Municipal Restructuring Solutions: Detroit and Beyond Harriet M. Welch Jordan A. Kroop Sherri L. Dahl August, 2013
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 2
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 3
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 4
Reduce Expenditures • Workforce reduction • Service reduction Privatize Eliminate Share with other communities • Reduce costs Energy cost reduction programs Pooled purchasing Health insurance cost reductions 5
And if none of that works . . . A Chapter 9 filing . . . If eligible . . . And a plan of adjustment 6
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 7
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 8
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 otherwise, 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 9
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). 10
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 of this title.” 11
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? 12
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. 13
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. 14
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 . 15
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. 16
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. 17
Which Has Priority? Debt Obligations v. Pension Obligations Detroit, MI : Michigan’s constitution protects pension liabilities; June 13 th 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 obligations if the latter are deemed unsecured. 18
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