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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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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...

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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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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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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...

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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.  

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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.

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Detroit: At Least as Bad as Expected

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...

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Stockton Bankruptcy Portends Pension Debate

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...

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San Bernardino Says OK to CalPERS in New Budget

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....

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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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Section 903 – In Chapter 9 Does Federal Law Trump State Law or Vice Versa?

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...

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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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Stockton Can Stay in Bankruptcy

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...

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I’m a Creditor of Detroit…Now What? (Part 2 of 2)

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:

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...
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I’m a Creditor of Detroit…Now What? (Part 1 of 2)

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:

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