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As MuniBK has frequently advocated, compromise is the hallmark of any successful bankruptcy. Recently, the major financial institutions holding Jefferson County debt have agreed to compromise their claims as the basis for a formal plan of adjustment that is expected to be filed by July 2. This move, which will help bring the largest municipal bankruptcy in American history to a swift conclusion, highlights the benefits (and costs) of compromise. 

To achieve this result, approximately 80% of the creditors reportedly agreed to a 60% recovery on the face amount of their notes – a significant discount from the $2.4 billion that they were owed. The plan of adjustment will seek to impose these terms on the creditors who did not formally consent.  Additional sophisticated investors will provide the refinancing needed to allow the county to have access to capital upon emergence.  Under the agreement, sewer tax rates will also rise over the next four years. 

If approved, the plan of adjustment...

Detroit received a rare bit of good news as word emerged that the city’s emergency manager, Kevyn Orr, is close to reaching an agreement with two of the city’s secured creditors to accept concessions on repayment of their debt. Although it was unclear which creditors were involved, the amount of debt involved, or the extent and nature of the concessions, any relief from Detroit’s financial woes was welcome news.

Unfortunately, the positive news was too little too late to enhance Standard & Poor’s view of Detroit’s financial prospects. The ratings agency took the unusual step of applying a “superdowngrade” to Detroit’s bond rating, cutting it four levels to CCC- and continuing to list its outlook as negative. The downgrade came in anticipation of bondholders being asked to accept diminished payouts as part of the city’s attempt to restructure its debt.

These developments, days ahead of Detroit’s meeting with labor groups and creditors, combined with the emergency manager’s refusal to...

Now that Jefferson County is wrapping up its Chapter 9 proceeding, an examination of the components that led to its downfall is in order. As the New York Times aptly wrote, “Jefferson County’s problems involve corrupt politicians and bad luck, but they also include a longstanding reluctance to face facts…” 

Sound familiar to Detroit? While observers can focus on the past, Detroit should follow Jefferson County’s latest lead: compromise. 

The key to any successful resolution of Detroit’s distress will be frank confrontation. Put everyone in a room and let them yell and scream about what they are owed and who has superior claims. Then, get to the real business of starting to craft a compromise that might work. Such a discussion may be on the horizon, with recent reports indicating that key constituents are trying to schedule a meeting for mid-June. 

The proposed offer to Detroit creditors, reportedly ten cents on the dollar, may be too little for major stakeholders to seriously consider...

The IRS has issued a Technical Advice Memorandum that could significantly impact the ability of special districts to issue tax-exempt debt and to seek bankruptcy relief under Chapter 9.

The memorandum concludes that a community development district formed under the Florida Uniform Community Development District Act of 1980 (the “Florida Act”) was not a “political subdivision” for purposes of Treasury Regulation Section 1.103-1(b). This section defines “political subdivision” as “any division of any State or local governmental unit which is a municipal corporation or which has been delegated the right to exercise part of the sovereign power of the unit.”

“Community development district” is defined in Section 190.003(6) of the Florida Act in part as “a local unit of special-purpose government which is created pursuant to this act and limited to the performance of those specialized functions authorized by this act….” 

The IRS concluded that due to the low number of registered voters within...

Chapter 9 debtors must demonstrate “feasibility” before their plans of adjustment can be confirmed by a bankruptcy court. This is similar to the corporate reorganization requirement that a plan is “not likely to be followed by liquidation or the need for further financial reorganization.” Generally, feasibility means that the debtor has the ability and financial wherewithal to make the payments to creditors outlined in the proposed plan. This test is designed to prevent Chapter 9 debtors from indulging in over-optimism at the expense of itself, its creditors and its constituents. 

A Chapter 9 debtor has the burden of establishing that the plan is feasible. Bankruptcy courts will generally assess the reasonableness of revenue projections and expenses, and consider whether the debtor will be able to make payments on its prepetition debts and provide for municipal operations. See In Re Mount Carbon Metropolitan District.

A debtor will generally want to provide the bankruptcy court with...

