Editor's note: This is the second in a two-part series.
It was said about the Orange County bankruptcy that "there was never before a financial recovery plan devised by local governments that places such emphasis on winning lawsuits."
The Orange County case was all about suing a large number of deep pocket defendants who had taken advantage of Orange County's incompetent administrators and loaned Orange County over $20 billion for investments backed by about $5 billion in collateral. When the value of the investments declined steeply, the tsunami of bond defaults hit.
San Diego's situation does not appear to be one that can only be resolved through litigation.
A certain amount of litigation, or at least threats of it, will probably be part of the dynamic of any settlement talks with affected parties, but the resolution of the city's problems will come through successful negotiations with its employees, raising additional revenues (e.g., garbage collection fees), reducing certain services temporarily and issuing new bonds. Only the issues related to the city employees might involve litigation -- and you don't need to go into bankruptcy to file a lawsuit.
Law requires negotiations
Even if it weren't common sense, the Bankruptcy Code requires a city to engage in negotiations with its creditors to develop a plan of debt adjustment before a city can file bankruptcy. Those negotiations can result either in a formal plan, which is submitted to a bankruptcy court for approval, or may make the filing altogether unnecessary.
The city is presently involved in such negotiations in the shadow of the bankruptcy court. And the involved parties surely know that bankruptcy is a weapon of which the city has not disarmed itself. They know what can and cannot be done if the city chooses bankruptcy because of intransigence.
But the fact is that more successful debt adjustments occur through negotiations than court-imposed fiat; in the private corporate world, only 10 percent or so of companies that file Chapter 11 successfully reorganize.
Bankruptcy no magic pill
In the Orange County case, everyone recognized that a modest return to creditors would impair Orange County's ability to go back into the capital markets.
In addition, Orange County attempted various methods to raise money to pay creditors a substantial distribution -- often 100 percent). It lobbied for a proposition to raise taxes. While it obtained well over 50 percent approval, the measure failed because it did not get 66 percent approval. The county finally got state and other legislation that allowed reallocation of funds from certain agencies to Orange County for use in payment to creditors. This resulted in certain cutbacks in services by those agencies. Finally, Orange County undertook certain cost savings measures such as hiring freezes, a voluntary separation program and a suspension of salary increases.
If San Diego were to file a bankruptcy, it would be an admission of failure. Failure by the interested parties to act responsibly and to recognize that belt-tightening is unavoidable and tax or fee increases inescapable. Bankruptcy will not allow us to eliminate the pain caused by the ill-conceived pension budgeting schemes of the past. Our current leaders, both public and private, have an opportunity to leave a legacy of either civic achievement or bankruptcy, both financial and political.
The market, the shrewdest and keenest observer of all matters financial, does not appear to think that a city bankruptcy is likely. Trading of city bonds on the secondary market, notwithstanding the publicity about a bankruptcy scenario, has not been at any significant discount from the bonds' face value -- in other words, the holders of those bonds do not think there is an imminent threat of default. Those bondholders will, I hope, be proved correct if the city's leaders prove worthy of the challenge.
Vilaplana is a shareholder of Seltzer Caplan McMahon Vitek and focuses his practice on the handling of insolvency matters, particularly complicated business bankruptcies and international transactions. Send comments to editor@sddt.com. All letters are forwarded to the author and may be used as Letters to the Editor.
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