8.5.13

This morning’s eBlog, largely excerpted from this morning’s eNews to follow, looks at four bankruptcy cases affecting hundreds of municipalities―three chapter 9’s, and one chapter 11. I should point out that in the near-decade long effort to restore chapter 9 in the federal code, I do not recollect a single municipal elected official who evinced enthusiasm about supporting this legislation; most felt that filing for municipal bankruptcy would constitute a failure of leadership. Indeed, I vividly recall a representative of a national organization testifying before the Maryland legislature recently in opposition to state enabling legislation to permit a city or county in the Terrapin state to file for federal bankruptcy protection. It is, after all, a step in which an elected leader’s role is significantly suspended for the duration. It is, however, often the only option available to ensure the provision of essential, lifesaving services that are only provided in America by cities, towns, and counties.

By some strange formation of the stars, three significant municipal bankruptcies geographically spread across the country are coming to a head―even as a fourth potential corporate bankruptcy, which could critically affect emergency 911 services in hundreds of cities and towns, is lurking. The decision to excerpt these four is to try to help readers understand not just the extraordinary complexity of the municipal bankruptcy process, but also how many other municipalities are affected among the tens of thousands of creditors involved in these chapter 9 cases.

Motown Mediator. U.S. Bankruptcy Judge Steven Rhodes yesterday formally appointed Chief U.S. District Judge Gerald Rosen to mediate disputes between Detroit and its creditors during the city’s pendancy in chapter 9 municipal bankruptcy. That will facilitate his ability to resolve disputes, especially with regard to the financial health of the city’s pension funds. Under the order, Judge Rosen is authorized to enter any order necessary to facilitate mediation talks, and he is guaranteed confidentiality in his mediator’s role: “All proceedings, discussions, negotiation, and writings incident to mediation shall be privileged and confidential, and shall not be disclosed, filed or placed in evidence.” In addition to the key dispute with regard to the unfunded liabilities of the city’s two pension funds, Judge Rosen is authorized to try and resolve disputed issues ranging from the treatment of creditors, priorities, business terms, and contract issues. Why it matters: The potential of a trusted third party to resolve issues could be critical in saving time and resources. Perhaps the most critical issue on which the city could benefit would be with regard to the significant differences involving the city’s two pension funds—where the gap between Emergency Manager Orr’s unfunded liability of $3.5 and the unions is nearly $2.5 million. If this difference could be resolved out of court, it would preserve essential resources critical to the city’s recovery.

City Hall’s estimated $1.4 million-a-month restructuring tab includes a consulting company billing $275 an hour for a 22-year-old financial analyst who graduated from college last year, according to records obtained by The Detroit News.

Wade P. Johnston got his bachelor’s degree in finance in 2012 from Michigan State University and is part of the team the consultants, Conway MacKenzie, have working to turn around city operations. The Birmingham firm billed the city $288,671 for the work of 11 staffers over two weeks in July, including more than $26,000 for Johnston alone.

The records give a rare look at the costs being picked up by the city and state, a breakdown city council members and other critics have argued has been hidden amid Detroit’s historic bankruptcy. Conway MacKenzie’s hourly rates range from $495 for the group’s senior managing director to $275 for Johnston, who started with the company in June as a senior associate, according to records.

Critics questioned the wisdom of spending $275 an hour for a 22-year-old.

“What experience would he have to base that hourly rate on?” said Michael Wells, Detroit Public Library retiree and former UAW Local 2200 president. “I hope these firms, that they don’t use this as an opportunity to enrich themselves. I don’t expect them to be altruistic, but I don’t expect them to pick on a carcass.”

But a spokesman for Emergency Manager Kevyn Orr’s office defended the spending, saying the hourly amounts were negotiated by the city as flat rates within job classifications to save money. And Conway MacKenzie has given the city a 25 percent discount off its bills, the spokesman, Bill Nowling, said.

