallejo could not formulate a reliable projection for Union Bank until it reached an agreement with the Unions. Ultimately, absent an agreement with the Unions, Vallejo's discussions with Union Bank stalled in April 2008.

With the fiscal year and interim agreements with the Unions ending and no prospect of extension, the city council authorized Vallejo to file a petition under chapter 9 on May 6, 2008. The Unions responded with a counteroffer two days later.

Vallejo's last proposal to the Unions was made on May 14, 2008 and the Unions' counteroffer two days later. The counteroffer included one-time pay cuts and deferred previously owed pay raises, but included onerous terms like a four-year extension of the CBAs with corresponding salary increases for those years and eventual reinstatement of the deferred salary increases. The Unions also offered to extend the interim agreements through the 2008-2009 fiscal year. Vallejo rejected the counteroffer because it could not meet the terms and the counteroffer did not provide a long-term solution.

During its negotiations with the Unions, Vallejo never discussed a plan of adjustment under chapter 9. Rather, the evidence shows the parties discussed how a bankruptcy would affect the Unions; i.e., what claim the Unions would have and how their claim could be augmented by extending the CBAs before the petition date. The Unions proposed a four-year extension of the CBAs in their last counteroffer to ensure a larger claim if Vallejo accepted the counteroffer but later filed for bankruptcy.

With no agreement with the Unions in place, Vallejo filed its petition on May 23, 2008. The Unions objected to the petition on the ground that Vallejo did not meet the eligibility requirements under § 109(c).

After an eight day trial, the court ruled that Vallejo was insolvent as of the petition date because the city's General Fund would (1) begin the fiscal year 2008-2009 with no reserves (and possibly with a negative balance); (2) operate at a multi-million dollar deficit in fiscal year 2008-2009; and (3) would not have sufficient available funds and cash flow to pay Vallejo's debts as they became due—in particular, Vallejo "would not have been able to pay the General Fund payroll that became due on July 11, 2008." The court also observed that without a balanced budget for the fiscal year 2008-2009,...