02.20.14

The Cost to Taxpayers of Municipal Bankruptcy.  The Motor City’s federal bankruptcy judge, the indubitable Steven Rhodes, yesterday questioned the need for a new team of high-cost attorneys to get involved in the city’s seven-month-old Chapter 9 case. During the court hearing, Judge Rhodes queried the U.S. Trustee’s office with questions about its December appointment of a Committee of Unsecured Creditors, and Judge Rhodes noted to Brett Miller, who is charging the City of Detroit $1,050 an hour for his services: “You’re going to cost the city millions of dollars…Every dollar they spend on you is a dollar less for a police officer.” The federal judge also questioned the need for a new team of high-cost attorneys to get involved in the city’s seven-month-old Chapter 9 case. The Motor City is asking Judge Rhodes to disband the committee, arguing it could inflate legal bills city taxpayers are already footing for a committee of retirees in the largest municipal bankruptcy in U.S. history, or, as City Attorney Jeffrey Ellman told the court: “This could be another millions of dollars that the city doesn’t have that it can’t really afford that would be diverted from other purposes.” Mr. Miller indicated yesterday that his firm could agree to a $1 million cap on the total fees it would charge the city. But that is not all: Detroit’s Committee of Unsecured Creditors is also proposing to hire another firm, according to court records, where the lawyers’ fees range from $195 to $300 per hour. Judge Rhodes, ever mindful that every dollar syphoned off is a dollar less for a sustainable future for the Motor City, followed up, asking why other attorneys vying to represent the Unsecured Creditors’ Committee would not join ongoing mediation negotiations in the bankruptcy case, pointedly noting: “What’s the committee going to do, given your statement that you’re not going to participate in mediation? That leaves litigation.”

The unscheduled, unmusical lecture from the bench earned a response from Counselor Miller who admitted the committee “may now have to rethink” its earlier strategy, given the Judge’s prodding for all parties in the case to negotiate a consensual resolution of paring down Detroit’s $11. 5 billion in unsecured debts. Nevertheless, Maria Giannirakis, an attorney for the U.S. Trustee’s Region 9 office, an administrative arm of the federal bankruptcy court system, said the office felt legally compelled to create the committee, which includes a major bond insurer and Detroit’s two pension funds, leading Judge Rhodes to follow up: “So your view is Congress intended to impose millions of dollars in costs on the city of Detroit with no value?” he asked Ms. Giannirakis—who replied the committee will represent “thousands” of individuals and vendors who had legal claims and unpaid bills prior to the city’s July 18, 2013 bankruptcy filing. One of the quandaries of a municipal bankruptcy is the large number of citizens, employees, and retirees who cannot afford representation—leaving Judge Rhodes in the discomforting role. He said yesterday he would take the issue under advisement and issue a written opinion at a later date.

When is a bond bonding? Judge Rhodes, who is not paid in excess of $1,000 an hour, had a long day yesterday, where he also heard arguments from bond insurers, including National Public Finance Guarantee Corp., Ambac Assurance Corp., and Assured Guaranty Ltd., who are challenging Detroit’s proposal in its draft plan of adjustment—which the city expects to file today or tomorrow—to treat its unlimited-tax general obligation bonds as unsecured. In the courtroom yesterday, Detroit argued that these municipal bonds are not secured by any lien or pledge that would survive federal bankruptcy, notwithstanding a property tax levy approved by voters specifically for the GO debt payments: “There is no lien, there is no property interest, those creditors are like all others….There is no grant of a lien on property tax revenues collected by the city.” To which Judge Rhodes responded by asking if that meant that all the Motor City’s full faith and credit promises―or pledges―to repay the bonds were “unsecured promises.” The city’s chief attorney responded “Yes.” Subsequently, Judge Rhodes asked what would happen to the tax levy if he were to determine that the bonds were unsecured―to which the attorney responded: “That’s between the taxpayers and the city,” adding that Motor City Mayor Mike Duggan might have to decide how to handle the problem, but admitting it would open the city up to lawsuits from taxpayers. The case raises challenges under Michigan laws and raises significant property tax-related questions. The insurers yesterday told Judge Rhodes that the voter-approved tax revenue is, essentially, a special, dedicated revenue. Under Michigan law, the city is restricted to using those revenues only for debt service on the bonds, and is prohibited from using it for any other purpose: “These are not simple promises the city made to its bondholders…These are requirements under state laws.” But, in addition, the bond insurers raised a second issue: the claim that bondholders have a property interest in the tax revenue raised under the voter-approved levy, claiming that municipal taxes raised for the sole purpose of paying unlimited-tax GO bonds are equal to a grant of property. In response, Detroit’s attorney admitted to the court that the Motor City had been reporting in its recent audits that it was fully collecting the property taxes, while it actually was not. This discussion led Judge Rhodes to note: “It is true that in most circumstances a creditor’s property interests still have to be respected…but why doesn’t the language [in state law] specifically say the bondholders have a lien or the bondholders have a security interest?” Urging the parties to continue their negotiations, Judge Rhodes said he would issue a written ruling on the matter in “two or three” weeks, noting that “As I’m sure you’re aware, a decision here is most likely all or nothing….One side is going to win and the other side is going to lose.”

