Municipal Restructuring Solutions: Detroit and Beyond Harriet M. - - PowerPoint PPT Presentation

Municipal Restructuring Solutions: Detroit and Beyond

Harriet M. Welch Jordan A. Kroop Sherri L. Dahl

August, 2013

2

Alternatives to Chapter 9 Bankruptcy Filing

• Borrowing from internal pools
• Pension Plans
• Commercial lenders
• Refinancing
• Issuance of judgment bonds
• Postponing payments or restructuring
• Individual creditor discussions and workouts
• Cutting expenses
• Payroll reductions
• Renegotiation of pension system for incoming employees and

current employee contributions

• Redefine future retiree medical benefits
• Consolidation of services – change service levels
• Increase service fees
• Sell non-critical assets

3

Increase Revenues

• Increase taxes
• Income tax
• Property tax
• Voted – what percentage approval?
• Does state law permit un-voted increase?
• Other taxes
• Bed tax
• Ticket tax
• Rental car tax
• “Sin Tax” – alcohol / cigarettes

4

Other sources of Revenue

• Fines/forfeitures – traffic, parking, civil filing
• Licenses/permits – inspection fees, business fees,

building, zoning, operating license, cell tower fees

• Service charges – solid waste collections, recycling
• Utility system revenues
• Traffic cameras
• Sale or lease of property
• Mineral rights
• Geothermal or solar power facilities
• Wind turbines
• Sale/lease-back of public facilities
• Parking facilities
• Asset sales
• Public-public option using ground lease

5

Reduce Expenditures

• Workforce reduction
• Service reduction
• Privatize
• Eliminate
• Share with other communities
• Reduce costs
• Energy cost reduction programs
• Pooled purchasing
• Health insurance cost reductions

6

And if none of that works . . . A Chapter 9 filing . . . If eligible . . . And a plan of adjustment

7

History of Municipal Bankruptcy

• First federal Municipality Bankruptcy Act, enacted in 1934 during

the Depression – held unconstitutional in Ashton v. Cameron County Water Improvement District (1936) as improper interference with states’ sovereignty

• Second municipal bankruptcy legislation adopted in 1937, was

upheld as constitutional in U.S. v. Bekins (1938).

• Current Chapter 9 of the U.S. Bankruptcy Code strikes

essentially same constitutional balance as 1937 statute

• No real constitutional challenge to Chapter 9 in recent cases
• Wholesale constitutional challenges not likely to succeed in light of

Bekins precedent

8

Primary Current Issues in Chapter 9 Cases

• Eligibility for Chapter 9 Relief
• Treatment of General Obligation versus

Special Revenue Bonds

• Treatment of Pension Obligations
• Treatment of Collective Bargaining

Obligations

9

Significant Differences between Chapters 9 & 11

The following Bankruptcy Code provisions apply only to Chapter 9:

• “the court may not, by any stay, order, or decree, in the case or
• therwise, interfere with (1) any of the political or governmental

powers of the debtor; (2) any of the property or revenues of the debtor; or (3) the debtor’s use or enjoyment of any income- producing property.” 11 U.S.C. § 904

• “This chapter does not limit or impair the power of a State to

control, by legislation or otherwise, a municipality of or in such State in the exercise of the political or governmental powers of such municipality, including expenditures for such exercise, but – (1) a State law prescribing a method of composition of indebtedness of such municipality may not bind any creditor that does not consent to such composition; and (2) a judgment entered under such a law may not bind a creditor that does not consent to such composition.” 11 U.S.C. § 903

10

Eligibility—State Law Authorization

• 11 states provide blanket authorization for municipal bankruptcy

(Alabama, Arizona, Arkansas, Colorado, Florida, Minnesota, Missouri, Nebraska, Oklahoma, South Carolina, and Texas);

• 22 states do not provide statutory access to municipal

bankruptcy (Georgia explicitly denies access; the following have no statute: Alaska, Delaware, Hawaii, Indiana, Kansas, Maine, Maryland, Mississippi, Massachusetts, Nevada, New Hampshire, New Mexico, N. Dakota, Rhode Island, S. Dakota, Tennessee, Utah, Vermont, Virginia, W. Virginia, Wisconsin, and Wyoming);

• 17 states set conditions for municipal bankruptcy (California,

Connecticut, Idaho, Illinois, Iowa, Kentucky, Louisiana, Michigan, Montana, New Jersey, New York, N. Carolina, Ohio, Oregon, Pennsylvania, and Washington).

