04.03.14

One More Lap.  U.S. Bankruptcy Judge Steven Rhodes yesterday approved Detroit’s revised, $120 million debtor-in-possession or DIP loan from Barclays, telling the courtroom the city “is not providing sufficient services to meet the basic needs of its citizens…This loan will provide the city with the means to begin to make up that deficit. The time to begin is now, if not before now…This court has previously held that the city is service-delivery insolvent.” The loan is to buy emergency vehicles and remediate blight in the city of about 700,000 people. The decision, coming after earlier rejections, now clears the way for the Motor City to gain access to its first borrowing since filing for municipal bankruptcy more than nine months ago. The Motor City plans to spend $36.2 million of the money on the police department, $28.5 million on the fire department and $35.6 million on blight removal. Creditors, including Syncora Guarantee Inc., which is locked in its own courtroom battle with Detroit, have opposed emergency manager Kevyn Orr’s program to restructure Detroit’s finances, including the $120 million loan. Under the version Judge Rhodes approved yesterday, Detroit will issue $120 million in bonds that would mature after it wins approval of its plan of adjustment. With court approval in hand, Detroit is expected to try to close the Barclays loan by April 15. After that, the city would be required to take on the bank’s legal expenses and fees. The debt matures either when the city exits bankruptcy or in 2.5 years. Detroit expects to pay it off with a $300 million post-bankruptcy financing. The loan is down from an original $350 million deal proposed last October, and pledges the city’s income taxes as collateral instead of gambling revenue. The city will pay an interest rate based on the London Interbank Offered Rate plus 3.5%, with 3% market flex built in. Barclays plans to resell the debt after the deal closes.

Plain English. Judge Rhodes yesterday requested that one of the city’s lawyers, Heather Lennox, for a description of the Motor City’s plan of adjustment that Detroit employees and retirees could understand, asking for a plain-English document for 32,000 current and retired public employees to use in deciding whether to vote to reduce some of their retirement benefits by as much as 26 percent―a vote will determine whether private foundations and the state of Michigan will put more than $800 million into Detroit’s underfunded pension system, the unprecedented, innovative key to resolving the city’s bankruptcy. Ms. Lennox said after yesterday’s hearing that she would provide the court with her plain-language explanation within two weeks. That task will matter: the city’s two groups of current and future retirees will be asked to vote on the plan: in order to benefit from a higher payout, a majority of those voting in each group must approve the city’s plan, and that majority must also hold two-thirds of the claims of all those voting.

Swapping.  Detroit returns to Judge Rhodes’ courtroom this morning to seek approval of an $85 million agreement it has reached with deal it reached with UBS and Bank of America Corp. to end interest-rate swaps that would otherwise threaten the city’s most reliable source of cash: casino taxes.Detroit emergency manager Kevyn Orr is to testify in favor of the settlement during a trial that begins at 9 a.m. today and is expected to last all day―the city’s attorneys, in a court filing, have noted: “Not a single objector has raised a valid argument showing that the settlement agreement is not within that reasonable range…Rather, the objectors insist that because the settlement is not, in their view, the best of all possible worlds, this court must substitute its business judgment for the city’s and require the city to litigate rather than compromise.” The bonds were originally proposed as part of a larger financing package designed to fund a deal with UBS and Bank of America to terminate the interest-rate swaps for about $165 million. The swaps, secured by casino-tax revenue, have cost taxpayers about $200 million since 2009. The green light for consideration this week came after Judge Rhodes yesterday rejected a request by Syncora and other creditors to delay consideration. The swaps, which are connected to pension obligation bonds issued by the city in 2005 and 2006, were designed to protect against rising interest rates by requiring banks to pay the city if rates climbed above a certain level. Instead, the rates fell, obligating the Motor City to pay about $4 million a month. Last January, the federal bankruptcy court rejected the city’s proposal to pay $165 million to end the swaps, calling it too costly—even though it was down from a deal reached days before the city’s bankruptcy filing to pay $230 million. The swaps agreement, if approved, would ensure that at least one group of creditors supports Detroit’s debt-adjustment plan when it comes up for trial in July. Under the accord, UBS and Bank of America’s Merrill Lynch unit would vote their impaired claims in favor of the plan. Several creditors have objected to the new settlement as too generous, too, saying the city should not be forced to pay for a financial bet that might have been illegal. Nevertheless, attorneys Syncora, which has vigorously fought the settlement, claim the federal court has no authority to “vaporize” the casino pledge. UBS and Bank of America, which have not spoken publicly about the swaps settlement, said in a joint court filing that they would engage in a lengthy legal battle with the city if the new settlement is not approved, noting that: “If the settlement is not approved, costly and hotly contested litigation will ensue that will likely take years to resolve…The settlement reflects very substantial concessions … and far exceeds the minimum requirement for reasonableness.” Complicating today’s hearing will be the position of Carole Neville, the attorney for the Motor City’s retiree committee, who is accusing Detroit of buying the banks’ support for Orr’s restructuring plan as a “coercive measure against all of its other creditors.” The banks have agreed to vote in favor of Detroit’s restructuring plan — called a plan of adjustment — in a move that could give the city’s bankruptcy lawyers the legal power to implement a forcible restructuring over the objections of creditors. That process is called a “cram down.”

