Let the Trial Begin. Citing a “mountain of evidence” that Detroit’s financial condition “is an awful mess,” attorneys for the Motor City opened the hearing before U.S. Bankruptcy Judge Steven Rhodes by trying to lay a foundation to prove the city is legally eligible for Chapter 9 bankruptcy, with the city’s lead attorney telling the court the city will present a “mountain of evidence” during the trial that Detroit is insolvent, that the city obtained the state’s authorization for bankruptcy, and that the city negotiated in good faith with creditors. His arguments opened a highly contentious trial that will extend into next week and perhaps into next month—and they came as the California Public Employees’ Retirement System (CalPERS) appealed (please see below) U.S. Bankruptcy Judge Meredith Jury’s ruling that San Bernardino is eligible for Chapter 9 bankruptcy, arguing the city did not file for bankruptcy in good faith or with any concept of a plan of adjustment, which CalPERS contends are two requirements for filing bankruptcy―and as Harrisburg, Pa., a city which opted to reject seeking federal bankruptcy protection, faced serious setbacks.
Yesterday’s long day opened the most critical stage so far of Detroit’s municipal bankruptcy case―to determine whether the city is eligible for federal municipal bankruptcy protection. Motown’s attorneys hope to finish their arguments by tomorrow, intending to call at least five witnesses, including Detroit emergency manager Kevyn Orr, the city’s investment banker Ken Buckfire, and police chief James Craig. Even as the historic hearings commenced in the courtroom, hundreds of protesters circled the downtown courthouse, many carrying banners and signs that attacked Michigan Governor Rick Snyder as favoring bondholders and banks over the city’s employees and its 23,000 retirees. Judge Steven Rhodes is not expected to issue a ruling on whether Detroit’s case can proceed until at least Nov. 13, a deadline he established today for attorneys to submit briefs on the definition of “good faith” negotiations.
For Judge Rhodes to find the city eligible, there are three hurdles: A) Is Detroit insolvent, B) did the city negotiate in good faith with its creditors, and C) was the city authorized to file for federal bankruptcy protection?
- Detroit’s lead attorney, Bruce Bennett, in his hour-long opening argument, testified that municipal bankruptcy was Detroit’s only option, stating there is a “mountain of evidence” proving the city is insolvent and presenting a timeline which he said demonstrates the city negotiated in good faith with its creditors: “The residents of Detroit would be dramatically prejudiced by denying Chapter 9 relief…Many of problems are so many of the city’s tax dollars are devoted to bonds and other legacy liabilities…The taxpayer puts up $1 and gets back…58 cents…It could someday be 35 cents. That’s an unstable situation. It’s not working now or in the future.” Raising taxes is impossible, he added. Rates are maxed out. “There is no other solution,” he testified. Bennett argued that teams of people were working on the city’s problems by the end of 2011: “It was a lot of time and a lot of effort in search of alternative solutions.” He said negotiations were tough, because unions refused to consider cutting pensions. Without bankruptcy, the city would soon be devoting 65 cents out of every tax dollar to pay off its debt, he said. Ernst & Young financial consultant Guarav Malhotra testified that the city’s financial condition was dire. He said Detroit nearly ran out of cash, risking a “payless payday,” in the weeks leading up to its July 18th bankruptcy filing. But an attorney for retired Detroit workers criticized Emergency Manager Kevyn Orr for floating a fictional number for a shortfall in the city’s pension funds. Attorney Anthony Ullman represents a committee of retired city workers fighting to preserve vested pension benefits targeted for cuts by Orr. Mr. Ullman criticized Orr for claiming the pension funds have a $3.5 billion shortfall. “This $3.5 billion figure is not a fact…At the time the (bankruptcy) petition was filed, the city did not know the size of the unfunded pension liability.” (Mr. Orr has not proposed specific cuts for pensions, but said he wants to lump the unfunded liability in with $11.5 billion in unsecured debts and pay those creditors a $2 billion settlement — about 17 cents for each dollar owed.) Jennifer Green, an attorney for Detroit’s two pension funds, said the “city’s financial information was incomplete.” She argued that the bankruptcy wasn’t a contingency plan, but was instead a foregone conclusion.
