California’s AB 506 Process: What Creditors Can Expect in the Wake of California Municipal Bankruptcies

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California’s AB 506 process was intended to help a municipality in restructuring its debt obligations and avoid bankruptcy. However, the lessons of the bankruptcies of the City of Stockton, the Town of Mammoth Lakes and the City of San Bernardino support the reality that a meaningful restructure requires material involvement by the major stakeholders. California’s recent wave of municipal bankruptcies tend to show that the AB 506 process has not changed this reality, but rather made a difficult process longer and more arduous.

In the wake of numerous municipalities filing for Chaptear 9 protection, California in late 2011 adopted Assembly Bill No. 506, which added certain legal hurdles before a California municipality may file for Chapter 9 protection. Assembly Bill No. 506 requires a “neutral evaluator process” prior to filing, which effectively mandates mediation under the auspices of a third-party neutral, among the municipality and numerous creditor constituencies. California unions, which lobbied for this new law, are now effectively guaranteed a seat at the table during these negotiations if their collective bargaining agreements would be implicated by the Chapter 9. The only exception that enables a municipality to avoid the neutral evaluation process is a declaration of a “fiscal emergency,” which itself still requires the municipality to meet specific criteria before filing. Since adoption of AB 506, a number of California municipalities have filed for Chapter 9 protection, including the City of Stockton ("Stockton"), the City of San Bernardino ("San Bernardino") and the Town of Mammoth Lakes ("Mammoth Lakes"). Additional California municipalities are likely to follow in similar suit as budget deficits continue to mount and strain the financial position of California cities.

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