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Stockton mediation first test of union backed law making it tough for cities to file bankruptcy

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POSTED February 29, 2012 8:05 p.m.


STOCKTON (AP) — Beleaguered Stockton is the first California city to test a new union-backed law aimed at protecting public employee contracts by making it harder for municipalities to file bankruptcy.

Stockton is trying to avoid becoming the most populous U.S. city in modern times to seek Chapter 9 protection by moving this week to participate in a 60-day evaluation process with its bond holders, creditors, employee unions and retirees.

If progress is made, the river port city would be allowed to extend negotiations by another 30 days, but talks can be called off any time if the municipality declares a fiscal emergency.

There is much uncertainty about how the process will work under the law, which took effect in January.

"This is the test case," said state Assemblyman Bob Wieckowski, D-Fremont, who authored the bill. "My biggest dream is that they use the process to get to the straight talk and they avoid filing Chapter 9."

Municipal bankruptcies are exceptionally rare. Of California's 482 cities and 58 counties, only two — Vallejo in 2008 and Orange County in 1994 — have filed for bankruptcy protection.

Stockton, a city of more than 290,000 people, located 50 miles south of the state capital, was hit hard by the recession and foreclosures, forcing it to make deep cuts to police and other services.

It has a combined $15 million deficit, a little more than 9 percent of the city's $165 million annual general fund. The deficit could double in the next fiscal year.

When the city demanded concessions from the police union last year, the union took out billboards, including one that read, "Welcome to the 2nd most dangerous city in California: Stop laying off cops!"

Labor leaders accused the city of mismanaging funds by spending on a sports arena and downtown structures.

Officer Steve Leonesio, president of the Stockton Police Officers' Association, told The Stockton Record that he welcomes a mediation process and opposes a city bankruptcy, which would mostly benefit outside lawyers.

In Vallejo, a bankruptcy allowed the city to unravel union contracts and roll back benefits. Public employee unions wanted to lessen the possibility of that happening elsewhere in California, especially as counties and cities struggle with recession-related budget shortfalls.

The San Francisco Bay area city emerged from bankruptcy court last year after a federal judge allowed it to cancel existing labor contracts and forced unions to renegotiate agreements with less generous benefits.

The California Professional Firefighters union and other labor groups pushed for state oversight to prevent "unfettered municipal bankruptcy," said Carroll Wills, a spokesman for the 30,000-member firefighters union. He said city and county bankruptcies can devastate local economies.

"We hope they treat the process as it's intended to be," Wills said Wednesday. "We had hoped for something that was a bit more structured than what ultimately came out in AB506. It seems pretty clear the citizens and businesses of Stockton don't want (bankruptcy) to happen."

The firefighters union wanted even stronger protections and had backed two previous bills with tougher wording. Both failed in 2010.

Those proposals would have made it even harder for cities and counties to seek bankruptcy protection. AB155 by Assemblyman Tony Mendoza, D-Norwalk, and SB88 by Sen. Mark DeSaulnier, D-Concord, sought to require municipalities to get approval from a state panel — the California Debt and Investment Advisory Commission — before filing in bankruptcy court.

Cities, counties and taxpayer advocate groups criticized those bills, saying they would infringe on the rights of local governments.

Wieckowski, a bankruptcy attorney, said he brought his expertise into the process last year by introducing the notion of alternative dispute resolution, which has become a popular way to resolve differences outside the courtroom.

Under his legislation, local governments and all parties would agree to a neutral evaluator, someone with at least 10 years of experience in bankruptcy proceedings or municipal debt. He said his intent was to defend labor contracts and protect local governments.

"A city cannot just close shop," he said in an interview this week. "If an individual declares bankruptcy, they say, take all my stuff, I give up. Stockton can't do that. Services still need to be provided, perhaps at a lower level, but people still live there. And all the parties have to recognize that there's a society there."

The mediation bill passed with bipartisan support in both houses of the Legislature and was signed by Gov. Jerry Brown last fall after Wieckowski agreed to give local governments more flexibility.

Cities, counties and groups such as the Howard Jarvis Taxpayers Association removed their opposition after the legislation allowed local governments to seek bankruptcy protection if they declared a fiscal emergency, which requires a public hearing and approval by a majority vote showing that the financial state of the local entity jeopardizes the health, safety, or well-being of its residents.

Wieckowski said he hopes the mediation process will lead to a frank discussion in Stockton about what steps the city needs to take to address its problems. Should Stockton eventually file for bankruptcy, it would be the most populous U.S. city to seek such protection in the last 30 years, according to James Spiotto, head of the bankruptcy practice at the Chicago-based law firm Chapman & Cutler.

Spiotto said municipalities have a very low default rate because they value their credibility. Since 1937, there have been 635 Chapter 9 filings, most of them utility or special tax districts, he said. That's compared to 11,772 companies that file for Chapter 11 protection in 2010, according to federal court statistics.

Ranked the nation's 66th largest city, Stockton has slightly more people than Toledo, Ohio, but fewer than Anchorage, Alaska, according to the 2010 U.S. Census.

State officials also are watching how the Stockton process plays out. Tom Dresslar, a spokesman for state Treasurer Bill Lockyer, said a municipal bankruptcy anywhere in California could have a ripple effect across the state.

"When any locality enters bankruptcy, it does more than inflict long-term harm on the community," he said. "The reputational stain can bleed onto local bond issuers and the state. We obviously hope that Stockton avoids bankruptcy."

Unlike the California Constitution, which says schools and bond holders must be paid first, municipalities have greater flexibility in dealing with bond holders under Chapter 9 bankruptcy.


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