“The city benefits because it pays one rate,” Nowling wrote in an email. “So, there are others with much more experience billing at the same rate within the classification.”

“Detroit has more than five decades of administrative neglect and deferred maintenance. The money being spent on the city’s restructuring professionals is an investment in improving city services.”

Conway MacKenzie’s contract allows it to bill up to $400,000 every two weeks for its work, which was first approved by Mayor Dave Bing and the Detroit City Council in January. The bill obtained by The News, covering July 8 through July 21, didn’t give a description of the work the employees did.

Officials from Conway MacKenzie wouldn’t comment, senior managing director Charles Moore said Monday. Johnston didn’t return calls for comment.

His biography on the Conway MacKenzie website says he is “highly skilled at preparing financial analyses and research that is utilized in litigation services and turnaround management.” Conway MacKenzie was his second job out of college and he is trying for his Chartered Financial Analyst Level II, a professional certification, according to the website.

Johnston logged nearly 95 hours over the two-week billing period. But two other staffers topped that, spending 107 hours each working on “operations restructuring.” That would mean those staffers averaged 11-hour days over five-day work weeks. Their hourly rate was $425.

Jim McTevia of McTevia & Associates, a turnaround firm in Bingham Farms, said $275 an hour for an entry-level staffer is reasonable given Johnston is part of a larger “machine,” although it may be on the high side. Tevia said his hourly rate for beginning staffers is about $225 an hour.

“The reality is this is a complicated and challenging restructuring,” said Scott Eisenberg, a managing partner with Amherst Partners, another turnaround firm in Birmingham. “If they bring better results, they will pay for themselves.”

Eisenberg said employees generally are paid about 35 percent of the hourly billing rate.

Conway’s rates are not the most expensive. The city’s bankruptcy firm Jones Day has charged up to $1,000 an hour, according to a July story in the Am Law Daily website.

Ed McNeil, with the American Federation of State, County and Municipal Employees Council 25, called the costs “incredible.”

“What was being done during that time period?” McNeil said. “You don’t know where the contracts are and you don’t know what people are doing. People continue to have to pull and prod to get information.”

Added Greg Murray, a former city employee and union official who was laid off last year: “It’s not just excessive, it’s outrageous if you look at the dire financial situation everyone says that the city is in.

“It confirms people are making money off of Detroit’s demise,” Murray said.

As of May, six consulting firms had been hired by the city for its turnaround estimated to cost up to $1.44 million a month. At that time, the city was paying more than $800,000 and the state paid the remainder of the tab. Nowling said in an email that the state is paying half of Conway’s bill.

McTevia said he expects the total turnaround costs to exceed $1 billion, which is not out of line with other large turnarounds, such as the Lehman Brothers’ bankruptcy.

Nowling said Orr is monitoring all contracts to “make sure city continues to receive value for the money it spends.”

The Benefits of Mediation. Indeed, the city of San Bernardino has advised U.S. Bankruptcy Judge Meredith Jury that the city and the San Bernardino Public Employees Association have reached a tentative agreement under which the city will not reject collective bargaining agreements, and the union will not oppose the city’s efforts to gain federal bankruptcy protection.
The city said that under the terms of the tentative agreement, it had reserved the right to reject the collective bargaining agreement at any time in the future, while the union (SBPEA) can respond through a motion for relief from the stay. San Bernadino had earlier implemented a “pendency plan” under which employees received 9.3% of normal benefits; paid time off was suspended through June 30, 2014; accrued sick leave was limited to 1,040 hours; and retiree medical benefits for all employees hired this year were eliminated, according to court documents. The union had requested the bankruptcy court to bar implementation of that plan, but agreed to drop its opposition under the terms of the tentative agreement―leaving only the California Public Employees’ Retirement System as the sole opponent, with CalPERS claiming San Bernarino should not be allowed to seek federal bankruptcy protection after the city repeatedly ignored warnings of mismanagement and failed to stop runaway spending. In addition, CalPERS claims the city did not negotiate in good faith with creditors and had no plan to reorganize its finances before it filed for bankruptcy, noting the city still has not proposed a reorganization plan. In response, the city has noted that it clearly qualifies for Chapter 9, since it is a municipality, it is eligible to be a debtor, it is insolvent, it desires to effect a plan to adjust its debts, and it has been unable to negotiate with creditors because such negotiations were impracticable. CalPERS is seeking to have Judge Jury dismiss dismiss the case from U.S. bankruptcy court, arguing that the city’s failure to plan should bar it from insolvency protection―with a hearing scheduled to hear the city’s motion for summary judgment on the issue Aug. 28.

