San Bernardino Wins Its Eligibility Fight

The Chapter 9 case of the city of San Bernardino, California will proceed. After a year in limbo and a spirited fight from the California Public Employees' Retirement System (CalPERS), San Bernardino was finally able to win a ruling from Bankruptcy Judge Meredith Jury that it is eligible to be a Chapter 9 debtor. 

San Bernardino filed for Chapter 9 on August 1, 2012, claiming a budget shortfall of $46 million. The eligibility fight centered on San Bernardino's claim that the requirement to negotiate in good faith with its creditors was impractical. CalPERS argued that the city effectively side-stepped its obligation to negotiate by ignoring warnings of its impending financial difficulties. Further, CalPERS insisted that the city waited until its financial predicament became so dire that the circumstances were exigent, thereby manufacturing a situation where negotiations became impractical. 

Despite CalPERS’ arguments, Judge Jury appeared to accept the genuineness of the need for San...


Let’s Watch Those Attorneys’ Fees: Another First in Detroit

Judge Steven Rhodes, who is overseeing Detroit’s Chapter 9 bankruptcy, appears set to take the unprecedented step of appointing an examiner to review professional fees in the case. 

Judge Rhodes proposed the use of an examiner prior to a hearing held on August 2, and, following that hearing, entered an order opening up a one week comment period in which parties could make suggestions for who the examiner should be. The use of fee examiners is on the rise in complex bankruptcy cases, having been used in the Lehman Brothers and General Motors bankruptcies, among others. 

The move by Judge Rhodes is notable because reviewing the retention and fees of a Chapter 9 debtor’s professionals is generally not within a bankruptcy court’s power. In most bankruptcy cases, a debtor must apply to the bankruptcy court for authorization to retain professionals, including attorneys, financial advisors and accountants. Once retained, those professionals may generally be paid out of a debtor’s estate, and...


Detroit News Roundup

Friday’s hearing in Detroit provided some indication of how the Detroit’s high-profile bankruptcy case will proceed moving forward. Judge Rhodes agreed to the creation of a committee of retired workers but left the U.S. Trustee to decide who its members would be, leaving open the possibility that organized labor would be represented.

Judge Rhodes also set a schedule going forward, ordering a hearing on the city’s eligibility to be a bankruptcy debtor on October 23, and indicating that the specific issues that will be addressed are whether Governor Rick Snyder's authorization for Chapter 9 bankruptcy filing was proper under the Michigan Constitution and whether the city has bargained in good faith with creditors. The city indicated it would file a plan by the end of the year while pensioners complained the cases were moving forward too quickly. Interested parties also have seven days to respond to his proposed mediator, Chief District Judge Gerald Rosen, of the U.S. District Court...


A Back Door Bailout for Detroit?

Chapter 9 is designed to "provide a financially-distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts." Much like Chapter 11, this can be accomplished in a variety of ways (other than a conversion of debt to equity), and a municipality has great latitude in proposing a plan of adjustment in order to accomplish the goals of Chapter 9. 

Chapter 9 does not imply a bailout by the federal government, or a takeover of the troubled municipality. Such an approach would be an offense to the notion of state sovereignty, a sacrosanct concept in the Chapter 9 realm. 

Recent news stories indicate that Detroit may attempt to push its retirees into the exchanges created by the Affordable Care Act (a/k/a Obamacare). The impact of this, depending on each individual retiree's income level, could be to shift the burden to federal taxpayers. Thus, rather than addressing one of Detroit's key problems: unfunded pension liabilities for retirees...


Can P3s Save the Public Sector?

Detroit’s recent bankruptcy filing, the largest Chapter 9 filing in U.S. history, highlights the potential consequences faced by our nation’s increasingly cash-strapped municipalities. Municipal bankruptcy filings remain relatively rare; approximately 40 governmental bodies (including utility authorities and special districts) have filed for Chapter 9 protection since 2008, which tracks the average of 8 filings per year since 1937. Nevertheless, Detroit’s experience proves that even major cities can quickly succumb to the pressures imposed by dwindling revenues and rising debt.

Given the country’s sluggish recovery from the Great Recession, as well as unrelenting increases in public pension and other long-term municipal debt, many public agencies are revisiting the viability of public-private partnerships, or “P3s,” as a financial salve. Structured correctly, a P3 can help a municipality maximize financing resources, increase return on investment, and expand and modernize services and...


Detroit’s Bankruptcy Case Gets Murkier With Other Collateral Lawsuits

On July 23, 2013, the Michigan Court of Appeals ordered a temporary halt to three lawsuits that seek to stop Detroit from filing for bankruptcy. The lawsuits were filed by city workers, retirees, and pension funds earlier this month, prior to Detroit’s bankruptcy filing on July 18, 2013

The suits anticipated that, in a bankruptcy, Detroit  would seek to cut retirement benefits. After filing the petition for relief under Chapter 9 of the Bankruptcy Code, Detroit’s emergency manager  requested an extension of the Chapter 9 automatic stay to include a freeze on legal actions such as those filed by the city workers, retirees, and pension funds. This is the first in what will certainly be many interesting events in the case of the nation’s largest city to have filed for Chapter 9. 