- Mr. Bennett testified that efforts to negotiate concessions with unions and retiree groups last summer were fruitless, making a bankruptcy filing the only viable option for Mr. Snyder and Mr. Orr to pursue. He also argued that it was impracticable to negotiate with the creditors―a threshold that allows the city to avoid the good faith test―which includes “thousands” of bondholders. “They were impracticable on the retiree side and…on the bondholder side,” Bennett said. “But we tried really hard anyway.” Creditor attorneys argued that Messieurs Orr and Gov. Snyder always planned to file for bankruptcy with the aim of cutting pensions and never negotiated in good faith. “It all adds up to a fairly deliberate plan to use Chapter 9 to find new ways to undermine the Michigan constitution,” UAW attorney Babette Ceccotti said. Sharon Levine, attorney for the city’s largest union, American Federation of State, County and Municipal Employees, argued that Detroit in fact had the ability to negotiate in good faith, contrary to Bennett’s assertion. “The timeline the city set for itself was a timeline to not allow an out-of-court negotiation to take place,” Levine said, arguing that the city cannot meet its burden of proof in the case and therefore is not eligible for Chapter 9. Jennifer Green, a lawyer for some city pension funds, said e-mails and documents showed that it was a “foregone conclusion” that Jones Day would pursue a Chapter 9 filing as a way to circumvent a provision in the Michigan Constitution that protects public employee pensions. She also accused Mr. Orr of rushing to make the Chapter 9 filing on July 18 only after learning that retirees were about to get a restraining order that would protect pensions. He said that trying to negotiate settlements with Detroit’s vast number of bondholders would have been “pointless,” and that an initial effort in June to discuss concessions with unions and retirees was met with stiff resistance. “We received no concrete proposal or feedback,” he said of the meeting. “What we got was ‘no.’” But lawyers for the unions and retiree groups challenged Mr. Bennett’s assertion that the city had made a so-called good-faith effort to reach a deal with workers and retirees. They argued that Mr. Orr’s presentation in June called for significant cuts in employee pensions and health care without offering the unions an opportunity to bargain on the issue. “The city announced at that meeting that these were not negotiations,” said Sharon Levine, a lawyer for the local council of AFSCME. By the time the unions had formally responded that they were willing to bargain, Mr. Orr was already preparing to recommend a bankruptcy filing to Mr. Snyder, Ms. Levine testified. In contrast, Mr. Bennett said the city invested considerable time exploring alternatives to bankruptcy, including a series of talks with unions. He argued negotiations became “impracticable” because of the sheer number of creditors and challenges facing the city. Concerned members of city and state governments have been working to find a solution to Detroit’s woes since at least December 2011, Bennett said. Bennett said the city’s creditors never offered alternative solutions. “The way you respond to a proposal you don’t like is you send back a proposal you do like,” he said. But Levine said the unions “tried to engage in discussions” and instead got a lecture from Detroit emergency manager Kevyn Orr. The creditors that objected to the city’s bankruptcy have repeatedly argued that the city’s plan to pursue retiree pension cuts should block the Chapter 9 filing. They say the plan violates the Michigan Constitution’s protection for public pensions. Rhodes ordered the state’s attorneys to bring forth evidence at the trial justifying why the Legislature tacked on $5.78 million to pay for emergency managers and consultants to a new emergency manager law — making it akin to an appropriations bill and immune to a voter referendum.
- Creditors yesterday suggested that the city’s bankruptcy filing was explicitly designed as a tool to cut pensions: “There’s no other way to read the evidence on that,” said Anthony Ullman, an attorney for Detroit’s retiree committee. Mr. Ullman showed the court an internal document from Mr. Orr’s spokesman, Bill Nowling, outlining talking points that would justify the bankruptcy filing. One point was that concessions were impractical because there were so many creditors. The talking points memo was dated July 8 — 10 days before the city filed bankruptcy. “While they were telling the world they wanted to have more meetings (with creditors), they had already internally and secretly decided it would claim impracticability,” Ullman said.
But Michigan Governor Rick Snyder’s testimony, expected on Monday, is likely to be the most sensational moment of the trial. He was subpoenaed by the United Auto Workers union, which represents some city workers in the case. Mr. Snyder will be questioned closely about his support of state legislation empowering him to appoint emergency managers to fix troubled cities. The legislation was passed in December — just weeks after Michigan voters had repealed a similar law. Judge Rhodes has already said he wants more information on why the legislation was passed as an appropriations bill, which makes it immune from a referendum to repeal it. His testimony will mark a first for a sitting governor in Chapter 9. Attorneys for the United Auto Workers union subpoenaed Gov. Snyder to answer questions about the motives and decisions leading to Detroit’s July filing. A ruling is not expected until at least mid-November. Outgoing Michigan Treasurer Andy Dillon and top Snyder aide Richard Baird, who was responsible for hiring Detroit emergency manager Kevyn Orr, are also expected to testify, likely on Tuesday. Emergency Manager Orr is expected to testify in the case tomorrow. Gov. Snyder has already sat for a three-hour deposition, and his attorney originally argued that should be sufficient. But U.S. Bankruptcy Judge Steven Rhodes has made clear he prefers live testimony. Judge Rhodes signaled that he would not rule on the city’s eligibility until at least Nov. 13. That’s the date he set for the city and its creditors to submit briefs on their legal definitions of good faith negotiations.
