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...

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.

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...

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....

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...

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...

With much of the focus in recent months on the bankruptcy filings of San Bernardino and Stockton, and the active stance that California Public Employees' Pension Fund (CalPERS) is taking in those cases, the small town of Pacific Grove is taking steps to keep CalPERS in check. Recent reports indicate that Pacific Grove is going on the offensive. Recognizing that its pension liabilities are at unsustainable levels, Pacific Grove is questioning how CalPERS computes its municipal liability. 

Understanding and questioning the computation will be the first step in negotiating a resolution. The city claims it cannot afford to terminate the pensions, but it will no doubt be keeping a close eye on the Stockton bankruptcy to see if it can exert any additional pressure. Absent a negotiated resolution for Stockton, the Bankruptcy Court will need to address whether the federal bankruptcy laws and the Constitution prohibit a state from granting special protections to pension funds and other...

The bankruptcy court overseeing the Stockton, California bankruptcy case has finally settled a much-watched dispute over whether the city was an eligible debtor under Chapter 9 of the Bankruptcy Code. On April 1, 2013, Judge Christopher Klein of the United States Bankruptcy Court for the Eastern District of California issued a bench ruling finding that Stockton is an eligible debtor and, therefore, entitled to remain in bankruptcy. 

The objecting creditors, which included Stockton’s bond insurers, had argued that the city failed the “good faith” requirement for Chapter 9 eligibility imposed by both California statute and the Bankruptcy Code. The creditors’ main point of contention was the city’s failure to negotiate or seek any concessions from the California Public Employees’ Retirement System (“CalPERS”) as part of the city’s pre-filing creditor negotiations. Rather than engage its largest creditor, the objecting creditors argued that the city instead sought disproportionate...

In Part 1 of this series, we examined some of the overarching issues that can make a Chapter 9 restructuring more challenging for creditors than a Chapter 11. The appointment of an emergency manager in Detroit makes it clear that Michigan is taking Detroit’s need to restructure seriously.

Detroit’s problems are well known:

• Geographic sprawl combined with declining residency have led to decreased tax revenue and increased expenses (fewer people live in Detroit now than at any other time since 1920);
• Pension Liabilities are increasing (retiree spending projected to be $1.5 billion between 2013-2017); and
• The city faces disproportionate and unsustainable power of the unions.

So, what should the creditors of Detroit be asking the city on the precipice of its formalized restructuring?

• Who will represent my interests and how can I get a seat at the table? The Bankruptcy Code allows a municipality to propose treatment of a creditor’s claim over that creditor’s objection if certain requirements...

Now that Michigan and Detroit have publicly admitted that Detroit is in world of financial trouble, creditors of Detroit must to ask themselves, “what’s next”?  Before addressing this question, it is important to understand some of the legal, political and practical obstacles that will face the city’s creditors. 

In a typical Chapter 11 bankruptcy case, the lines are easily and clearly drawn. In one corner are the debtors; in the other are the creditors. While there are varying types of creditors (secured, unsecured, subordinated and so forth), their interests and priorities are established by the Bankruptcy Code through the absolute priority rule. While there may be some litigation posturing in an effort to extract additional value for an “out of the money” constituency, generally, the rule of the day is compromise. Contrast this with Chapter 9 where there are additional complications:

• The debtor is afforded greater latitude to act without the approval of the Bankruptcy Court, which...

This guest post was contributed by J. Robert Medlin, a Senior Managing Director and Southwest regional leader in FTI’s Corporate Finance (“CF”) practice, resident in Dallas. 

Two of the largest issues facing municipalities today are underfunded pensions and unfunded “other” post-employment obligations (“OPEB “). Historically, deficiencies in public accounting rules have allowed these obligations to be obscured from view, but change is being phased in through the introduction of new GASB standards that require municipalities to disclose the full impact of pension and OPEB liabilities and expenses.

In addition to accounting disclosure deficiencies, the legacy benefit funding problem has been exacerbated by:

• Aggressive return rate assumptions that are significantly above actual median returns for the last five years;
• Public officials that are pressured to grant benefits due to the collective bargaining rights of public servants;
• Macroeconomic pressures and local stagnation;
• Actuaries complicit...

On Friday, Michigan Governor Rick Snyder published a formal declaration that a financial emergency exists in Detroit. As a result, unless opponents can convince the Governor to change his mind, a three-member emergency loan board appointed by the Governor will select an emergency manager. 

Governor Snyder’s announcement was, in effect, a confirmation of the state financial review team’s conclusion reached on February 19, 2013 that a financial emergency exists in Detroit because there is no satisfactory plan to resolve its extensive fiscal problems. The financial emergency process is occurring under Michigan’s 1990 emergency financial manager law, which became effective again in November after voters repealed a stronger financial manager law by referendum. A new law, passed in a lame duck legislative session and signed by Governor Snyder in December, does not become effective until March 27, 2013. The new law, once in effect, will give the emergency manager increased power, including...