11

11 U.S.C. § 109 (Chapter 9 Eligibility Requirements)

“An entity may be a debtor under chapter 9 . . . If and only if such entity (1) Is a municipality; (2) is specifically authorized, in its capacity as a municipality or by name, to be a debtor under such chapter by State law, or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor under such chapter; (3) is insolvent; (4) desires to effect a plan to adjust such debts; and (5)(A) has obtained the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter; (B) has negotiated in good faith with creditors and has failed to obtain the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter; (C) is unable to negotiate with creditors because such negotiation is impracticable; or (D) reasonably believes that a creditor may attempt to obtain a transfer that is avoidable under section 547

• f this title.”

12

Eligibility—Detroit, MI

• With the consent of the governor, Detroit filed for

Chapter 9 relief on July 18, 2013.

• Michigan Constitution provides: “The accrued

financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby.”

• Statute giving governor power provides that

governor must not violate state law. If pensions are impaired, did the governor violate Michigan law by even seeking Chapter 9 relief?

13

Eligibility—Harrisburg, PA

• Harrisburg, Pennsylvania (2011) Harrisburg

guaranteed debt issued by special purpose vehicle formed to finance an incinerator plant. Mayor resisted Chapter 9.

• City Council authorized Chapter 9 filing.
• Other elected state officials opposed filing.
• In November 2011, Bankruptcy Court dismissed

the Chapter 9 case, ruling that the filing was unauthorized under state law.

• The governor commenced a state court receiver

action.

14

Eligibility & CBA Issues—Vallejo, CA

• Vallejo, California (2008) Eligibility litigation lasted more than a

year, involving complex issues of insolvency and pre-bankruptcy good-faith negotiations with creditor constituencies.

• Principal litigants were police, firefighter, and public employee

unions.

• Bankruptcy Court held that labor agreements could be rejected

under Bankruptcy Code § 365.

• The parties negotiated new labor agreements.
• The plan of adjustment laid off city workers, required new city

workers to contribute more to pensions and all employees to contribute more to their health insurance benefits.

15

Collective Bargaining Agreements

• Vallejo, CA case established that Bankruptcy

Code § 1113 does not apply in Chapter 9 cases.

• As a result, debtor may unilaterally assume or

reject a collective bargaining agreement under the general provisions of Bankruptcy Code § 365 as long as the action does not constitute an unfair labor practice under NLRA.

• Unfair labor practice in the bankruptcy context is

described in the U.S. Supreme Court case of NLRB v. Bildisco & Bildisco.

16

Pension Issues—San Bernardino, CA

• San Bernardino, California (2012)

Sales and property tax revenues decreased dramatically, resulting in a Chapter 9 filing.

• After filing, the debtor ceased payments

to CalPERS for pension obligations.

• The plan currently pending defers $35

million of payments to CalPERS.

• CalPERS objected to eligibility based on

good faith grounds. A hearing on eligibility is scheduled for August 2013.

17

Pension vs. Bond Obligations—Stockton, CA

• Stockton, California (2012) Stockton filed after

declines in property and sales tax revenues.

• Stockton has proposed to significantly reduce its

general revenue bond debt while leaving its pension obligation owed to CalPERS unimpaired.

• Assured Guaranty Corp. and others objected to

the debtor’s eligibility for filing, arguing debtor did not negotiate in advance in good faith. Bankruptcy Court overruled objections.

