California city will be litmus for bankruptcy cases

SAN FRANCISCO -- A northern California city that declared bankruptcy last week has thrust itself into the national spotlight as a test case for thousands of floundering cities desperate to unload their extravagant public employee contracts.

"There's a wave of this coming across the U.S.," said Sajan George, an adviser to struggling public entities. "What happens in Vallejo could definitely set a precedent."

He was referring to the town of 117,000 that has been battered by the plummeting housing market and skyrocketing public employee contracts. On track to begin the next fiscal year with a $16 million deficit and no money in reserve, Vallejo made dubious history last Tuesday by becoming the largest California city to declare bankruptcy.By declaring Chapter 9 bankruptcy, the city hopes to freeze its debts and gain time to renegotiate its police and fire contracts, which comprise about 74 percent of its $80 million general fund budget. It also hopes a judge will void part or all of the contracts, allowing the city and unions to start from scratch.

"It's clear the way we've been doing business has not served us well," City Councilman Tom Bartee said. "We have to change that."

Because so few public entities have declared bankruptcy, no one's sure how labor contracts will be affected.

Vallejo's public safety unions have vowed to fight the proceedings, arguing that the city has plenty of money stashed in hidden accounts and is using bankruptcy to avoid paying police and fire fighters what they're owed.

The unions commissioned a report that concluded the city has other ways to balance its budget, union leaders said. The report has not been made public because it's part of ongoing labor negotiations.

Meanwhile, the unions would like an independent state audit of Vallejo's books.

"We don't believe they're insolvent," said Vallejo police detective Mat Mustard, vice president of the police union. "But by declaring bankruptcy, they've taken a financial crisis and turned it into a catastrophe. It's like using an elephant gun to shoot an ant."

It's very possible a judge will void Vallejo's labor contracts, George said. When airlines began filing bankruptcy several years ago, judges allowed them to renegotiate their union contracts, making bankruptcy an attractive option across the airline industry, he said.

Thousands of cities across the United States are in the same boat as Vallejo, but nearly all of them have found other ways to avoid Chapter 9, George said. They cut and outsource services, share services with neighboring cities, sell property and raise taxes and fees.

"Chapter 9 is still relatively unknown," he said. "It's not common now, but depending what happens in Vallejo it may become more common."

Vallejo intends to keep services at their current level throughout the bankruptcy proceedings, which are likely to take years, said city spokeswoman Joann West. But it's likely that the voters will be asked in November to pay higher taxes, several city council members said Tuesday.

Bankruptcy is not a cheap option. Legal fees may climb as high as $2 million, the city's credit rating will be damaged, developers and investors may avoid the city until its finances are resolved and property values may fall even further because of the public stigma, bankruptcy experts said.

E-mail Carolyn Jones at carolynjones(at)sfchronicle.com

(Distributed by Scripps Howard News Service, www.scrippsnews.com.)