On April 1, 2013, the U.S. Bankruptcy Court for the
Eastern District of California ruled that the City of Stockton qualified to
file for protection under chapter 9 of the Bankruptcy Code. The court's decision
on this issue serves as an important milestone for chapter 9 jurisprudence,
clarifying the requirements for "good faith" negotiations and being "insolvent"
as conditions to filing for chapter 9 protection. Significantly, the court held
that a municipal debtor need not negotiate with all of its creditors, only
those that it intends to impair.
The Bankruptcy Code enumerates various criteria with
respect to a municipality's eligibility to file for chapter 9 protection. In
pertinent part, section 109(c) of the Bankruptcy Code provides that an entity
may be a debtor under chapter 9 only if such entity is (i) insolvent, (ii) is
authorized to file for chapter 9 under applicable state law, and (iii) has
"negotiated with its creditors in good faith and has failed to obtain
the agreement of creditors holding at least a majority in amount of the claims
of each class that such entity intends to impair under" its plan of adjustment.
11 U.S.C. § 109(c)(2)-(5) (emphasis added) [an annotated version of this statute is available to lexis.com
subscribers]. Courts have previously interpreted the good faith
negotiations requirement as mandating prepetition negotiations among the
municipality and creditors that the municipality intends to impair under its
plan of adjustment. See In re City of Vallejo, 408 B.R. 280 (9th Cir. BAP 2009)
[an enhanced version of this opinion is available to lexis.com
subscribers]. In addition, section 901 of the Bankruptcy Code, which
incorporates other provisions of Title 11, requires that a debtor file its
petition in good faith.
Further, section 921(c) provides that the bankruptcy
court "may dismiss the petition if the debtor did not file in good faith
or if the petition does not meet the requirements of this title." 11 U.S.C. § 921(c)(emphasis
added) [annotated version].
On June 28, 2012, the City of Stockton, a city with over
290,000 residents, filed for chapter 9 protection. Stockton was one of three
California cities to file for chapter 9 in the summer of 2012-the others being
San Bernardino and Mammoth Lakes. However, Stockton's filing represents the largest
city to ever seek protection under chapter 9 of the Bankruptcy Code. Stockton's
chapter 9 filing was precipitated by reliance on "bubble" economic assumptions
to support significant debt obligations, spending to revitalize the city's
downtown, and rising pension costs. The City was particularly hard hit by the
subprime mortgage crisis and had one of the highest foreclosure rates in the
nation (which, in turn, decreased tax revenues). In 2012, Stockton defaulted on
its bond obligations, which resulted in the receivership of several properties
owned by Stockton, including City-owned parking garages and a building intended
to be the Stockton City Hall. In addition, Stockton's general fund had a $26
million deficit, which further inhibited the City's ability to service its debt
obligations and continue to pay for basic municipal services.
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