18

Which Has Priority? Debt Obligations v. Pension Obligations

Detroit, MI: Michigan’s constitution protects pension liabilities; June 13th pension bond payment of $35.3 million unpaid; Detroit calls GO bond obligations “unsecured” That Michigan has state constitutional protection for pension liabilities may not turn the obligation into something other than a general unsecured obligation under Chapter 9 of the Bankruptcy

• Code. Owing to the precedents set by, among others, the Vallejo,

CA Chapter 9 case, executory contracts such as CBAs and pension plans can likely be rejected, giving rise to unsecured claims that may be on the same level of priority as GO bond

• bligations if the latter are deemed unsecured.

19

Jefferson County, Alabama—Bonds

• Jefferson County, Alabama (2011)

County defaulted on sewer system debt (special purpose vehicle).

• Plan was agreed to in June 2013, which

has not yet been approved by the court.

• In the plan, creditors receive 60%
• JPMorgan will forgive $842 million.
• County will increase sewer rates by 7.4%

annually for 4 years.

20

General vs. Special Revenue Bonds

• General obligation bonds:
• not entitled to post-petition interest
• treated as unsecured claims, which may be impaired.
• Automatic stay applies.
• Special revenue bonds:
• Continue to be “secured” by revenue stream;
• Revenue stream may continue to be collected despite automatic stay;
• Subject to necessary operating expenses.

“Special Revenues” means: (A) receipts derived from the ownership, operation, or disposition of projects or systems of the debtor that are primarily used or intended to be used primarily to provide transportation, utility, or other services, including the proceeds of borrowings to finance the projects or systems; (B) special excise taxes imposed on particular activities or transactions; (C) incremental tax receipts from the benefited area in the case of tax-increment financing; (D)

• ther revenues or receipts derived from particular functions of the debtor, whether or not the

debtor has other functions; or (E) taxes specifically levied to finance one or more projects or systems, excluding receipts from general property, sales, or income taxes (other than tax- increment financing) levied to finance the general purposes of the debtor. 11 U.S.C. § 902(2).

• The characterization of a bond issuance in the indenture may not

necessarily mean that the issue will be characterized similarly for Bankruptcy Code purposes

21

Contagion

Are the current crop of municipal bankruptcies creating “contagion” for other issuers in the same states or across the municipal market? Are other bonds able to be marketed in the wake of uncertainty?

22

State statutes that secure GO bonds

While not “special revenue bonds,” some states have provisions that may “secure” GO bonds with statutory liens: California, Colorado, Louisiana, and Rhode Island. Rhode Island 45-12-1

“ . . . The power and obligation of each city and town to pay its general obligation bonds and notes, whether or not issued pursuant to this chapter, shall be unlimited, and each city and town shall levy ad valorem taxes upon all the taxable property within the city or town for the payment of the general obligation bonds or notes and interest

• n these bonds or notes, without limitation of rate or amount, except as otherwise

provided by or pursuant to law. The faith and credit ad valorem taxes, and general fund revenues of each city, town and district shall be pledged for the payment of the principal of, premium and the interest on, all general obligation bonds and notes of the city or town whether or not the pledge is stated in the bonds or notes, or in the proceedings authorizing their issue and shall constitute a first lien on such ad valorem taxes and general fund revenues. . . .” This was a recent change in Rhode Island law brought about largely in contemplation

• f state receiverships and possible Chapter 9 filings by Rhode Island municipalities. It

played a significant role in preparing for and affecting the Central Falls case, but has not been tested in court.

23

Restructuring – Orange County, CA & Westfall PA

• Orange County, California (1994) After loss of $1.7 billion in its

investment pool and after voters rejected a tax increase, a plan

• f adjustment was negotiated which included:
• (a) diverting tax funds from other agencies to pay bondholders;
• (b) county issued $880 million in 30-year bonds; and
• (c) Wall Street firms paid over $600 million to settle claims on

illegal investments.

• Westfall, Pennsylvania (2009) Filed bankruptcy after a $20

million judgment obtained by property developer.