How High is the chapter 9 Municipal Bankruptcy bar? Even as U.S. Bankruptcy Judge Steven Rhodes is assessing today in Detroit whether the Motor City has cleared the municipal bar to be eligible for municipal bankruptcy, the California Public Employees’ Retirement System (CalPERS) has filed its appeal of U.S. Bankruptcy Judge Meredith Jury’s ruling that San Bernardino is eligible for Chapter 9 bankruptcy, arguing San Bernardino did not file for bankruptcy in good faith or with any concept of a plan of adjustment, which CalPERS contends are two requirements for filing bankruptcy. In its filing, Calpers stated: “Never has a bankruptcy court set such a low bar for a municipal debtor to enter the doors of the bankruptcy court….In CalPERS view, Chapter 9 petitions must be scrutinized with a ‘jaded eye’ in order to honor Congress’ intent that the gates to Chapter 9 be intentionally difficult to open.” CalPERS, which has fought the city’s efforts to seek bankruptcy protection since it filed in August 2012, in its filing, wrote: “In its August 28 ruling, the bankruptcy court agreed that the City of San Bernardino did not negotiate with its principal creditors before filing for bankruptcy; did not consider alternatives to filing for bankruptcy; made significant preferential payments on the eve of filing and, a year after the bankruptcy filing, had no plan of adjustment.” Like Detroit, but unlike either Vallejo or Stockton, in their respective chapter 9 filings; San Bernardino is the first California city to attempt to impair the pension fund in its bankruptcy filing. Shortly before filing for municipal bankruptcy a year ago last in August, San Bernardino halted making $1.2 million bimonthly payments to the pension fund. Although it resumed payments in July, the city currently owes the pension fund $17 million in missed payments, interest and fees, according to CalPERS officials. San Bernardino Mayor Pat Morris said earlier this year in an interview that the city may not be able to make good on the missed payments. Judge Jury, in her opinion finding San Bernardino eligible, had opined: “The inactivity of the city to forestall cash flow insolvency in prior years does not mean, as a matter of law, the city is forever forbidden to file chapter 9 when the full impact of the cash situation was presented to the Common Council on July 10…Just because it did not act earlier, does not mean it cannot act now.” Meanwhile, San Bernardino’s case proceeded last week when the city filed a confidential term sheet that lays the groundwork for mediation with creditors slated to begin formally on Nov. 24th before U.S. Bankruptcy Judge Gregg Zive in Reno, Nev.
Harried in Harrisburg. Harrisburg, the city that opted not to seek federal municipal bankruptcy protection, could miss payroll in December or January unless it can overcome delays threatening transactions pivotal to its recovery plan. One of the city’s attorneys warned the City Council: “As I understand it, we are still at a real threat of being unable to meet payrolls either in December or in January if the money doesn’t come in.” The sale of the city’s incinerator to the Lancaster County Solid Waste Management Authority, which the Dauphin County commissioners approved Wednesday, and a 40-year lease of parking assets are key to the “Harrisburg Strong” recovery plan that Commonwealth Court Judge Bonnie Leadbetter approved last month as an alternative to municipal bankruptcy. The issue involves timely completion of a municipal bond transaction—requiring council approval to transfer assets related to the plan. State-appointed receiver William Lynch’s team wants to complete the necessary bond transactions by the end of November, but some council members fear they are being rushed. Harrisburg currently confronts more than $600 million of debt, including about $363 million in bond financing related to an incinerator retrofit project. Adding insult to injury, a key party to the city’s alternate recovery plan, AEW Capital Management LP, has withdrawn, and now the Dauphin County commissioners yesterday delayed approval of an ordinance to allow the county to issue up to $170 million in debt for the parking deal, pending further review. Moreover, Mr. Lynch is pressing to complete the bond sales while interest rates remain low; nevertheless, city council president Wanda Williams is counseling prudence: “I understand the seriousness and nature of the beast where you are talking about employees who are not going to get paychecks, but certainly [we must] do our due diligence and make sure that everything in the contracts are accurate and legal.” Concurrently, Tuesday, Judge Leadbetter dismissed city controller Dan Miller’s objections to the plan approval, “because they were untimely and because [Mr.] Miller lacks standing to assert them….The governing body and chief executive officer of a city in receivership are recognized under Act 47 as interested parties. The city controller is not.” Mr. Miller, who is running for mayor in next week’s general election after losing the Democratic primary to bookstore owner Eric Papenfuse, is the lone mayoral candidate to favor a federal bankruptcy filing.