A colleague who covers the Mt. Diablo Unified School District posted this blog item about the superintendent over there alerting parents about the possibility of state receivership in that district. She got the following information from the state Department of Education on a state takeover, why it happens and what it means.
“What State Receivership Means and Why It’s Best to Avoid It”
[School Services of California, Inc. Editor’s Note: It is probably just coincidence, but we have had quite a number of inquiries recently about the consequences of just turning over the keys to the district to the state if the state doesn’t stop cutting education. Since the Fiscal Crisis and Management Assistance Team (FCMAT) has responsibility for assisting districts in their efforts to avoid or deal with financial problems, we asked Joel Montero, FCMAT’s Deputy Executive Officer, to author this article.]
Last spring (of 2009), California had the highest number of districts ever with qualified or negative certifications on their Second Interim budgets, reflecting the growing number of districts in fiscal distress. (Blog note: The number rose in 2010).
When a district gets to the point where it no longer has the cash to pay its bills, it must apply for a state loan, which means state receivership. Unfortunately, as a sign of the times, we have received many questions from districts about what state receivership looks like. What follows is some information on current law and, for a practical matter, what we have seen most recently in the districts that have required a state loan.
Budget Reserves vs. Cash Reserves
A school district receives a qualified or negative certification generally because of its inability to maintain the state-required level of reserves in all three years of its multiyear projections. Running out of reserves by itself, however, does not cause a school district to require a state loan; running out of cash does.
The distinction between reserve levels and cash levels becomes clearer when looking at your General Fund balance sheet. Reserves are the (hopefully positive) difference between assets and liabilities, some of which are cash and some of which are not. On the assets side, there are several cash accounts that are obviously cash—Cash in County Treasury, Cash in Bank, Cash with Fiscal Agent, etc. Not all cash is accessible to pay bills—for example, Cash with Fiscal Agent is set aside for a specific purpose and the district may not have the legal authority to draw on that cash to pay for operations. Other assets are not cash—for example, Stores Inventory and Prepaid Expenses. Most liabilities are not cash, but one notable exception is Deferred Revenues, since this represents cash that has been received by the district. It is set up as a liability because it cannot be recognized as revenue until it has been spent on the specific purpose of the grantor agency.
It has generally held true that low reserve levels are an indicator of low cash levels and vice versa. However, with the recent state cash deferrals, this has become less true. School districts with prudent reserves are still having to manage their cash actively and borrow to get through the negative cash months. And districts with inadequate reserves are having an even tougher time ensuring that the cash is there to meet the obligations when due.
Cash Borrowing Options
There are several options available to a school district to borrow cash locally—from its other funds, using tax and revenue anticipation notes (TRANs), from the county office of education, or from the county treasurer (Education Code Sections [E.C.] 42621, 42620). However, all of these options are temporary, short-term borrowing—they generally require that the district pay back the borrowing within a year or less. For each of these types of borrowing, the district is required to prepare a cash flow projection that indicates that the borrowing can be paid back from the district’s future revenues in the time frame required.
If the cash flow projection, however, shows that the district will be unable to pay back the local borrowing, it means that the cash balance is trending downward with no end in sight—that the future revenues are not enough to keep up with operational obligations plus pay back the borrowing. If the district is unable to borrow locally, then the only other option is to request a loan from the state.
A loan (technically referred to in the Education Code as an emergency appropriation) from the state requires that one of the district’s local representatives to the State Legislature sponsor a bill through the legislative process. This is typically an urgency bill, meaning that it requires at least a two-thirds vote of each house of the Legislature so that it can become effective upon the Governor’s signature. The legislative process takes many months, so a state loan should be initiated early enough to ensure that the cash is there when the district needs it, and the timing needs to work within the legislative calendar. Typically, the bill has to be introduced in January in order to work its way through all of the legislative committees and the floors of both houses by the summer or early fall.
A loan from the state results in the state taking control of the school district. The degree of state control is determined by the size of the loan relative to the district’s budget. Specifically, per E.C. 41326(a), if the loan is less than twice the size of the district’s required reserve level, a State Trustee is assigned and assumes authority over the financial aspects of the school district’s activities.
If the size of the loan exceeds twice the size of the district’s required reserve level, the following takes place:
• The school Board loses its powers and becomes advisory only [E.C. 41326(c)(1)]
• The Superintendent is no longer employed by the district [E.C. 41326(c)(2)]
• A State Administrator is assigned and assumes the powers of the Board and Superintendent [E.C. 41326(b)]
State loans are typically set up for repayment over 20 years. In both situations above, state control remains over the school district until the loan is fully repaid. The State Trustee or State Administrator reports directly to the Superintendent of Public Instruction—the state of California—not the local school Board or community.
The state loan is sized to accommodate the anticipated shortfall in cash that the district will need during the life of the loan in order to meet its obligations. In addition, all of the costs of ensuring a fiscal recovery are the responsibility of the district (E.C. 41328) and are added to the amount of the state loan.
The cost of recovery when a State Administrator is assigned includes:
The cost of the compensation package for the State Administrator (E.C. 41326[(b)][(8)]
The cost of additional staffing as determined by the State Administrator to be necessary for ensuring fiscal recovery (E.C. 41326[(b)][(9)]
The cost of management reviews and developing a recovery plan, including the cost of the initial comprehensive review and follow-up reviews every six months encompassing these five areas of the district (E.C. 41327.1):
Community relations and governance
Any other expenditures deemed necessary by the State Administrator to help ensure fiscal recovery
On the natural, a state loan will be much larger than what the district would otherwise need to borrow locally if it had been able to solve its own fiscal crisis. Therefore, a district that receives a state loan needs to make more expenditure cuts and/or take longer to pay the loan back.
The comprehensive review and six-month follow-up studies measure the district’s progress in meeting the standards established. In the areas where the district has progressed enough in meeting the standards, the Board receives its powers back and a Superintendent is hired to administer those areas. It normally takes several years before the Board regains any of its powers. State control remains, either in the form of a State Administrator or State Trustee, with stay or rescind power over certain Board actions until the state loan is paid off.
The State Administrator’s mission is to restore fiscal solvency as soon as possible so that the loan can be paid back to the state. This will be done by reducing expenditures to a level that is lower than revenues so that the reserves can be rebuilt over time while the state loan is being paid back. This means that all possible avenues for balancing the budget are pursued. The State Administrator cannot set aside any contractual obligations that the district has already entered into, including vendor contracts and bargaining unit contracts, without renegotiating them. If modifying provisions of these contracts is critical to gaining fiscal solvency, the State Administrator has the power to invoke the timelines available in the contracts or by law, including the ability to use the impasse/factfinding process to unilaterally impose changes in collective bargaining agreements.
A district in financial trouble will regain fiscal solvency. If the district and the Board, while it has the power, do not take the necessary actions locally to restore fiscal solvency, the same actions and more will be imposed by the state. The typical state loan is established to be a 20-year payback. The district remains under some level of state control until that payback is complete. Generally, recovery costs more and takes longer if a state loan is required.
In the long term, taking the necessary actions locally and avoiding a state loan will result in greater local control, less outside intervention, and better long-term outcomes for students, employees, and the community.