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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...

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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...

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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...

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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...

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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...

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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.

 

 

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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...

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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...

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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...

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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...

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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...

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California Public Policy Center Estimates CA Debt in Excess of $1.1 Trillion

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...

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SEC Charges Harrisburg, PA with First Ever Municipal 10(b) and 10(b)(5) Violations

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...

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Good Faith: Not Always as Easy as it Sounds

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...

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Will The Next Wave of Chapter 9 Filings Be From Public Hospitals?

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...

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Detroit, California, Jefferson County…Oh My!

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...

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Jefferson County Bankruptcy Court Rules That Automatic Stay Applies to Action Even Though the County is Not a Named Defendant

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...

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War on CalPERS?

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...

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Budget Realities: Pension and OPEB Liabilities Facing Municipalities

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...
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Goodwin Procter Partner Deborah Schrier-Rape to Moderate Panel on Municipal Insolvency Issues at 21st Annual ABI Bankruptcy Battleground West Los Angeles on March 22

On March 22, Goodwin Procter partner and MuniBK editor Deborah Schrier-Rape will participate in the 21st Annual American Bankruptcy Institute conference entitled, “Bankruptcy Battleground West Los Angeles.” This year the conference will be held at the Hyatt Regency Century Plaza in Los Angeles, California.

Deborah will act as moderator for the panel entitled, “Boom & Bust: California Cities.” The panelists will include: Hon. Christopher M. Klein, U.S. Bankruptcy Court (E.D.Cal.); J. Robert Medlin of FTI Consulting, Inc.; Karol K. Denniston of Schiff Hardin LLP; and Jeffry A. Davis of Mintz, Levin, Cohn, Ferris, Glovsky & Popeo, PC.

The panelists will discuss pending Chapter 9 cases involving a number of California cities including Stockton, San Bernardino, and Mammoth Lakes. In addition, they will discuss matters particular to municipalities in California including:

  • the requirements of AB 506 and its gate-keeper function;
     
  • the structure and enforcement of municipal bonds in...
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