As discussed in previous posts, there are key legal differences between Chapter 11 and Chapter 9. The “best interests” standard, a requirement for the confirmation of a plan under both Chapter 9 and Chapter 11, is considerably less onerous on the Chapter 9 debtor than the Chapter 11 debtor.

Under Chapter 11, the “best interests of creditors” standard is a familiar one. It requires that each claimant that has not accepted the plan receive at least as much as they would have received under a hypothetical Chapter 7 liquidation.

A municipality, however, cannot be liquidated under Chapter 7. Instead the Chapter 9 “best interests” standard requires only that the municipality show that the plan provides a better alternative for creditors than what they already have, which is just dismissal of the case. Under a dismissal scenario, creditors are left to fight it out using whatever litigation tools they can muster to recover on their claims.  This generally means little to no payment.

As one...

Detroit's Emergency Manager Kevyn Orr recently announced that he will make his decision on filing a petition under Chapter 9 of the Bankruptcy Code in about five weeks. Within that timeframe, Orr will try to speak with the city's many labor unions and make progress on many other goals. 

Orr's plan involves designating a new police chief, restructuring the fire department via an outside expert, maximizing the efficiency of the public transportation system, speeding up demolition of blight, and analyzing the pension systems for potential modifications. He has placed a high emphasis on change and quick improvements based on evaluations of the city's  continually worsening financial state.  

In the continuing saga of Chapter 9 petitions in San Bernardino and Stockton, California, the cities' largest creditor, CalPERS, has petitioned the Bankruptcy Court to disqualify counsel for National Public Finance Guarantee (NPFG), the cities’ bond insurer.

CalPERS alleges that Winston & Strawn, counsel for NPFG, hired lawyers from K&L Gates that had previously worked on CalPERS matters, causing a conflict of interest.  

NPFG wants CalPERS to take a cut in the payments otherwise allowed to CalPERS.  They hired Winston & Strawn to represent it in the Chapter 9 cases, but certain of those lawyers had worked on CalPERS matters.  

A hearing is set for June 5, 2013, on the San Bernardino's eligibility for Chapter 9 (Stockton was already approved as a Chapter 9 case) and motions made by CalPERS and two city employee unions seeking relief from the automatic stay to sue in state court.

A recent study by the California Public Policy Center concluded that the combined debt owed by California’s state and local government entities is likely to exceed $1.1 trillion dollars. The CPPC totaled the debt of state government ($132.6 billion), public school districts ($49.7 billion), city governments ($68.1 billion), county governments ($22.1 billion), redevelopment agencies and “special districts” ($110.4 billion) and unfunded state and local government pension obligations (from $265.1 to $586.4 billion). 

In addition to the eye-popping total, the report also raises interesting points about the nature and amount of the state’s debt.

CPPC argues that current estimates of California’s pension obligations vastly underestimate the scale of the amount of unfunded obligations. State estimates generally assume a rate of return on pension fund investments of 7.5%. CPPC believes a rate of 5.5% or even 4.5% is more realistic. Correcting for this error adds $321.3 billion to pension...

Most Chapter 11 cases have a “playbook.” Depending on the industry and reasons for a company’s downfall, there is usually a debt-for-equity swap, a distribution to unsecured creditors and/or a sale. The threat of litigation, or even liquidation, works to keep all parties “honest” and at the negotiating table. One of the benefits of Chapter 11 is the fact that the “rules of engagement” are well-known by the sophisticated players, and the Bankruptcy Code and an extensive body of case law guide the parties.

Chapter 9 lacks much of this clarity, making it a scarier place for traditional funds to invest. 

Similarly, the nature of municipal debt, traditionally considered lower risk because of a dedicated revenue stream for repayment, the taxing power of municipalities or the fact that the bonds were insured, is changing. Projects supporting revenue streams have failed, the tax base is shrinking and insurers are becoming more aggressive regarding their contractual rights both in Chapter 9...

