All Aboard For Stockton

I recently posted elsewhere that the City of Stockton, California had filed a plan of adjustment to which the principal competing creditors--retirees (through their proxy CalPERS) and bondholders had agreed. Implementation of the plan was conditioned on Stockton residents agreeing to raise their taxes. This past Tuesday saw those voters approve an increase in the local sales tax from 8.25% to 9%.

In my draft article, Fairness and Risk in Stockton: Pensions, Bonds, and Taxes -- When Doing Nothing is Doing Well, I observed that Chapter 9 of the Bankruptcy Code fails to include official representation of municipal residents and eligible voters. Both are indirectly represented in the sense that the officials they elected must have decided to seek bankruptcy relief but unlike creditors they lack an official voice once the case begins. Notwithstanding lack of an express statutory role, Bankruptcy Judge Christopher Klein appointed a taxpayer committee in Stockton's case. But, more importantly, California law required a vote by city residents before taxes could be increased.

So, as it turns out, in Stockton taxpayers were able to vote, albeit not directly on the plan. Yet, it remains the case that city residents as such don't have any say over their future. In other words, a city may in the course of its bankruptcy reduce municipal services. Stockton made most of its service reductions before filing but it could have equally done so during the case. City residents as a stakeholder entity have no voice. While they can "vote the rascals out" at the next election, a city whose plan has been confirmed has little leeway going forward. Thus, I recommend that Bankruptcy Courts in future cases take a step beyond what the Code requires and in most cases appoint a "citizens committee" whose mandate would be to represent the interests of service recipients. Like other official committees, the city would bear the reasonable costs and professional expenses of a citizens committee.

Municipal bankruptcy may be the best solution for the financial issues facing many cities but the vital process of plan negotiation should be open to meaningful input from all stakeholders.

Comments

[nosedive]

You correctly point out the essential argument against citizens committees. City residents elected folks to manage the city and they in turn decided to file for bankruptcy. Then you ignore your point by saying that voters shouldn't have to live with the consequences of the decisions of the people that they elect.

What specific rights/powers would you advocate a "citizens committee" be afforded?

[Scott Pryor]

Outside bankruptcy creditors are on their own but the BC provides for collective, debtor-financed unsecured creditor representation through committees. Ditto in limited cases for shareholders. The justification for such subsidies is the collective, legally binding effects of bankruptcy reorganization. Service recipients (and taxpayers) are practically as much stakeholders as creditors; there is no principled reason to subsidize the collective action of one and not the others. It's equally the case that creditors "made their bed" with city government when they extended credit as did voters when they elected the city council but the former get Code-authorized representation while voters don't. The net effect is to shift risk away from market participants who generally are able to evaluate/hedge the risks and to residents who aren't. I think this is unfair.

[nosedive]

You cannot equate the position of unsecured creditors with city residents/taxpayers, except to the extent that both would rather that the municipality was financially healthy. Their positions are not remotely the same. As a general proposition, the debtor municipality is a representative of its taxpayers/residents and is deemed to represent their interests before the bankruptcy court.

Not sure if what you advocate would create a situation where a debtor municipality would want a plan confirmed over the objections of a committee of its own residents.
As a practical matter how do you advocate that members of a citizens' committee be chosen? Should they be elected by residents?

I get that your practical point is that residents/taxpayers can get a bad deal in a bankruptcy plan. Beholden elected officials under pressure don't seek to reduce pension obligations in the plan, etc. No doubt that possibility exists. The solution is to elect officials that will seek to better protect their residents in bankruptcy. The perils of democracy.