• Plan confirmed reduced the developer’s claim to $6 million paid
• ver 20 years without interest.
• Property taxes were raised by 48 percent, with gradual decrease

each year over 20 years

24

Credit Information

• For those you who require CLE or CPD credits please note the

following states have been approved, California and Ohio (self- study); as well as Arizona, New York, and New Jersey through state reciprocity laws. CPD and CPE have also been approved. Florida and Ohio are still pending CLE. If you require credit in a jurisdiction not pre-approved we can assist.

• Please write down the following affirmation code. Tomorrow you

will receive an email with a link to an online affidavit. Open this link and complete the form. Don’t forget to include the affirmation code on the form. Once completed, PDF a copy of the signed form to Robin Hallagan at robin.hallagan@squiresanders.com.

• Remember to complete the webinar survey immediately

following the end of this presentation. You are required to complete this evaluation before receiving a certificate of attendance.

For Position Only

25

APPENDIX

26

Comparison of Chapter 9 & 11

Chapter 9 Chapter 11

Judge assigned by Chief Judge of the Circuit Random assignment within district Involuntary filing not permitted Voluntary & involuntary permitted Debtor can pay pre-bankruptcy debt post- bankruptcy Debtor may not pay pre-bankruptcy debt post-bankruptcy without Court approval No forced sales Secured creditor may force sale of assets to satisfy secured creditor’s lien Court cannot order spending reductions

• r increase in taxes.

Court cannot control debt incurred post- bankruptcy. Court may not interfere with most activities. Court must approve everything outside the ordinary course of business Court confirms plan of adjustment and maintains jurisdiction over implementation. Same (plan of reorganization)

27

Comparison of Chap. 9 & 11 (cont.)

Chapter 9 Chapter 11

U.S. Trustee appoints committees, if necessary; no other role U.S. Trustee has general authority over all actions, including reporting requirements No Court approval to retain and pay professionals. Court approval required for retention and payment of professionals Preferences are generally treated the same as in chapter 11, except that a transfers to or for the benefit of a bondholder or noteholder may not be avoided as a preference. (11 U.S.C. 926(b)) Must be specifically authorized by state

• law. 11 U.S.C. § 109(c)(2) (“is

specifically authorized, in its capacity as a municipality or by name, to be a debtor under such chapter by State law, or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor under such chapter”). Not applicable Eligibility hotly litigated Eligibility rarely litigated

28

Appendix: Michigan – Act 436 of 2012

• 141.1566 Chapter 9 proceeding.
• Sec. 26.
• (1) With the written approval of the governor, a local government

may file a petition under chapter 9 and exercise powers pursuant to federal bankruptcy law if the local government adopts a resolution, by a majority vote of the governing body of the local government, that declares a financial emergency in the local

• government. Except as otherwise provided in this subsection, if

the local government has a strong mayor, the resolution requires strong mayor approval. The resolution shall include a statement determining that the financial condition of the local government jeopardizes the health, safety, and welfare of the residents who reside within the local government or service area of the local government absent the protections of chapter 9 and that the local government is or will be unable to pay its obligations within 60 days following the adoption of the resolution.

29

Appendix: Michigan – Act 436 of 2012 (cont.)

• (2) If the governor approves a local government to proceed

under chapter 9, the governor shall inform the local government in writing of the decision. The governor may place contingencies

• n a local government in order to proceed under chapter 9

including, but not limited to, appointing a person to act exclusively on behalf of the local government in the chapter 9 bankruptcy proceedings. If the governor does not appoint a person to act exclusively on behalf of the local government in chapter 9 bankruptcy proceedings, the chief administrative

• fficer of the local government shall act exclusively on behalf of

the local government in chapter 9 bankruptcy proceedings. Upon receipt of the written approval and subject to this subsection, the local government may proceed under chapter 9 and exercise powers under federal bankruptcy law.

• (3) If the governor does not approve a local government to

proceed under chapter 9, the local government shall within 7 days select 1 of the other local options as provided in section 7.

