Detroit’s Pension Blues. Detroit’s two pension funds—the General Retirement System and the Police and Fire Retirement System—experienced losses of 47% and 33% on real estate investments from 2008 to 2012. In 2006 businessman Robert Shumake asked the boards of Detroit’s two pension funds to give him $27 million to invest in real estate through his firm Inheritance Capital Group. The general employee pension invested $12 million with Inheritance; the police and fire fund invested $15 million, according to a suit they filed against the company in Wayne County Court in 2011. The stakes were valued at $1.7 million and $11.6 million, respectively, as of June 30, 2011. Inheritance Capital Group filed for chapter 11 corporate bankruptcy in April 2012. Mr. Shumake filed for personal bankruptcy last January. Now as Judge Rhodes takes charge in a U.S. Bankruptcy Court, and as the federalism battle between Michigan’s constitutional protection of pensions plays out against the Emergency Manager’s plan to sharply reduce retirement benefits affecting some 30,000 employees and retirees, the pension investment choices will haunt. Emergency Manager Orr’s report notes that Detroit’s pensions are underfunded by as much as $3.5 billion, in part because of unrealistic assumptions of 8% annual investment returns. The pensions say the gap between assets and obligations to retirees is $700 million, according to a June 20 statement. Although authorities have investigated investments, the present General Retirement System Board is acting responsibly, according to its legal counsel, Michael VanOverbeke. He says the fund has fared well compared with other public pensions.
The funds receive contributions from the city and employees and invest them in stocks, bonds, private equity, and real estate. Board members, who are chosen by employees, retirees, and Detroit’s mayor, do not necessarily have investment experience. Moreover, there is some speculation that some of these questionable investments made from 2006 to 2008, were influenced by then-Mayor Kwame Kilpatrick, who has served prison time for perjury and now faces sentencing for a March 11 conviction on federal corruption and racketeering charges. The murk deepened with the Kilpatrick administration’s sale of $1.4 billion in debt in 2005 to fund the pension and create a pool of money that attracted speculative offers for pension fund investments. The value of real estate held by the General Retirement System declined about 47%, or $293.2 million, from June 30, 2008, to June 30, 2012, according to reports filed with the state treasurer. The Police and Fire Retirement System’s real estate investments declined 33%, or $228.3 million. Those numbers compare to a 3.6% gain during that period by the National Council of Real Estate Investment Fiduciaries property index, which gauges a pool of almost 7,200 commercial properties acquired by pensions and nonprofit investors. The $2 billion general employee fund lost $16 million in fiscal 2010 after writing off a housing development near Sarasota, Fla., that fell apart after the real estate bubble burst, according to pension fund records. The $3.2 billion police and fire fund lost about $15 million on 1,100 vacant acres 30 miles east of Dallas that were to be sold to homebuilders. A 2006 loan guarantee for a Westin hotel and condos in downtown Detroit cost the two funds $14 million. In addition, the funds lost more than $20 million investing in a telecommunications company founded by a Detroit businessman, $30 million on a cargo airline, and almost $70 million on collateralized debt obligations—securities backed by a pool of bonds, loans, and other assets. A real estate adviser to the boards, Chauncey Mayfield, has pled guilty to federal bribery charges. He flew Kilpatrick and Jeffrey Beasley, the city’s former treasurer, to Las Vegas for a weekend that included golf, rooms at the Venetian Resort Hotel & Casino, concerts by Toni Braxton and Prince, and massages at the Canyon Ranch Spa, according to a complaint last year by the SEC—shades of Jefferson County. This June, the SEC alleged that Mayfield stole $3.1 million from Detroit’s police and fire pension to buy two strip malls in California. Mr. Mayfield and his firm agreed to settle the case, without admitting or denying liability, by paying back the amount.
Windy City Nuptuals. Mayor Rahm Emanuel this week interrupted a key meeting at City Hall to announce the betrothal of one of the city’s most celebrated attorneys, currently a crack lawyer at the prestigious Municipal Securities Rulemaking Board, where she presides over an ever growing empire, not to mention increasingly fierce Italian designer shoe competition with another budding Chicago student, Puffy Majroh. Mayor Emanuel reported there would be fiscal implications to the wedding, as he would be forced to call up hundreds of off duty police officers in anticipation of record crowds to observe the joyful rites. Nevertheless, he expected the star-studded rites to attract international media attention, calling the event a “Prada in the Stada.”
