Commentary

More and more California municipalities are creeping nearer to the fiscal cliff—the most recent casualty being the city of Santa Monica.

Having been involved in a Chapter 9 bankruptcy as an officer of California’s County of Orange, and watching neighboring cities, like San Bernardino, doing the same, one wonders why strapped cities don’t consider going down the disincorporating road, as it is potentially much cheaper to become a jurisdiction of their counties.

With California’s 483 cities, many at the brink of insolvency, it’s time to discuss why they should consider disincorporation and let the county in which they are located take over the necessary public safety and related civic functions.

One great indicator of a candidate is its lateness in preparing annual comprehensive financial reports. There’s currently no penalty for a city’s tardiness. But if a property owner is one minute late on paying property tax, they will be assessed a 10 percent penalty on the amount due.

The Golden State has 58 counties, and each should have a Local Agency Formation Commission, affectionately referred to as LAFCO. I served on Orange County’s LAFCO for some eight years. Each year, I was successful in moving an unincorporated island into the city it was located in or adjacent to. Many larger unincorporated areas actually pursue cityhood instead, with four new cities recently created in Riverside County alone.

But what can be done can also be undone. Let me give a story of a recent potential disincorporation. In June 2011, state lawmakers received Senate Bill 89 on a Monday, and it was approved by the Legislature and signed by Gov. Jerry Brown some 36 hours later. Incidents like these are why a 72-hour rule was imposed on the Legislature by Proposition 54 in 2016.

SB 89 went after post-2004 vehicle license fee (VLF) revenue to cities and redirected it to Sacramento. This maneuver impacted the four new cities in Riverside County that had incorporated after 2004. The VLF was a significant component of the budgeted revenues of these victimized cities as well as the County of Orange, which used this revenue stream to pay down its bankruptcy-related debt. One of the cities, Jurupa Valley, announced that it would consider disincorporation.

The saber-rattling caused everyone to review the Cortese-Knox Hertzberg Local Government Reorganization Act of 2000, which specified the procedures for local government changes of organization. Here’s what it stipulated:

1. A completed application must be submitted to LAFCO providing the resolution for disincorporating, a generic plan for services, an environmental review document, and a property tax exchange agreement between the county and the city.


2. LAFCO must hold a noticed public hearing and can impose terms and conditions.


3. LAFCO must then hold another public hearing if more than half of the residents protest the disincorporation.


4. An election must be held and is successful if the majority of voters approve.


5. LAFCO’s staff then files documents to complete the disincorporation.

LAFCO then implements the disincorporation as follows:

1. Requests the county to perform an audit to determine the city’s current debt, the amount of money in its treasury, and the amount of receivables due to the city.


2. The city’s public officers must turn over its public property and funds to the county board of supervisors.


3. The board of supervisors then winds up the affairs of the now former city. Should outstanding debts of the city exceed its assets, the county is required to levy a tax on the formerly incorporated territory to address the shortfall.

In 2015, Assembly Bill 851 made some improvements, starting with more specifics concerning the contents of the plan for services following the disincorporation:

1. What agency will provide the services currently provided to the city?


2. How will the services be financed? If through property taxes, the new service provider should receive the same allocation of this revenue source as the city allocated to this specific service.


3. What are the existing finance sources?


4. What is the status and exit plan for any potential bankruptcy proceeding?


5. Are there any state enforcement actions relating to services currently provided by the city?


6. Requires a written statement from each entity that will be providing services that it has received the plan.

LAFCO will perform a comprehensive fiscal analysis for the past three years, which means the city should be current on its annual audits before it engages in this alternative. And the city should process the disincorporation in a timely fashion, not increase compensation for the governing board ahead of this exercise, and keep expenditures within the current city budget amounts.

Basically, this alternative should be done in a professional manner, and the city should be ready to own up to any residual debts through a parcel or other tax. Like a homeowner’s association, if more was spent than received in income, a special assessment should be anticipated.

Although the process is simple and should be orderly, it is very rare. Only two cities have disincorporated since the creation of LAFCOs in 1963. Sometimes it takes a grand jury report to induce a city to do a reality check. In 2015, the Santa Barbara County Grand Jury called on the city of Guadalupe to disincorporate due to fiscal mismanagement, a declining tax base, and increasing debt obligations. Its city council decided to dig in and tough it out. It still has not released its June 30, 2023, financial audit report.

AB 851 sailed through the State Legislature without one “no” vote. It was supported by the California Association of Local Agency Formation Commissions (CALAFCO) and had no formal opposition. But years later, there are still no takers. And a search of the word “disincorporation” on the CALAFCO comes up crickets. Why? Who will be the leader in this exit plan?

Does it seem too onerous? After all, it is not an easy road to travel. But filing Chapter 9 bankruptcy is very expensive. Tragically, in the end, it may be cheaper to legally default on debts, like bondholders or successful litigants, through a federal bankruptcy court than to face the music of residents not only hanging on to their location but paying a steeper tax for the privilege.

Expect these cities to dig in and keep slogging it out, while providing minimal services to their residents, which will make it less desirable for potential new taxpayers to locate a home or business there. And this will only continue the downward trend toward either Chapter 9 bankruptcy or, you guessed it, disincorporation.