Trial Delay Granted. Responding to a complaint that “The city has been trying to beat creditors into submission,” Judge Rhodes yesterday said he understood creditors’ concerns and would post a new schedule to provide more time for the Motor City’s 170,000 creditors to respond to its revised plan of debt adjustment and disclosure statement. The revisions, which featured lower recovery rates for bondholders and most pensioners than the original plan, had triggered a request from Syncora and the Motor City’s other major creditors to delay by at least 10 days next week’s scheduled hearing on the disclosure statement. In addition, Judge Rhodes said he would send out applications for a municipal finance expert to weigh in on the feasibility of the city’s final plan.

Three Dimensional Chess & A Tale of Two Cities. The process of exiting municipal bankruptcy involves, in every case, a multidimensional challenge to address tens of thousands of creditors—including mayhap the most important creditor—the future—and all in the alien territory of a federal court. This month, we continue in unprecedented territory, as the negotiations with creditors in San Bernardino is happening behind closed doors, while the concurrent negotiations in Detroit are very, very public, and as Jefferson County—the largest municipal bankruptcy in U.S. history prior to Detroit, faces risks of falling back into bankruptcy (please see item below). Similarly, all three municipalities must contemplate federal appeals—San Bernardino in the 9th U.S. Circuit Court of Appeals, Detroit in the U.S. 6th Circuit Court of Appeals, and Jefferson County before a U.S. District Court. If you were to try to imagine negotiating with 170,000 creditors—acutely aware that, in effect, the most critical creditor—the future of your city or county was not even listed as a creditor—try to imagine how you might proceed, understanding that every hour is depleting not just your already bankrupt municipal resources, but also vital resources to have any hope for a sustainable future. Rare reports from San Bernardino appear to indicate that federal court monitored negotiations are going well—perhaps in no small part because the number of negotiators are so much smaller and the media is not present—a very sharp contrast from the very, very public process underway in the Motor City. With the sand and resources rapidly running out in Detroit: how would you negotiate with 170,000 creditors? With a carrot or a stick? Especially knowing that each and every day spent in negotiations comes at a fearsome cost to your city or county’s future.

Consider the unhappy quandaries besetting Kevyn Orr: how should he balance threats versus offers to reach a deal? How much longer does he have until the unique in American history DIA-state package falls off the table as the state legislature in Lansing runs out its clock? What would you do about your city’s retirees? Unlike a private corporation (think General Motors and Ford), where federal bankruptcy allows you to jettison them onto a federal plan, not only is that not an option in municipal bankruptcy, but as Mr. Orr noted to me a year ago: many are making no more than $19,000 annually. Cuts of any severity would not only put them under the federal poverty level, but would likely harm Detroit’s property, income, and sales and use tax revenues, even while imposing greater social service burdens on the city. But how would you get retirees to the table—especially when, as in San Bernardino too—the state constitution protects those retiree benefits from any cuts? Is it, then, surprising that Mr. Orr’s team is expressing greater and greater frustration? Mr. Orr would like, in our imperfect world, to have agreements in place with all creditors by the end of June, especially as Gov. Rick Snyder is pressing legislators to approve $350 million over 20 years for the settlement package by the end of May. But, not unnaturally, state legislators, already wary of any perception of taking their taxpayers’ money and sending it to Detroit, are almost certain to adjourn before making any decision in the light of an inability to achieve some consensus in Detroit by the middle of next month. That, in turn, would risk the $466 million pledged by foundations and donors to the Detroit Institute of Art. Everything is connected, so there is significant risk that if agreements do not begin to gel, all the city’s creditors will be the poorer—including—and especially, any future for the Motor City.

In our unique form of municipal bankruptcy democracy, Detroit retirees and its thousands and thousands of other creditors will have an opportunity in the next several weeks to vote. It is hard to imagine how hard that vote will be—or how much it will harm or benefit the future of San Bernardino or Detroit—the uninvited creditors not at the table. It is even harder knowing that lurking in the future are two federal appeals courts—and, mayhap, the U.S. Supreme Court—not to mention that chance that failure to get it right amongst themselves, now, risks the future.