Municipal Bankruptcy Schedules. Just as Judge Rhodes has proposed an ambitious schedule for Detroit to exit bankruptcy, Jefferson County, Alabama has proposed its own aggressive timetable for exiting Chapter 9 bankruptcy this year; however, objections have been lodged before the judge overseeing the case can even confirm the schedule. Jefferson County understands that every day consumed in federal court keeps an expensive meter running. In the Jefferson County case, a local water board, a city, assorted elected officials, and others who oppose a proposed wastewater sewer rate increase critical to the proposed exit plan, have filed objections. The county will be asking U.S. Bankruptcy Court Judge Thomas Bennett next Tuesday to approve the county’s 822-page disclosure statement detailing facts about the county’s fiscal condition and its plan of adjustment, which hinges on refinancing $1.9 billion of sewer warrants. Judge Bennett will also lend an ear to arguments from objectors. (Jefferson County filed for bankruptcy in November 2011 citing $4.2 billion of warrants — $3.1 billion attributed to the insolvent sewer system.) The county, in a revised disclosure statement filed Monday, wrote that “the compromises and settlements embodied by the plan [of adjustment] resolve many highly complex and uncertain issues that could take years and millions of dollars to litigate to finality….The comprehensive and final resolution of these issues under the plan provides for a fair and equitable result and greater distributions to the county’s creditors, and offers the county and its sewer system a ‘fresh start’ from a history plagued by actual and potential litigations.” In its proposed exit plan, Jefferson County proposes to make creditors holding general obligation, school and lease warrants whole for principal, while making adjustments to indentures, redemption schedules, or, in the case of the lease warrants, extending the maturity schedule. In some cases, higher penalty interest rates that were imposed on variable-rate debt may not be paid. The key to successful exit involves the county’s plan to restructure $3.2 billion of debt on its sewer system, much of which consists of failed variable-rate demand and auction-rate warrants—a part of the proposed plan achieved through agreement with creditors of the county’s sewer system through which the county projects achieving more than $1.3 billion of concessions, which would reduce the sewer system’s indebtedness to approximately $1.9 billion. But in comments filed by the City of Bessemer and Birmingham’s Water Works Board (Birmingham had earlier filed suit against its surrounding Jefferson County over the proposed closure of hospital services.), the two objected that Jefferson County’s disclosure statement fails to adequately address “financial information, data, valuations or projections” and risks that are relevant to creditors’ decisions whether to accept or reject the proposed plan—the Water Works Board provides billing for 113,000 of the county’s sewer customers while Bessemer, a municipality in Jefferson County, also provides billing for 19,258 sewer customers. The two objectors assert they are “parties in interest” because of their “pecuniary and practical interest in the long-term viability of the [county’s] plan.” The Water Works Board and Bessemer also said that a proposed plan for refinancing sewer warrants later this year initially decreases outstanding debt to $1.9 billion or $13,000 per sewer system customer, but would then grow to a peak of $2.55 billion or $17,000 per customer because of the way the financing is structured. Under Jefco’s proposed plan, official sewer system creditors, including those who are not parties to the county’s negotiated agreements approving the debt restructuring, would realize a return on their investments of between 65% and 80%. Creditors who choose to pursue insurance claims would receive 65 cents on the dollar, while those who forego insurance would be guaranteed 80 cents on the dollar. In order for the sewer system debt restructuring to occur, the county proposes to issue $1.9 billion of warrants soon after confirmation of the bankruptcy plan. Outside of the courtroom objections to Jefferson County’s proposed exit plan, churches and community organizations are planning their own meetings to organize protests over the planned rate increases. Today is the deadline for filing objections to the county’s revised disclosure statement and plan. If Judge Bennett approves the plan and voting procedures next week, ballots will be sent to all of the county’s creditors. The county already has agreements from major creditors holding the sewer, school, lease, and GO warrants who have agreed to vote for the plan. Ballots must be returned by Oct. 7. A hearing confirming the plan is tentatively scheduled for November 12th, and Jefferson County is planning to officially exit Chapter 9 bankruptcy by New Year’s Eve.
Municipal Bankruptcy ≠ A Bailout. Some readers appear to still be confused about chapter 9 municipal bankruptcy, believing it somehow triggers a federal bailout. As can be seen from the ongoing trials and tribulations of Jefferson County as it seeks to exit and Detroit as it seeks to enter; municipal bankruptcy is an expensive, exhausting process of readjusting debt and getting back on one’s feet without any federal assistance—except for the patience of U.S. Bankruptcy court judges. Put another way, as former Rhode Island Supreme Court Justice and Receiver for Central Falls in its chapter 9 bankruptcy put it: ‘Frank, if a mother sees that her house is on fire, and she dials 9-1-1, a creditor, a retiree, a contractor is not going to respond. The key is to preserve sufficient cash to ensure the provision of essential services while working out an adjustment plan to equitably address all the city’s creditors…’ In effect, chapter 9 imposes a freeze on payments to non-essential creditors in order for a city or county to provide the most critical and essential services to its citizens. As if to underscore that, consider yesterday’s debate and action on the floor of the U.S. Senate:
“As Detroit decays, Chicago is a maelstrom of violence, and yet no one questions sending billions of your dollars to Egypt, to despots and dictators in foreign countries. Our nation’s bridges are crumbling, and few politicians from either party will question billions of dollars being spent overseas.” ~ Sen. Paul Rand (R-Ky), during debate on the Senate floor this week on his amendment to the FY2014 Transportation Appropriations bill to shift $1.5 billion in annual U.S. aid to Egypt to infrastructure repairs across the U.S. The amendment was rejected 86-13.
