The state of California is in financial distress. Unlike its municipalities, California cannot seek protection under the United States Bankruptcy Code (“Bankruptcy Code”). The state will have to address the crisis through a range of non-bankruptcy options. State issued IOUs will have to be paid. Contractors may be amenable to renegotiating their contracts. Perhaps the arrival of “stimulus package” funds will alleviate some distress. Debt will be reduced by agreement, in some cases, and refinanced or extended in others.
Bankruptcy issues are determined by the Bankruptcy Code and federal court opinions interpreting the Code. Bankruptcy is not an option for the state of California because the Bankruptcy Code does not allow for a state filing. Chapter 9 of the Bankruptcy Code allows a municipal corporation to adjust its debts under the protection of the United States Bankruptcy Court so long as the filing is authorized by the state where the “municipality” is located. The Bankruptcy Code defines “municipality” as a “political subdivision or public agency or instrumentality of a State.”
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It is well established under federal case law that the definition of “municipality” includes “cities, counties, townships, school districts, and public improvement districts.”
California cities have filed for Chapter 9 bankruptcy protection in the past. As recently as last year, 2008, the city of Vallejo, California, filed a Chapter 9 bankruptcy case. In 1994 Orange County, California, saddled with millions of dollars in debt, filed for Chapter 9 bankruptcy protection. Other California cities are reported to be weighing their bankruptcy strategies.
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The “Stimulus Package,” assuming it arrives soon, will provide some relief to California. However, the stimulus funds will not solve all of California’s budget mess for three reasons: First the package, projected at approximately 21 billion dollars, may not be large enough; next, these funds are specifically directed to education and economic stimulation. The governor and the state legislature will have to work hard to ensure compliance with the federal terms attached to the stimulus fund. Finally, the budget deficit itself is a moving target. With the school year scheduled to resume in the next several weeks and unpaid contractors “lawyering up,” the deficit will continue to grow.
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Who is hardest hit? Everyone has been hit hard. General bondholders and lenders are most concerned. Holders of special revenue bonds are also paying attention. Dealmakers are feeling the decline in the flow of deals. Lawyers are concerned about the decline in the market and a proposed new bankruptcy bill.
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Since bankruptcy is out as an option, what will happen to California as it faces a deficit in excess of twenty-three billion dollars? If California’s non-bankruptcy options fail, the state may default on its obligations. In the face of a default, it will be difficult, if not impossible, for the state to find new money in the bond market.
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With California brush fires, the budget mess brewing, and its cities consulting bankruptcy counsel, Californians are in for in for a long, hot summer.
Perhaps you’ve invested in a company, which is at the mercy of the State of California, if California pays, the company will be fine, if not, the company and its stock might sink. What can an investor do in this situation? Stock options can provide a means for insuring a trading portfolio against drops in stock price. A put option is similar to home or auto insurance, if something catastrophic happens, the put option protects the personal stock portfolio.
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Put option stock insurance can often be purchased fairly cheaply. An out-of-the-money put option provides the least amount of additional capital for providing portfolio insurance. An in-the-money put option requires the largest amount of additional capital, but also reduces the negative impact due to the erosion of time value that’s often experienced with out-of-the-money put options.
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[tags] California, United States Bankruptcy Code, Contractors, Chapter 9 bankruptcy protection, Vallejo, California, Orange County, brush fires [/tags]