07.08.14

The Exorbitant Cost of Municipal Bankruptcy.  One of the most troubling aspects of municipal bankruptcy is the high, associated cost of professional and legal fees. Every dollar consumed, after all, is a dollar less for a municipality’s future—not to mention a dollar less to be shared amongst its creditors. Detroit—with the largest municipal bankruptcy in the nation’s history, and still a week short of its first anniversary since filing last July, has been billed more than $75 million in fees and expenses from 19 professional services firms through late June―of which the Motor City has paid about $64 million to date to some 19 firms and companies, according to city records, including more than $38 million paid to law firms. The bulk of the remainder, 15 percent, has been put on hold under U.S. Bankruptcy Judge Steven Rhodes’ instructions to be withheld until after the invoices clear a review by a fee examiner―with last year’s quarterly fee examiner reviewsubmitted to the U.S. bankruptcy court last May, detailing just under $36 million in gross fees and expenses claimed through last Dec. 31st. According to Crain’s, the pending reports indicate more than $40 million in new invoices since then, with the city paying out more than $32 million since the beginning of the year—with Jones Day, the Motor City’s lead bankruptcy counsel charging over $26 million through late last month, followed by audit and professional services firm Ernst & Young LLP with just under $9.5 million since the bankruptcy petition.  To put those figures in context, the most expensive prior municipal bankruptcy was in the second largest in U.S. history—Jefferson County, Alabama, where professional fees topped $35 million with much of it in legal bills before the county exited bankruptcy last December. In contrast, Vallejo, Ca. has spent more than $13 million in various fees, and Stockton, Ca. around $12 million.

Taking Stock in Stockton. Stockton’s municipal bankruptcy trial before U.S. Bankruptcy Judge Christopher Klein is scheduled to resume this afternoon in Sacramento after a break of more than a month, but a final ruling—which could address the fundamental federalism issue whether a federal law could preempt a state constitution—appears unlikely. Marc Levinson, Stockton’s lead bankruptcy attorney, said the only thing he is reasonably certain of is that the Judge Klein will set a value for the collateral the city used to secure a $35 million loan from its one remaining creditor, Franklin Templeton Investments, with which Stockton has yet to reach a negotiated settlement: The collateral used by the city was Swenson Golf Course, Van Buskirk Golf Course, and Oak Park.

To date, Stockton has offered to repay creditor Franklin about 1 percent of its loan, roughly $350,000—with the city’s witnesses testifying that needed maintenance at Swenson, Van Buskirk, and Oak Park renders the properties virtually devoid of financial value. In contrast, an expert witness for Franklin Templeton testified the properties are worth close to $15 million. Thus, should Judge Klein determine a value of the collateral this afternoon, that would clear the deck for Stockton to modify its proposed plan of adjustment—with Stockton likely to submit a modified plan of adjustment to the court later in July. It will be then that the action ion the main ring will pit mutual fund giant and Stockton creditor Franklin Templeton Investments against the California Public Employees’ Retirement System (CalPERS), the largest public pension fund in the U.S.―with Franklin Templeton arguing it would be inequitable for the federal court to exempt creditor CalPERS from any diminution (Franklin Templeton, which manages assets of more than $908 billion, is the lone creditor challenging Stockton’s plan of adjustment to exit its municipal two-year bankruptcy, arguing that the northern California municipality wants to unfairly slice a debt repayment, while leaving public pension contributions intact. The city is offering Franklin Templeton about $350,000, or less than 1%, back on a $35 million loan that financed fire stations, a police station, bridges, street improvements, and parks.): Stockton’s retirement contributions should be reduced to free up money for a more equitable share of its loan repayment—a looming decision with regard to whether a federal court has a role to play in weighing a challenge between a state constitution and the chapter 9 municipal bankruptcy law which calls for a fair and equitable allocation of a bankrupt municipalities remaining assets amongst its creditors.

Even though the City of Stockton has neither reduced its contributions to CalPERS, nor proposed to do so in its proposed plan of adjustment, Judge Klein has been clear that his role in the bankruptcy case is not simply to rubber stamp Stockton’s plan of adjustment, but rather to ascertain that the city’s proposed plan of adjustment will ensure a sustainable fiscal future and municipal service solvency—citing CalPERS costs as his main area of concern. (Note: Franklin Templeton is separately challenging a new law in Puerto Rico allowing some troubled public agencies to restructure their debt, saying it violates the U.S. Constitution.) For its part, CalPERS testified before Judge Klein last month that it would impose a $1.6 billion exit fee on Stockton should the city—as part of its plan of adjustment—choose to impair or exit its relationship with the giant California public pension agency.