Swap Agreement. In a revised, new settlement proposal, Detroit’s chief attorney advised Judge Rhodes yesterday, there was agreement on a plan that would “change many things very substantially,” referring to a third settlement between Detroit and its counterparties, UBS AG and Merrill Lynch Capital Services, that could erase a controversial financial transaction that helped drive the city into Chapter 9 bankruptcy. Judge Rhodes has rejected the first two, which would have paid the banks $210 million and $165 million respectively. The interest rate swap agreement in question, which was brokered by former Mayor Kwame Kilpatrick’s administration in 2005, involved interest-rate swaps, which were used to secure an interest rate of 6% on $1.4 billion in debt issued that year to pay off Detroit’s unfunded pension liabilities at the time—but a swap that blew up for the Motor City when U.S. interest rates plummeted—leaving the city desperately on the hook and costing some 5% of its annual budget today. An attorney for the city yesterday testified before Judge Rhodes that the city’s intent is to finalize and submit details of the new proposed swaps settlement with the court within three to four days. Notwithstanding, a different attorney for the Motor City advised the court that Detroit still hopes to file its proposed bankruptcy restructuring plan “this week”―to which the ever wry Judge Rhodes responded: “How many days until March 1?” (That is the date Judge Rhodes has set as the deadline for filing the plan with the federal court.) The attorney responded; “We’re well prepared to file our plan. But then there’s the process of getting the plan approved.”

Will Jeffco’s Exit from municipal bankruptcy be appealed? With new elections for the Jefferson County Commission ahead, former Birmingham City Council President Roderick Royal, a plaintiff in one of the appeals to U.S. Bankruptcy Judge Thomas Bennett’s approval of Jefferson County’s successful exit from chapter 9 municipal bankruptcy, has qualified to run for the District 1 Jefferson County Commission seat against incumbent George Bowman. Should candidate Royal be elected, he would be in an awkward position, because the costs of an appeal. Which would be expected to cost the county’s taxpayers in the range of $25 million, would almost surely have sharply negative consequences for the county’s budget and fiscal recovery—and just as surely reverse yesterday’s credit rating upgrade by Moody’s—in addition to plunging the county into a process that could extend for months if not years. Jefferson County last week filed a motion asking the court for partial dismissal of all appeals, with the one appeal likely to proceed being the U.S. Bankruptcy Court’s denial of ratepayers’ claims against Jefferson County for $1.63 billion sought on behalf of about 130,000 sewer system customers. That appeal, by itself, could have significant repercussions, with the sewer ratepayers claiming they are creditors in the county’s bankruptcy, because they were “burdened by overcharges of $1.63 billion in increased sewer fees and charges” that resulted from the unlawful issuance of $3.2 billion in adjustable-rate sewer warrants in 2002 and 2003 and related interest rate swaps—with the opponents claiming the County to “overcharge sewer fees,” in return for bribes paid by what have been termed “private promoters” to county commissioners. (Former Jefferson County Commission President Larry Langford was convicted on 61 federal charges in October of 2009 for bribery, money laundering, mail and wire fraud, conspiracy, and filing a false tax return.).  Jefferson County’s attorneys have told the court that the “the portion of the appeal pertaining to the order confirming the county’s bankruptcy plan is constitutionally, equitably, and statutorily moot, so that aspect of the appeal should be dismissed,” urging the court should dismiss the appeal, except as it relates to the sewer ratepayers’ proof of claim filed for $1.63 billion—the claim which was rejected by the federal bankruptcy court last year.

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