• History: 2012, Act 436, Eff. Mar. 28, 2013

30

Appendix: Ohio Rev. Code 133.36

• 133.36 Refunding of securities under bankruptcy act.

For the purpose of enabling subdivisions to take advantage of the act of congress entitled "An act to establish a uniform system of bankruptcy throughout the United States," approved July 1, 1898, including acts amendatory thereof and supplementary thereto, and for that purpose only, and notwithstanding any statutes of this state to the contrary, particularly this chapter, the taxing authority of any subdivision provided for in the act and acts amendatory thereof and supplementary thereto, upon approval of the tax commissioner, may file a petition stating that the subdivision is insolvent or unable to meet its debts as they mature, and that it desires to effect a plan for the composition or readjustment of its debts, and to take such further proceedings as are set forth in the act of congress and acts amendatory thereof and supplementary thereto as they relate to any such subdivision. The taxing authority

• f any subdivision provided for in the act, at any time such acts are

in force and applicable, may upon like approval refund its

• utstanding securities, whether matured or unmatured, and

exchange refunding bonds for the securities being refunded.

31

Appendix: Ohio Rev. Code 133.36 (cont.)

In its order approving such refunding, or in any amendment thereof, the tax commissioner shall fix the maturities of the bonds to be issued, which need not be subject to sections 133.20 and 133.21 of the Revised Code, or any other sections of the Revised Code limiting the maturities thereof. Such refunding bonds may bear different rates of interest for different periods of time during their life. No such bonds shall mature in more than thirty years. The debt charges thereon shall have the same status with respect to the limitations imposed by Section 2 of Article XII, Ohio Constitution, as the debt charges on the securities which are

• refunded. No taxing subdivision shall be permitted, in availing itself
• f such acts of congress, to scale down, cut down, or reduce the

principal sum of its securities, except that interest thereon may be reduced in whole or in part.

• Effective Date: 10-30-1989

32

What is a Municipality?

• “The term “municipality” means political

subdivision or public agency or instrumentality of a State.” 11 U.S.C. § 101(40).

• Bankruptcy Code does not further define

political subdivision, public agency, or instrumentality

• Several cases define what qualifies as a

municipality

33

Cases holding that debtor not municipality

• 10 decisions between 1965 and 2012 regarding what is a

municipality

• 7 of 10 determined that the debtor was a municipality
• Cases holding that debtor was not a municipality
• In re Las Vegas Monorail (Bankr. D. Nev. 2010) Chapter 11 case. Ambac

Assurance Corp argued that LVM was a municipality and should be in Chapter 9. HELD: LVM is not a municipality (instrumentality of the state). Important: Nevada does not have a state statute authorizing chapter 9 filings;

• In re County of Orange (Bankr. C.D. Cal. 1995) Commingled investment pool

debtor . HELD: not a municipality;

• Central Falls v. Central Falls Teachers’ Union (Bankr. D.R.I. 2012) Question:

Whether the school district was part of the city and subject to the city’s Chapter 9 bankruptcy? HELD: Until 1991, the school district was part of the city of Central

• Falls. After 1991, the school district no longer part of the city due to amendments

to the city charter, deleting two words.

34

Appendix: Cases holding that debtor is a municipality

• 1. In re New York City Off-Track Betting Corp., 427 B.R. 256

(Bankr. S.D.N.Y. 2010). New York City Off-Track Betting Corp (“OTBC”) initiated municipal insolvency proceedings under chapter 9 of the Bankruptcy Code. Creditors objected arguing, among

• ther things, that OTBC could not satisfy the Chapter 9 municipal

debtor requirements. The court concluded that OTBC qualified as a municipality because it was a public benefit corporation “created by the State for the general purpose of performing functions essentially governmental in nature.”

35

Appendix: Cases holding that debtor is a municipality

• 2. In re Westport Transit District, 165 B.R. 93 (Bankr. D. Conn.