Fundamental issues that go to the heart of governance and federalism. Yesterday, we noted some interest and pressure to seek action in Congress to enact new federal legislation for state bankruptcy. The incomparable Jim Spiotto yesterday provided me with his St. Valentine’s day, 2011 testimony on this issue before the House Judiciary Committee, of which the most critical portion follows:
Principles of Federalism and Dual Sovereignty Preclude any Bankruptcy Proceeding Without a State’s Consent
The enactment of a bankruptcy vehicle for States would face a number of legal impediments. As a threshold matter, the dual sovereignty of the Federal Government and the States precludes the Federal Government from imposing a mandatory bankruptcy procedure on the States. Dual sovereignty is a defining feature of our Nation’s constitutional blueprint.[i] States, upon ratification of the Constitution, did not consent to become mere appendages of the Federal Government. Rather, they entered the Union “with their sovereignty intact.”[ii] As noted in the decision of Federal Maritime Commission v. South Carolina State Ports Authority, 535 U.S. 743, 152 L. Ed. 2d 962, 122 S. Ct. 1864 (2002) (“Federal Maritime Commission”), the U.S. Supreme Court, has applied a presumption — first explicitly stated in Hans v. Louisiana, 134 U.S. 1, 33 L. Ed. 842, 10 S. Ct. 504 (1890) — that the Constitution was not intended to “raise up” any proceedings against the States that were “anomalous and unheard of when the Constitution was adopted.”[iii] In holding that the doctrine of sovereign immunity barred the Federal Maritime Commission from adjudicating a complaint against a State agency that had not consented to be subject to the proceeding, the Court held that it attributed great significance to the fact that States were not subject to private suits in administrative adjudication at the time of the founding of our Nation.[iv] Accordingly, the initial hurdle a State bankruptcy statute would face is a challenge that it fails to afford the States the dignity and respect due sovereign entities. As there was no State bankruptcy procedure in effect at the time of the Nation’s beginning, no such process should be “raised up” in the form of Federal legislation to be imposed upon the States at this time. In short, the State as dual sovereign can decide when to pay, what to pay and whether to pay and those decisions by a State cannot be changed by the Federal Government without the State’s consent.
The Lessons Learned From Constitutional Challenges to Municipal Bankruptcy Provisions
The Tenth Amendment to the Constitution explicitly articulates the Constitution’s principle of Federalism by providing that powers not granted to the Federal Government nor prohibited to the States by the Constitution of the United States are reserved to the States respectively or to the people. Accordingly, while Article I, Section 8 of the Constitution gives Congress the power to “establish uniform laws on the subject of bankruptcies throughout the United States,” that power may not interfere with the power reserved to the States by the Tenth Amendment. While there may be precedent for the Federal preemption of bankruptcy law for corporations and individuals, there was, at our Nation’s founding, no precedent for a dual sovereign passing a law regulating the bankruptcy of the other. This remains the case today. The earliest iterations of statutes providing for municipal debt adjustment (Chapter IX) not unexpectedly resulted in a review of the constitutionality of municipal bankruptcy by the U.S. Supreme Court. As municipalities are instrumentalities of the State or sub-sovereigns, the principles derived from those early decisions with respect to Federalism and the ability of Congress to legislate in the sphere of the States are applicable to the subject at hand.
As you know, the current version of Chapter 9 of the Bankruptcy Code attempts to embrace the concept of sovereignty of States and the limitations imposed by the Tenth Amendment. Section 903 of the Bankruptcy Code specifically reserves a State’s power to control municipalities.[v] In addition, § 904 of the Bankruptcy Code specifically limits the jurisdiction and powers of the Court over the municipality.[vi] As a result, the power of a Bankruptcy Court presiding over a Chapter 9 case is quite limited and cannot interfere with the revenue or government and affairs of the municipality. The jurisdiction of the Bankruptcy Court over the municipality flows from the specific authorization of the State in question to allow the municipality to file. Most States have chosen not to specifically authorize their municipalities to file. In fact, only fifteen States have unconditionally authorized municipalities to file Chapter 9 petitions.[vii]
[i] See Gregory v. Ashcroft, 501 U.S. 452, 457, 115 L. Ed. 2d 410, 111 S. Ct. 2395 (1991).
[ii] See Blatchford v. Native Village of Noatak, 501 U.S. 775, 779, 115 L. Ed. 686, 111 S. Ct. 2578 (1991).
[iii] Hans, 134 U.S. at 18.
[iv]Federal Maritime Commission, 535 U.S. at 755.
[v] “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 . . .” 11 U.S.C. § 903.
[vi] “Notwithstanding any power of the court, unless the debtor consents or the plan so provides, 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.
[vii]See States listed in Note 1.