Get Out the Vote! Yesterday might have been the last day when some 32,000 retirees and employees with Motor City pension claims in Detroit’s municipal bankruptcy could feel secure their votes would be received and counted. That’s because of the deadline for receipt of their ballots in Segundo, California, where a company by the name of Kurtzman Carson Consultants has been hired to do the tally. Motor City retirees and employees have received either a Class 10 or Class 11 ballot regarding cuts to their pension benefits and any clawback of their annuity savings fund that would apply to some of those covered by the general retirement system (Class 10 represents police and fire, and Class 11 represents general retirees). For Detroit’s plan of adjustment to be accepted, both Class 10 and Class 11 must approve the plan by a two-thirds majority; moreover, a failure to achieve the margin of approval necessary would jeopardize the so-called “grand bargain” through which the state, wealthy foundations, and the Detroit Institute of Arts pledged the equivalent of $816 million to reduce pension cuts in exchange for spinning off the DIA to a nonprofit trust: the state and foundations have made clear the funding will only be made available if retirees vote to approve the city’s bankruptcy plan. Retirees who have health care benefit claims, in addition, have received class 12 ballots. If emergency manager Kevyn Orr’s plan is approved, general retirees would lose all future cost-of-living adjustments plus 4.5% of their monthly pension checks. About 9,900 general retirees and active workers also face a clawback of excessive interest from annuity savings funds. Police and fire would not see any cuts to current pension checks, and their annual cost-of-living adjustment would decrease to about 1% from a little more than 2%. If one class or both classes reject the plan, the outside funding for pensions will not be available. And the cuts would be deeper, according to the Orr’s team.

Detroit Tomorrow. Motor City Mayor Mike Duggan last month announced the formation of Detroit’s first innovation district: “We have right now some great creative energy occurring in downtown and Midtown…The focus of the innovation district will be to create an anchor to support neighborhood business incubators across the city…The concept of these districts, “geographic areas where leading-edge anchor institutions and companies cluster and connect with startups, business incubators and accelerators,” as described by Bruce Katz and Julie Wagner in their Brooking’s report, The Rise of Innovation Districts: A New Geography of Innovation in America, describe areas or neighborhoods that “are also physically compact, transit-accessible and technically wired and offer mixed-use housing, office and retail.”

Yet, even before one of the Motor City’s re-emerging neighborhoods was branded as an innovation district, it was labeled by some as a “creative corridor:” a neighborhood where organizations such as the Detroit Creative Corridor Center have been incubating and growing small creative firms in an attempt to fill its arteries with economic activity―drawing in filmmakers, ad agencies, digital media, branding agencies, architects, designers, etc. into downtown and Midtown Detroit―and slowly and organically clustering them into distinct centers of activity. One of the early clusters, centering on Detroit’s Grand Circus Park, has become home to many top names in advertising, graphic design, and digital media. The new Lowe Campbell Ewald office anchors the eastern edge at Ford Field, surrounded by the Skidmore Studios, Lambert Edwards & Associates and Hudson Editorial offices near the Detroit Opera House. Firms such as Gyro Creative Group and Detroit Lives! are on the western edge, approaching Capitol Park. Up the avenue, a retail and design center is emerging at the intersection of Cass and Canfield streets, with interior design firm Patrick Thompson Design holding down the retail floor of the Auburn apartment building along with a host of retailers, including Norah and Hugh, two home-goods stores, and Source Booksellers. Around the corner, retailers Nest and City Bird look onto Shinola’s retail headquarters and the new Willys Detroit shop. Meanwhile, in another neighborhood, a design, research, and development hub is emerging—engendered, at least in part, by all the anchor institutions clustered in the area, including: The Henry Ford Innovation Institute, the College of Creative Studies, and Wayne State University’s coming $90 million biosciences facility. But these emerging urban centers of dynamism were not plotted on a map—rather they appear to be gathering steam—only the New Center cluster was intentional. Yet, in the past four years, the number of creative firms — which some would define this type of business activity happening in a district — has jumped from around 15 to 50. The encouraging start for Mayor Duggan’s 17-person panel, chaired by Henry Ford Health System’s Nancy Schlichting, are critical: the city’s extraordinary costs to get out of the largest bankruptcy in the nation’s future mean its path forward to service solvency and a sustainable future could rest on its success in the creation of economic clusters of the future.

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