Mediators May Play Key Role in Municipal Bankruptcies

Hon. Randall Newsome (Ret.) successfully served as a mediator in hundreds of cases both as a full-time neutral at JAMS as well during his 28 years as a settlement and bankruptcy judge.

In the past few months, there has been a marked increase in the number of counties and municipalities either declaring bankruptcy or heading down the road towards filing for Chapter 9. We’ve seen this happen to Jefferson County in Alabama, and then Stockton, Mammoth and San Bernardino in California. The pace of these is not likely to decrease, with even Warren Buffet forecasting more municipal and county bankruptcies. In light of this, legislators will be looking for new tools to navigate such uncharted territory. As Buffet noted, now that large cities are declaring bankruptcy, others may soon follow suit as a previously unthinkable option to deal with mounting debt.

Perhaps seeing the way the wind was blowing on this, California passed a law in October 2011 that sets up specific requirements for municipal bankruptcies. As a condition of declaring Chapter 9, a municipality must either 1) declare a fiscal emergency (as was the case with San Bernardino; or 2) agree to a 60-day mediation period, after which if they still cannot put a deal together they are free to file Chapter 9. The mediation period may be extended at least once – and multiple extensions are technically possible if the parties are willing.

Granted, mediation in Stockton did not work per se, at least in a traditional sense of a successfully negotiated deal. However, this does not mean that mediation did not play an important role in the bankruptcy process – and the eventual resolution of the case. It is likely that mediation revealed areas of agreement for at least some of the parties, while some issues remained unresolved. This is not a process that didn’t work; this is progress.

As these municipal bankruptcies take shape, it could be that the most overlooked benefits of mediation may begin to shine. Mediation gets things organized, it gets parties talking, and it clarifies positions. It reveals points of agreement that could lead to early, potentially money-saving, deals for parties where they would have had to wait for Chapter 9 if they did not engage in mediation. In short, mediation breathes a little air into what can be a tense, fractious process where parties are entrenched and missing great opportunities because they cannot yet not see eye to eye. Mediation opens space for things to happen – even things that many may not have expected before going in.

This is likely what legislators in California had in mind when they passed the law providing for mediation in municipal bankruptcies. In fact, they made a point of not calling the process mediation. Rather, they used the term neutral evaluation. Legislators did not want a process where someone shuttled back and forth between entrenched parties with offers. Instead, they wanted an evaluative process where a neutral voice had the power to not only offer counsel and advice, but provide leadership and direct the parties to points of agreement and even options they cannot see for themselves. This is where the true value of an experienced mediator shines.

As municipalities confront bankruptcies, mediation may provide an opportunity to take a realistic look at the situation and discover options for reaching deals that may not be apparent from heading straight into Chapter 9. As such, mediators could become true economic allies for our country’s ailing cities.