Politics undoubtedly influence the public narrative surrounding a municipality’s slide into bankruptcy. Last week, however, the Securities and Exchange Commission served notice that public officials need to be careful of what they say. For the first time ever, the SEC charged a municipality, Harrisburg, Pennsylvania, with violations of Section 10(b) of the Exchange Act and Rule 10(b)(5) for making materially misleading statements.

While Harrisburg filed a Chapter 9 petition in October of 2011, the petition was dismissed on the grounds that the bankruptcy filing was not authorized under Pennsylvania law. Instead, a receiver was appointed to implement a “recovery plan” and take control of the city’s finances. The city remains under the control of the receiver.

The charges from the SEC cover a two-year period, from January 2009 through March 2011 and relate to statements made by Harrisburg officials, including a “State of the City” address made in April 2009 by the mayor. According to the...

In his first report as Detroit’s Emergency Manager, Kevyn Orr outlined the city’s problems. To those familiar with the situation, there were no surprises about the top level interrelated problems facing  Detroit: urban sprawl/blight, soaring and unsustainable union contracts and pension liabilities, a history of municipal “borrowing from Peter to pay Paul,” archaic infrastructure, and systemic municipal inefficiencies. The result is a current negative cash position of $162 million and the blunt assertion that debt payment on current obligations will not be made in order to prevent the city from running out of cash. Moreover, Detroit has in all likelihood lost its access to capital in the marketplace given its current credit ratings, the amount of outstanding debt, and its stated inability to repay the obligations. As a result, the solution must be a comprehensive overhaul of the current municipal system. 

Addressing problems of this magnitude will require widespread, comprehensive...

In April, the city of Stockton, California, became the largest U.S. city to become eligible for Chapter 9 bankruptcy relief. U.S. Bankruptcy Judge Christopher Klein, to whom the bankruptcy case was assigned, reasoned that, due to its current financial situation, the city required “the muscle of the contract-impairing power of federal bankruptcy law” to continue providing its citizens with basic services.

Stockton will now prepare and present a restructuring plan to reorganize more than $1 billion in debt, which includes approximately $900 million in public pension obligations owed to the California Public Employee’s Retirement System (CalPERS). Despite the city’s prior representations regarding its intention to repay those pension obligations in full, many observers suspect that the city will seek a reduction of its CalPERS’ debt. If approved, such a move would represent the first reduction in public pension obligations in the nation obtained through Chapter 9 proceedings – a precedent...

The goal of most Chapter 9 bankruptcy cases is confirmation of a plan of adjustment. Confirmation requires a finding by the Bankruptcy Court that the proposed plan satisfies a number of legal standards, which include the requirement that the plan be “proposed in good faith and not by any means forbidden by law.” 

There is no definition of “good faith” in the Bankruptcy Code and few courts have been asked to decide what good faith is in the context of a municipal bankruptcy. Broadly speaking, to find that a plan was proposed in good faith, courts generally require that the plan treat all interested parties fairly and that the efforts used to confirm the plan meet due process standards. While assessing whether there is fairness in treatment and process, and thus good faith, may appear simple, the unique constituencies, contexts and controversies that characterize municipality bankruptcies under Chapter 9 can make good faith determinations difficult.

Municipalities that are formulating...

The city of Stockton recently received bankruptcy court approval to enter into a settlement agreement with Wells Fargo and Ambac Assurance Corp. restructuring over $13.3 million of city debt.  The deal, reached as a result of confidential mediation, relates to specific securities issued by the city in connection with redevelopment efforts in 2003.  The city-issued securities are backed by lease payments covering Stockton’s main downtown police facilities, a library and three fire stations.  Wells Fargo acts as the certificate trustee, while Ambac is the certificate insurer.       

The settlement agreement will provide Stockton with much-needed additional liquidity by allowing it to tap into a reserve fund established as part of the original certificate issuance.  Reserve fund monies will be used to pay principal and interest on the debt for fiscal year 2013.  In fiscal year 2014, the city’s general fund obligations will be reduced by approximately 70%.  The city will also benefit from...