1994). Westport Transit District (“WTD”) sought relief from the municipal bankruptcy provisions of the Bankruptcy Code after a $1 million judgment was entered against it in a state-court antitrust action brought by Westport Taxi Service, Inc. The court concluded that the phrase “of a State” in section 101(40) of the Bankruptcy Code does not signify that municipal bankruptcy is limited to a public agency of a particular state as opposed to a public agency

• f a town. The court determined that WTD met the definition of

municipality because: (1) it was created through the state’s transit district enabling statutes; (2) its board of directors were appointed by member towns, cities or boroughs; (3) the district could assume all powers of the department of transportation within the district, including the establishment of passenger fares, regulation of existing transit systems, and the right to use revenues to subsidize transit systems operating under private ownership; (4) the district was authorized to acquire an existing transit system; and (5) the district could issue bonds and notes, and obtain state guaranties of payment.

36

Appendix: Cases holding that debtor is a municipality

• 3. In re Sullivan County Regional Refuse Disposal District, 165

B.R. 60 (Bankr. D.N.H. 1994). On September 16, 1993, the Sullivan County Regional Refuse Disposal District and the Southern Windsor/Windsor Counties Solid Waste Management District each filed chapter 9 municipal bankruptcy petitions. Although not disputed by the parties, the court found that the debtors were political subdivisions of the state in implementing federally mandated solid waste laws. Therefore, the debtors were determined to be municipalities as defined by the Bankruptcy Code.

37

Appendix: Cases holding that debtor is a municipality

• 4. In re Greene County Hospital, 59 B.R. 388 (S.D. Miss. 1986).

In 1986, a District Court concluded that Greene County Hospital was a municipality and therefore qualified for municipal bankruptcy

• relief. The lower court had previously concluded that the Hospital

was a public agency. The District Court applied a test examining whether an entity is public or private by determining whether it is subject to control by a public authority, state or municipal. The court identified several sections of the Community Hospitals chapter of the Mississippi Code confirming that the board of supervisors had the power to exert some control over the county hospitals, even though the power was traditionally limited to real estate and property management. Accordingly, the District Court held that the Hospital was a municipality.

38

Appendix: Cases holding that debtor is a municipality

• 5. Pleasant View Utility District of Cheatham County, Tennessee,

24 B.R. 632 (Bankr. M.D. Tenn. 1982). The Pleasant View Utility District initiated chapter 9 proceedings after unsuccessful negotiations seeking additional funding, including negotiations with holders of the District’s outstanding bonds. Although the parties did not dispute that the District was a municipality, the court found that it was a municipality based on a Tennessee Code provision classifying utility districts as municipalities or public corporations.

39

Appendix: Cases holding that debtor is a municipality

• 6. In re North and South Shenango Joint Municipal Authority, 14

B.R. 414 (Bankr. W.D. Pa. 1981) Authority was incorporated to construct and operate a sewer system which was later found to have been defectively constructed. Pennsylvania law required the Department of Internal Affairs to approve or disapprove the filing of any bankruptcy petition on behalf of a political subdivision. After the Authority filed a chapter 9 case, the Bankruptcy Court concluded that it was not a political subdivision, but that it was a public agency or instrumentality. In making this determination, the Bankruptcy Court relied on the definition of political subdivision in the Pennsylvania Consolidated Statutes. The Bankruptcy Court listed the independent powers held by authorities in Pennsylvania, including the power to make contracts, sue and be sued, acquire property, maintain and operate projects, execute instruments, borrow money, and eminent domain. Finally, in rendering its decision, the Bankruptcy Court stressed that a bankruptcy would be more economical than a receivership and listed the protections and advantages of bankruptcy reorganization procedures.

40

Appendix: Cases holding that debtor is a municipality

• 7. In re York County Natural Gas Authority, 238 F.Supp. 964

(W.D. S.C. 1965). In this case, the court concluded that the Debtor was a public agency by applying the legal test contrasting private entities to public entities which are subject to control by public authority, state or municipal. The court applied the following definition of public: pertaining to, or belonging to, the people; relating to a nation, state or community.