 

This has been a week of municipal bankruptcy schedule setting, with federal judges in Detroit and Jefferson County trying to reach consensus on schedules for the respective municipalities to exit bankruptcy, and then yesterday California U.S. Bankruptcy Judge Meredith Jury, presiding over San Bernardino’s chapter 9 petition, announced that next week she will appoint U.S. Bankruptcy Judge Gregg Zive of Nevada as mediator—and will issue an order explaining what issues the judge will be mediating. San Bernardino and its creditors agreed on Judge Zive as a mediator, notwithstanding the city’s position that no mediator should be appointed unless and until a decision has been made regarding the city’s eligibility to be in chapter 9 bankruptcy—Judge Jury had previously scheduled a hearing for later this month for summary judgment on eligibility, a position opposed by CalPERS and a city employee union. These two opponents have until today to file papers in opposition to the city’s eligibility to be in chapter 9 municipal bankruptcy; other creditors, Ambac Assurance Co., Erste Europäische Pfandbrief-und Kommunalkreditbank AG and Wells Fargo NA, have already filed a joint document in support of the city’s eligibility for bankruptcy. The threesome, who call themselves, not the three musketeers, but rather the POB (Pension Obligation Bond) creditors, recommended the court grant summary judgment in favor of the city on Chapter 9 eligibility; overrule in their entirety the objections to eligibility filed by the SBPEA, CalPERS, and other creditors; and enter an order of relief. Their joint interests—and stake—relate to their respective roles with respect to San Bernardino’s issuance of $50.4 million in taxable pension obligation bonds to refund the city’s obligations to CalPERS relating to municipal employees’ pension benefits. San Bernardino has missed approximately $13 million in payments to the pension fund. San Bernardino’s retirees’ attorneys have urged there should be a retirees’ committee similar to what has been done in the Detroit Chapter 9 bankruptcy case; however, San Bernardino City Attorney James Penman argued in a court filing that the city cannot afford the cost, noting: Detroit “has proposed dramatic reductions to retiree health care benefits and an official retiree committee may make sense for Detroit….Unlike the City of Detroit, San Bernardino has not proposed any such cuts to the health care benefits of its retirees.” Moreover, San Bernardino argued that with revenues of $1.2 billion, Detroit is more fiscally capable of financing the cost of an official retiree committee. In contrast, San Bernardino, with about 200,000 residents, does not have that kind of financial resources.

Motown & Jeffco. Almost like bookends, Jefferson County’s bankruptcy schedule and Detroit’s tentative schedule put San Bernardino’s in the middle. What all three cases demonstrate is not only the enormous amount of time and resources required to complete this plan of adjustment refereed by a federal bankruptcy court, but also how this process tends to affect neighboring municipalities. Sometimes we forgot how interconnected municipalities are in a metropolitan area. Thus, in Jefferson County, the City of Birmingham has significant fiscal stakes in the final agreement, and so too in Motown—with some 100,000 creditors scrambling over the long period of adjudication in the U.S. Bankruptcy court, neighboring jurisdictions will be affected. These intergovernmental conflicts strain the ability to impose rigid or aggressive timetables for exiting Chapter 9 bankruptcy, and each municipality 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.

As always, we are very grateful for your comments and questions.

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