In a decision not likely to sit well with bondholders and other creditors, the city of San Bernardino has decided to resume payments to the California Public Employees’ Retirement System (CalPERS) but to no other creditors. CalPERS, which is the city’s largest creditor, is owed more than $12 million on account of missed pension fund contributions. Going forward, the city will make the required bi-weekly $1.2 million payments, which will have no impact on the arrears owed CalPERS.

While the bankruptcy judge presiding over the city of Stockton’s bankruptcy case recently green-lit its Chapter 9 petition, San Bernardino’s petition remains up in the air. Indeed, a timeline for a final decision on the Chapter 9 petition remains unclear. Also unclear is what effect, if any, resuming payments to CalPERS will have on CalPERS’ objection to San Bernardino’s Chapter 9 petition. CalPERS had objected to San Bernardino’s Chapter 9 petition early on, yet did not object to Stockton’s Chapter 9 petition....

The focus over the past several months has been on municipal bankruptcies. The press has covered San Bernardino, Stockton, Detroit and others. Yet, there may be a whole new wave of bankruptcy filings approaching.

Starting with Mendocino Coast District Hospital, which filed Chapter 9, we may be seeing a new trend: public hospitals resorting to bankruptcy for their financial woes. But, can Chapter 9 of the Bankruptcy Code be applied to public hospitals?

The first requirement in a Chapter 9 bankruptcy is that the debtor must be a “municipality.” The Bankruptcy Codedefines municipality as a “political subdivision or public agency or instrumentality of the [s]tate.”  The Bankruptcy Code does not define “political subdivision,” “public agency” or “instrumentality of the [s]tate.” Nonetheless, the legislative history of Chapter 9 shows that Congress intended these terms to be interpreted broadly. Cities, counties, townships, and the like generally fall under the rubric of “political...

While much of the focus in municipal bankruptcies has been on cities that have actually filed for Chapter 9 relief or appear to be on the precipice of doing so, there are numerous other municipalities that could be heading down that path, absent a dramatic change in circumstance. 

Recent reports indicate that as many as 40% of hometowns in Pennsylvania may be headed for financial trouble. Most officials point the finger at municipal pensions that are “out of whack” with the current tax base of the municipality, especially as the residents of the towns age and decline. Restructuring these obligations can be a political hot potato. A recent bill has proposed changes to the pension rules for new workers.  While this will likely bring opposition from the unions, compromise is the key to avoiding a bankruptcy filing. 

While Pennsylvania has Act 47 to help stressed and distressed municipalities attempt to solve their problems short of a Chapter 9 filing, New York Governor Andrew Cuomo...

On April 15, 2013, the United States Bankruptcy Court for the Northern District of Alabama ruled that the automatic stay applied to a lawsuit pending in the New York state court even though the County was not a named  defendant because of the “sameness” of another action currently pending in New York state court in which the County is a named defendant.

The lawsuits pending in New York state court stem from Jefferson County’s issuance of warrants secured exclusively by revenue generated by its Sewer System which were underwritten by JPMorgan and its affiliate. The County also entered into several interest rate swap transactions with JPMorgan related to these warrants. Between 2002 and 2005, the County and JPMorgan made several agreements with Assured and Syncora Guarantee in which Assured and Syncora issued policies that insured against the County’s failure to pay principal and interest on the warrants. Assured also reinsured over $360 million in policies originally issued by Syncora...

In San Bernardino, California, a fight is brewing regarding the scope of Section 903 of the Bankruptcy Code. It stems from the motions filed by the San Bernardino Public Employees Association (SBPEA), the San Bernardino Police Officers Association (SBPOA) and the San Bernardino City Professional Firefighters (SBCPF) in response to the city’s motion to reject collective bargaining agreements with these unions.  These groups are seeking relief from the automatic stay to pursue various state remedies. The issue to be decided by the Bankruptcy Court is whether the city’s rejection of the collective bargaining agreements is an impermissible violation of state law.

The city contends that the Bankruptcy Code clearly gives it the authority to reject executory contracts, including collective bargaining agreements. The unions, on the other hand, argue that the city’s proposed rejection violates state law. 

The dispute was made more contentious when the California Public Employees’ Retirement...