09.11.13

To be Insolvent or not to be, that is the question. U.S. Bankruptcy Judge Steven Rhodes yesterday, in response to requests from the major creditors of the 100,000 involved in Detroit’s efforts to secure bankruptcy eligibility, agreed to delay by nearly a month the first part of the trial to determine if the city is eligible for Chapter 9 protection to give parties more time to argue legal issues. Judge Rhodes delayed the date for the first part of the eligibility trial to Oct. 15 from Sept. 18, but he will continue to divide the trial into two phases: legal challenges to eligibility on Oct. 15th, and factual challenges Oct. 23rd as originally scheduled, with a final decision likely following soon after. Perhaps expressing some frustration, Judge Rhodes yesterday stated: “The city is struggling under incomprehensible financial burden.  In an attempt to create a viable, if not thriving future for itself, it needs to do that with all deliberate speed.” The city’s creditors, including unions and pension funds, over the past week launched a fresh effort to fight the schedule, arguing they need more time for discovery and for the eligibility trial itself. Jones Day attorney Bruce Bennett, representing Detroit, Tuesday urged Rhodes to keep to a schedule that allows a final decision on whether the city is eligible to file for Chapter 9 by the end of October. “What’s important to us is that this process is concluded as rapidly as possible,” Bennett said. The move, a victory for the city’s unions and retirees who had asked for additional time, may slow Detroit’s effort to keep the historic bankruptcy case on a fast track toward a late 2014 conclusion. A final decision on eligibility, however, is still likely to come at the end of October. In a series of motions filed Friday and Monday, attorneys for the UAW, AFSCME, pension funds, retiree associations, bondholders, and insurers raised concerns about time restrictions and the seemingly accelerated schedule U.S. Bankruptcy Judge Rhodes has set over the next six weeks, so these, the largest creditors are asking Judge Rhodes to reconsider his ambitious and expedited process for determining the city’s eligibility for bankruptcy protection. On Monday, 11 of the 12 parties objecting to Detroit’s proposal to pay UBS and Bank of America 75 cents to 82 cents on the dollar to terminate an interest rate swap agreement filed a unified objection to Judge Rhodes’ plan for a two-day hearing on the proposed settlement; Judge Rhodes has assigned the city’s attorney four hours and all objectors five hours Sept. 23-24 to present their arguments for and against the proposal, writing: “The objectors are concerned that live witness testimony may take up much of the nine hours of hearing time, leaving insufficient time for argument.” The objectors, led by Syncora Guarantee, an insurer of the interest rate swaps and underlining pension bonds, proposed streamlining the court proceedings by eliminating live witness testimony in favor of detailing sworn deposition statements, documented evidence and witness testimony on demand to explain a complicated debt arrangement tied to $1.4 billion in pension debt. The UAW, AFSCME, and retiree groups also want more time to make arguments against Detroit’s eligibility for bankruptcy protection than the one day, Sept. 18th, the judge has scheduled. If Judge Rhodes does not slow down the pace or give Detroit’s creditors more time to prepare, they have the right to appeal.

Hearing from the Governor. Michigan Gov. Rick Snyder yesterday agreed to testify in Detroit’s bankruptcy trial as part of a settlement between the state government and city employee unions and other retiree groups, who last week subpoenaed Gov. Snyder, State Treasurer Andy Dillon, and other top state officials. In exchange for their depositions, the unions agreed to limit the scope of their questioning and to limit the depositions to three hours each. The American Federation of State, County & Municipal Employees and the United Auto Workers last week subpoenaed the state officials, saying they want to learn the steps leading to the city’s historic July 18 Chapter 9 filing in an effort to prove that the city did not file its petition in good faith.  Michigan Attorney General Bill Schuette’s office originally opposed the request, claiming it involved privileged information and was irrelevant to the question of whether Detroit is eligible for Chapter 9 protection. But after discussions before Judge Rhodes yesterday, during which the Judge repeatedly scolded the attorney general’s office for filing late objections to the creditors’ subpoenas, the state agreed to the deposition, waiving its objection that the governor is protected by executive privilege. Judge Rhodes also questioned whether it was in Detroit’s and Michigan’s best interest to prevent Gov. Snyder’s testimony.

Ranking Creditors in a Municipal Bankruptcy. With some 100,000 creditors clamoring to be first in line to be paid, one of the most difficult challenges is to determine whom to pay and whom not to pay. Emergency Manager Kevyn Orr’s office has said he intends to pay vendors through the bankruptcy, even for debts incurred before the city filed for bankruptcy—a decision similar to the actions taken by other municipalities during Chapter 9 bankruptcy, including Vallejo and Stockton, Ca., and Jefferson County, Alabama; it is dissimilar to corporate Chapter 11 bankruptcies, where payments on most invoices incurred before bankruptcy — known as pre-petition debt — must be stopped. In contrast, in Chapter 9, municipalities have the authority to continue to pay vendors for the earlier goods and services. David Carrington, President of the Jefferson County Commission, noted: “Jefferson County made the business decision to pay its pre-petition vendors in the ordinary course post-petition. No motion or order was required. No creditors committee was formed. The plan leaves all trade debt unimpaired.”

One of the legal issues that could be tested in San Bernardino’s or Detroit’s municipal bankruptcies is the authority a municipality has to make such payments – or whether it is required to, as opposed to a Chapter 11 corporate bankruptcy where there can be a “critical vendors” list or motion, outlining which vendors the corporation determined to be essential to operations. When a city or county—municipal corporations–is on the edge of insolvency, the municipality has the same hard decisions to make; but it does not appear to be a list required by the federal law. Indeed, it appears there were no such equivalent lists created in Stockton, Vallejo, or Jefferson County—but both Stockton and Vallejo made the decision that it was important to continue paying the vendors. Detroit has not filed a critical-vendor motion.  Nevertheless, according to Emergency Manager Orr’s spokesperson, several area businesses in Detroit have received “essential vendor” from Mr. Orr, stating: “You have been identified by the (department redacted) as an essential vendor. As an essential vendor, the (department redacted), in consultation with the Emergency Manager’s office, has determined to continue payments to you in the ordinary course… The United States Bankruptcy Code allows a municipality, such as the city of Detroit, to exercise its discretion in determining whether to satisfy obligations of its vendors and other creditors, including those obligations that arose prior to the commencement of a Chapter 9 bankruptcy case.”

Substantial Decline & Spiraling Downward. Scott Beard, the head of the organization, San Bernardino Residents for Responsible Government, which is heading up the recall effort in the city against the mayor, city attorney and seven members of the City Council, this week said that over the last 15 years he witnessed steadily worsening crime, an exodus of residents and businesses, a hollowing out of the city’s core and its pride—calling it a “substantial decline and spiraling downward.” Mr. Beard attributed the common denominator in all of this was the city’s leadership, noting: “No one has taken responsibility for it, even to this day.” The recall advocates hope a new leadership team of elected officials would propose a stronger outline for how to lift the city out of bankruptcy and make it more hospitable to business and to residents, including reinvigorating the downtown area. But Councilwoman Virginia Marquez, who was elected in 2009 and seeking re-election, said that while she shared Mr. Beard’s frustrations, she worried about the cost to the city, estimated as high as $450,000.

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