The bankruptcy case of the City of Vallejo, Calif., the largest chapter 9 case filed since the Orange County case 15 years ago, continues to produce significant decisions on issues of first impression. First, following a lengthy trial, the Bankruptcy Court for the Eastern District of California, where the City's case is pending, found that the City met all of the qualifications necessary to be a municipal debtor under chapter 9. In re City of Vallejo, 2008 WL 4180008 (Bankr. E.D. Cal. Sept. 5, 2008).

Clearly, Vallejo is a municipality; California law specifically allows it to file a petition; and it sought to effect a plan to adjust its debts. The more troublesome issues were the requirements that the City be "insolvent" as defined in section 101(32)(C), and that it either had negotiated in good faith with its creditors, but failed to obtain agreement to a plan; or it was unable to negotiate with its creditors because such negotiation was impracticable.

The court determined that the City was insolvent because it was unable to adopt a balanced budget for its fiscal year 2008-09. Significantly, the court found the insolvency analysis to be a prospective one. The City did not have to wait until it ran out of cash before it was deemed insolvent. The court also determined that insolvency is measured by the City's obligations at the time the petition is filed, and not by what might happen going forward. In addition, the court determined that the City had negotiated with its creditors as much as was reasonably practical prior to filing its bankruptcy petition.

The court's eligibility decision is now on appeal before the Bankruptcy Appellate Panel of the Ninth Circuit Court of Appeals; the issue has been argued but not decided.

Collective Bargaining Agreements

While the appeal is pending, the bankruptcy court took up the City's second major motion—to approve rejection of its collective bargaining agreements with its unions—principally its public safety unions, the police and firefighters. The motion to approve rejection was hotly contested by the unions, and the court once again held a lengthy evidentiary hearing.

Following this hearing, the court issued a detailed memorandum on the major legal issue presented by the motion: the standard that must be applied to the decision to reject or not reject the collective bargaining agreements. In re City of Vallejo, 403 B.R. 72 (Bankr. E.D. Cal. March 13, 2009). Significantly, the court did not issue a substantive order on the motion to approve rejection.

The court first determined that federal bankruptcy law governed the process, not California law, which the unions argued governed whether the City could reject the collective bargaining agreements.

Then the court focused on the requirements the City must meet under the Bankruptcy Code to reject a collective bargaining agreement. This is a contentious issue, important because of a peculiarity in chapter 9. Until 1984, unexpired collective bargaining agreements were subject to rejection under the terms of section 365. The United States Supreme Court's opinion in NLRB v. Bildisco & Bildisco, 456 U.S. 513 (1984), in effect, said just that.

At the behest of organized labor, Congress then enacted section 1113, imposing on chapter 11 debtors procedural and substantive requirements that must be met before the rejection of a collective bargaining agreement, in contrast to other executory contracts that could be rejected under section 365. However, the legislation enacting section 1113 failed to incorporate section 1113 into chapter 9. A good part of statutory law has been incorporated into chapter 9 from other parts of the Bankruptcy Code by section 901(a). Section 1113 is not listed in section 901(a), and Congress later considered incorporating section 1113 into chapter 9, but did not.

In the Vallejo case, the unions invited the bankruptcy court to imply section 1113 into chapter 9, but the court declined to do so, citing Congressional legislative history.

Accordingly, the court determined that the City's motion to approve rejection was governed by the standards required by section 365, as interpreted by Bildisco, and without reference to section 1113's requirements. The latter would have required the City to address: whether the collective bargaining agreements burden the City; whether, after careful scrutiny, the balance of equities favored contract rejection; and whether reasonable efforts had been made to negotiate a voluntary modification and were not likely to produce a prompt and satisfactory solution.

The court declined to make those determinations, however, noting that negotiations between the City and the unions were ongoing. Instead, the court ordered the parties to further mediate the dispute before another bankruptcy judge. Whatever the outcome of that mediation, the Vallejo case is likely to continue to produce further interesting decisions interpreting chapter 9.