Trial Date Set for Stockton Eligibility

After months of legal wrangling, the legal issues surrounding whether Stockton is eligible to file for Chapter 9 protection will come to a head in a four-day trial beginning on March 25. The trial essentially pits the interests of CalPERS, which contends it is entitled to continue to receive full payment under California law against certain bondholders and bond insurers, who contend that CalPERS’ claim should be treated as an unsecured claim and, therefore, receive the same treatment as the bondholders. 

While the similarity of the claims of creditors should be an issue reserved for confirmation of any plan of adjustment, the creditors seem poised to try to make it a central issue to Stockton’s eligibility to be a Chapter 9 debtor, as Stockton  is required to prove it has satisfied the state and federal hurdles to a Chapter 9 filing. Absent a last minute settlement, the outcome of the trial, which presiding Judge Christopher Klein has promised will...

The city of San Bernardino filed its voluntary petition for relief under Chapter 9 of the Bankruptcy Code on August 1, 2012. Six months later, the city and the California Public Employees’ Retirement System (“CalPERS”) continue to be  at odds. 

Prior to the status conference scheduled for February 12, 2013, CalPERS filed a report contending that the city’s condition had “deteriorated” since the December status conference held at the Bankruptcy Court. CalPERS argued that there has been a “mass exodus” of key personnel that “were critical to the city’s restructuring efforts and instrumental in developing and maintaining the city’s relationship with CalPERS and other key creditor constituencies.”  In addition, CalPERS accused the city of not being “transparent” in its dealings with creditors. 

In its response, the city of San Bernardino refuted CalPERS’ accusations and advised the Bankruptcy Court that the CalPERS’ report, which relied on blogs and other media reports to support its...

The California Public Employees’ Retirement System (“CalPERS”), the largest public pension fund in the United States, recently lost the motion it filed in the bankruptcy proceedings of the city of San Bernardino to have the automatic stay lifted with respect to overdue pension payments. U.S. Bankruptcy Judge Meredith Jury based her denial partly on the city’s representations that forcing the payment of outstanding CalPERS obligations at this time would be a “death knell” for the city.

Unlike other California cities that have sought Chapter 9protection, San Bernardino is the first to stop its payments to CalPERS as part of its recovery strategy. Since stopping the pension payments shortly after its bankruptcy filing in August 2012, the city’s delinquent obligation to CalPERS has risen to approximately $8 million and is expected to increase to between $13 million and $19 million by June 30, 2013, the end of the city’s current fiscal year. Judge Jury’s ruling disadvantaged CalPERS,...

A municipality cannot avail itself of Chapter 9 protection unless it is specifically authorized to do so by the state where it is located. 11 U.S.C. 109(c)(2)  As more states become home to financially troubled municipalities, some are questioning whether a state and municipal partnership could be beneficial. Should states take an increased oversight role with respect to  financially distressed municipalities and require them to make regular progress reports to the state? The bottom line:  It can’t hurt. 

Michigan legislators have recently proposed a scheme that would provide a financially distressed municipality with four options, each of which has a varying degree of state involvement, including, if all else failed, Chapter 9. California and New York are considering similar, more proactive approaches. 

These measures recognize several realities that all municipalities with “top line” problems are facing. First, there is only so much money to go around. This has been demonstrated in...

CalPERS has fired back at the city of San Bernardino and its pendency plan for operating during the Chapter 9 case, calling it  “criminal” and a “sham.” A copy of the pendency plan can be found here. Since filing for bankruptcy, the city has stopped making its bi-weekly payments to CalPERS. As a result, San Bernardino now owes CalPERS approximately $8 million. 

While CalPERS may cast aspersions on the city’s motivation, financially, the city is faced with either making the CalPERS payment or making its payroll. Even though the hit to CalPERS is 0.00329% of its overall portfolio, CalPERS has a legitimate concern that any acquiescence to San Bernardino’s refusal to pay will set a negative precedent for future Chapter 9 cases. As there are pending municipal bankruptcies underway throughout the state, CalPERS does not want to undermine its position that it is a priority creditor for the municipalities of California. 

The legal issue is whether the pensions of government workers take...

The third video segment of MuniBK’s panel, “OpporMUNIties in Chapter 9: What Distressed Investors Should Know,” featured at the Bond Buyer’s 22nd annual California Public Finance Conference focuses on:

• Challenges faced by municipalities that have a “top line” problem;
• An analysis of certain types of municipal debt and a municipality’s willingness to pay;
• Elements of "fairness" including pension reform and retiree benefits;
• The “firewall” between general obligation bonds and special revenue bonds in Chapter 9; and
• Legal fees and other costs of restructuring.