On Friday, the Michigan Circuit Court ruled that the state law that allowed Michigan Governor Snyder to approve the bankruptcy filing violated the Michigan Constitution. The Court ordered Kevyn Orr, the...


Jefferson County Bondholders Take Fee Fight to Higher Court

The indenture trustee for Jefferson County, Alabama bondholders recently appealed a bankruptcy court ruling that allowed the county to pay their bankruptcy lawyers out of the revenue from the municipal sewer system, which also backed the bonds. The bankruptcy court’s opinion was the third issued in the case addressing sewer system revenues and the various parties’ interests in those funds. 

In a lengthy opinion, Judge Bennett held that the fees of the bankruptcy lawyers were payable from sewer revenues ahead of payments to bondholders. Certain amounts would be considered operating expenses for the sewer system, which were contractually allowed to be paid. Others, the court held, would be categorized as necessary operating expenses under section 928(b) of the Bankruptcy Code.

The effect of categorizing certain expenses as necessary operating expenses is to give such amounts priority over the bondholders’ lien on the revenues in the bankruptcy case. As this decision alters the contractual...


Judge Orders Detroit Bankruptcy Filing Withdrawn

On Friday, Michigan State Circuit Court Judge Rosemarie Aquilina ordered the city of Detroit’s emergency manager, Kevyn Orr, to withdraw a federal bankruptcy petition filed on behalf of the city earlier this week, calling the law which allowed Michigan Gov. Rick Snyder to authorize the filing “unconstitutional.” The ruling was issued as part of a lawsuit  filed by  two retirement systems for the city to block the Chapter 9 filing.

On Thursday, July 18, 2013, the city of Detroit filed for the largest municipal bankruptcy in history, with an estimated $18 billion of debt. Mr. Orr, an attorney brought in by Gov. Snyder, recommended the filing. Mr. Orr has stated that he hopes to have Detroit emerge from Chapter 9 by later summer or early fall.  He previously characterized Detroit’s general obligation bonds as unsecured debt.




Detroit Files for Chapter 9

The city of Detroit filed for bankruptcy protection in the Bankruptcy Court for the Eastern District of Michigan on Thursday. Detroit’s bankruptcy is the largest Chapter 9 case in U.S. history. The filing comes just over three months after Governor Rick Snyder appointed Emergency Manager Kevyn Orr to try to solve the city’s apparently intractable debt woes.

As Orr stated in a declaration filed with the Court, “[a]fter decades of fiscal mismanagement, plummeting population, employment and revenues, decaying city infrastructure, deteriorating city services and excessive borrowing that provided short term band-aids at the cost of deepening insolvency, the city of Detroit today is a shadow of the thriving metropolis that it once was.” The city’s debt had swollen to over $18 billion by Orr’s count, with 38 cents of every city dollar going to service legacy debt. The city’s filing will give it an opportunity to formulate a proposal to make its debt burden more manageable.

A fight over the...


Jefferson County Files Plan of Adjustment

On Sunday, Jefferson County, Alabama filed its plan of adjustment and disclosure statement, officially initiating the end game of its Chapter 9 bankruptcy. The county and its stakeholders have been working towards the filing for months, with the county and the holders of much of its sewer system-related debt reaching a compromise that forms the basis for and is incorporated into the plan.

The plan will cut Jefferson County’s sewer system-related debt by $1.3 billion, to approximately $1.9 billion. In turn, the county will issue new warrants in an amount sufficient to make payments of approximately $1.835 billion to those creditors. The plan increases county sewer rates to ensure that the sewer system will generate adequate funds to service indebtedness, maintain operations, meet capital needs for the foreseeable future, and preserve county services. JPMorgan, who was alleged to have acted improperly in arranging risky securities deals that pushed the county into bankruptcy, will...


New York State Takes Steps Toward Establishing Bankruptcy Alternative for Cash-Strapped Municipalities

New York State Governor Andrew Cuomo, along with other state lawmakers, recently announced plans to establish a financial restructuring board to help financially distressed municipalities. The board would consist of ten members, six of whom would be appointed by the Governor, and would be tasked with making recommendations on improving finances and the management and delivery of municipal services. The board would have the ability to give participating municipalities up to $5 million to make any recommended changes.

In addition to financial oversight assistance, the board would also have the authority to serve as a binding arbitration panel to assist municipalities and their unions in resolving contract issues in an expedited process, provided both the municipality and the union agree to submit to arbitration. The financial oversight board is an attempt by state lawmakers to provide an alternative resolution process that does not include a bankruptcy filing.  The recent bankruptcy...


Jefferson County Enters the Home Stretch On the Backs of Bondholders

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 Roundup: There’s Good News and There’s Bad News (Mostly Bad News)

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...


Is Detroit Jefferson County All Over Again?

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...


When is a Political Subdivision Not a Political Subdivision? When the IRS Says So

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...


Visionary Schemes Need Not Apply: The Chapter 9 Plan Feasibility Requirement

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...


How is the “Best Interests” Standard Different Under Chapter 9 and Chapter 11?

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...


Orr Will Announce His Decision on Chapter 9 Petition in Five Weeks

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.  


CalPERS Seeks to Disqualify Counsel for National Public Finance Guarantee

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.


Will Traditional Chapter 11 Investors Find a Role in Chapter 9?

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...