It Ain’t Over ‘Til It’s Over. Even when a city or county gains federal approval to successfully exit municipal bankruptcy, the road to recovery can prove steep and rocky. So it is that Jefferson County, as it prepares for an appeal of its exit next month before U.S. District Court Sharon Lovelace in Birmingham, the county is beset by not just the legal costs and risks inherent in any appeal, but also by a new financial burden in the wake of last October’s appointment of a federal receiver to resolve a 30-year-old complaint over discriminatory hiring practices―said receiver recently requested $24 million from the county to address hiring problems―and, with revenues not matching anticipation in the county’s budget, County Commission President David Carrington notes the federal request will be “problematic.” The federal receiver recently asked for $400,000 in the current fiscal year to hire five employees for the Jefferson County’s human resources department, and requested $9.8 million for FY2015, and projects a request of $13.75 million for FY2016. To which, President Carrington notes: “The county will be able to internally absorb this year’s budget request, since there are budgeted monies available for more than 400 open positions that still need to be filled in coordination with the receiver and the Personnel Board…Next year’s budget for the (federal) receiver will be much more problematic and will most probably require shifting general fund department allocations with associated reductions in service levels, using a significant portion of one-time monies for one-time expenditures, and aligning the county’s capital priorities.” The unfunded federal mandate on the post-chapter 9 county comes as the county has recognized nearly $100 million in general sales and use tax revenues over the previous year, as well as increases in assessed property values, ad valorem tax collections have fallen by $6.6 million to $540.05 million, and educational sales tax collections, which secure warrants issued for school improvements, also declined by $1 million. Beset by federal unfunded mandates on one side, the impending appeal on a second side, Jefferson County now awaits unfriendly fiscal fire on a third: the Birmingham News reports that the Mayor of neighboring Trussville, Alabama has threatened to sue the county, because state law requires counties to maintain roads within city limits. With the onset of its descent into bankruptcy, the Commission had adopted a resolution in 2009 announcing that it would no longer maintain its roads in municipalities. The suit, similar to the litigation by Birmingham against Jefferson County with regard to emergency room hospital services, could engender a whole new round of costly litigation—even as Jefferson County officials work to avoid a new round of expensive trials and tribulations. Meanwhile, the county has no choice but to finance the costs of the pending appeal to determine whether U.S. Bankruptcy Judge Thomas Bennett’s approval of the county’s plan of adjustment last November should stand. The County’s final step in exiting was to issue $1.8 billion of new sewer refunding warrants, the proceeds of which were to write down $3.14 billion in old sewer warrants. Now it is this sewer debt that comprises the basis of three appeals filed by 13 litigants, whose lead plaintiff is Jefferson County Tax Assessor Andrew Bennett. The lead attorney for the litigants has, according to the Bond Buyer, “repeatedly told the court that his clients are elected state, and local officials and residents who are creditors of the county, and who represent a presumed ‘class of creditors’ on the county’s sewer system. The County has responded that such claims should be moot, because they were discharged by the adjustment plan, arguing that the federal court should consider the only portion of the appeal that is not moot: whether the bankruptcy court erred in disallowing the proofs of claim for $1.63 billion filed by the ratepayers. Unlike private corporations, which may use federal bankruptcy to discharge their debts and cease to exist, municipal bankruptcy was enacted specifically to ensure that essential public services would continue uninterrupted while the municipality reorganized its debts and put together a plan of adjustment to enable it to exit bankruptcy and—hopefully—realize a sustainable future. The federal law, however, does not provide for a “place at the debtor table” of a sustainable future. The unfunded federal mandates and costly new appeal now raise a very real risk to the County’s ongoing recovery in a bankruptcy which U.S. Bankruptcy Judge Thomas Bennett written: “The loss of this unencumbered revenue source was rooted in the inability of the state of Alabama and its Legislature to properly enact a statute…All those who attribute Jefferson County’s bankruptcy case and Cooper Green’s plight only to conduct and actions by the county are ill-informed…The state of Alabama and its legislators are a significant, precipitating cause. Both before and after filing its Chapter 9 case, the county’s revenue-seeking activities with Alabama have been to no avail.”

Pay-to-Play. Federal law enforcement officials have subpoenaed the Rev. Horace Sheffield to find out what he knows with regard to rumors about efforts to make contributions to members of the Motor City’s City Council to influence the outcome of the vote for the council presidency, according to sources familiar with the investigation, as reported this morning by the Detroit News. The public corruption investigation, which the News writes is “apparently in its early stages,” was triggered by a conversation at an Eastern Market bar approximately five weeks ago involving Detroit Police Chief James Craig; political consultant Adolph Mongo; and Reverend Sheffield, a prominent Detroit pastor, the father of Detroit Councilwoman Mary Sheffield, and a congressional challenger to U.S. Rep. John Conyers, the Ranking Member of the U.S. House of Representatives Committee on the Judiciary. The paper reports the men allegedly discussed rumors that someone was trying to buy the votes of City Council members―so that the FBI has opened an investigation, and Rev. Sheffield has already been scheduled to testify in front of a federal grand jury the week after next. The federal prosecutor on the case is Assistant U.S. Attorney Michael Bullotta, one of the lead prosecutors in former, and now incarcerated, Mayor Kwame Kilpatrick corruption trial.

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