Sharing Services & State Bankruptcy

August 5, 2014
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Trial Delay. The U.S. 6th Circuit Courts of Appeals has agreed to defer appeals by some Motor City creditors with regard to U.S. Bankruptcy Judge Steven Rhodes’ decision last December finding the city eligible for federal bankruptcy protection in the wake of five groups representing Detroit’s retirees requesting a postponement. The creditors told the court they were working with Kevyn Orr and his team to reach a settlement agreement, instead asking the court to delay the hearing until after the confirmation plan trial scheduled to begin during the National Conference of State Legislature’s annual meeting in Minneapolis the week after next. The creditors, along with attorneys for both the State of Michigan and Detroit, had written, in a letter to the panel of judges from the 6th Circuit: “We believe that any action by this court other than holding these appeals in abeyance until after the plan confirmation would significantly undermine a sensitive settlement and court-ordered mediation process, and would jeopardize both the city’s expeditious emergence from bankruptcy and over $800 million of critical funding commitments from the state of Michigan and other outside sources…Holding the appeals in abeyance also ensures that this court will not unnecessarily decide important state and federal constitutional issues.”

Sharing Services & Crossing Bridges. San Bernardino’s City Council last evening voted 5-2 to grant permission to the city’s manager, Allen Parker, to request proposals from neighboring fire departments that may be able to provide the bankrupt municipality with essential fire and rescue services, including the possibility of seeking to have San Bernardino County take over city fire services—indeed, if Mr. Parker’s with his counterpart, San Bernardino County CAO Greg Devereaux or with any other agencies lead to a proposal, the City Council will then vote on whether or not to accept it—albeit with San Bernardino City Attorney Gary Saenz warning he would anticipate the fire union would file suit against the municipality, arguing that the city charter requires the city to maintain its own Fire Department, noting: “There have been legal opinions that say we are allowed, and there have been others saying we aren’t allowed…That’s a bridge to be crossed.” Last night, San Bernardino Councilmember Fred Shorett commented: “There will come a time when the judge will throw us out of bankruptcy court” if the city fails to demonstrate it has a plan to provide fiscal sustainability and essential service solvency, noting: “We need to be looking under every stone.” However, Councilmembers John Valdivia and Benito Barrios opposed the motion, reflecting the comments of the majority of residents who spoke Monday night, with Councilman Valdiva stating: “I feel that as well, that this is political and there’s a vendetta against our firefighters…Not one agency around us wants to touch us, yet we continue going down that path.” Public agencies that could provide service instead of, or together with, the San Bernardino Fire Department include the San Bernardino County Fire Department and Cal Fire, according to a one-page report. Proposals to share are not new to the city, and last year the city commissioned a study to assess the risks and potential benefits—with said study, presented to the Council in June, advising against requesting such a contract at present, and instead recommending the closure of two of the city’s fire stations—and renegotiating its mutual aid agreements. The report to the Council also reported that the California Department of Forestry and Fire Protection (Cal Fire) would not respond, because San Bernardino was in bankruptcy, and the reported advised that no other agencies were interested in a joint powers authority. Finally, the report noted that annexation to the county could take two years. Nevertheless, Councilmember Shorett has been looking farther down the road, reporting that the city could realize as much as $8-$12 million annually through sharing services.

Even with the majority vote last evening, however, the city could confront another snag: some believe the city’s charter mandates that the city retain fire services in-house: the language reads: “The Fire Department shall consist of a Chief of the Fire Department and as many ranking officers, firefighters, and other employees as the Mayor and Council may determine,” albeit another provision in the charter is: “Council shall have power to establish and maintain a fire department, prescribe fire limits and adopt regulations for the protection of the City against fires.” Further potentially complicating the question is one of five proposed amendments that could go before the city’s voters in November, reading: “The language contained in this Charter is intended to be permissive and enabling rather than restrictive or limiting, and shall be liberally and broadly construed in favor of the exercise by the City of its power to govern with respect to any matter which is a municipal affair.”

Does Puerto Rico Offer a way for States in Severe Fiscal Distress? David Skeel, who teaches bankruptcy law at the University of Pennsylvania Law School and a fellow presenter at the Widener Law School Symposium, Bankruptcy and Beyond” in Harrisburg, Pa., in April, yesterday wrote an op ed for the Wall Street Journal, “A Puerto Rican Solution for Illinois,” noting that “If a U.S. commonwealth can declare bankruptcy, it may open the way for states in debt trouble.” Professor Skeel wrote that “If Puerto Rico can restructure its debt, there could be hope for states—particularly Illinois—whose own finances are sketchy.” In his piece, Prof Skeel notes that under the U.S. Constitution, “only Congress has the power to enact bankruptcy laws…, which also prohibits a state (or commonwealth) from altering the terms of existing contracts. And it points to a provision in the federal bankruptcy code that invalidates state laws to restructure municipal debt;” however, Prof Skeel noted that: “Since the early decades of the 19th century, the Supreme Court has permitted states to have their own bankruptcy-like laws if there is no federal alternative—as there isn’t for Puerto Rico. The Constitution’s Contract Clause would be a death knell for Puerto Rico’s debt-restructuring law if courts interpreted it strictly. But they don’t.
“States are permitted to intervene if there is a genuine emergency, and the state action is reasonable and necessary to address the emergency. This flexibility was the basis for provisions in the Michigan law that also made it possible to bring in an emergency manager in Detroit. The provision in the federal bankruptcy code that invalidates state laws to restructure municipal debt probably does not apply to Puerto Rico—since its municipalities are not permitted to use Chapter 9.” He notes that Congress, in its wisdom…: “could dispel the uncertainty by allowing Puerto Rico’s public corporations to file for bankruptcy under Chapter 9—(similar to the legislation, HR 5305, we reported on by Puerto Rican U.S. Rep Pedro Pierluisia, last week.), adding: “Ideally, Puerto Rico itself, not just its municipalities, could be allowed to file for Chapter 9. The unpalatable alternatives are an unlikely, and unwise, federal bailout, or a messy default.”

In a key graph (especially when one scans the enclosed box illustrating how costly borrowing is for defaulted sovereigns…), Prof. Skeel writes: “Whether or not Congress acts, Puerto Rico, with a total public debt of $73 billion, has become the most important test case ever for the question of whether American states should be permitted to file for bankruptcy. Unlike Detroit, whose fiscal woes do not reflect a statewide crisis, Puerto Rico’s crisis is pervasive. If the commonwealth can successfully restructure the debt of its public corporations, this will strongly suggest that Congress should provide a mechanism for troubled states to file for bankruptcy.”
He notes, particularly: “The state that should be watching Puerto Rico most closely is Illinois. With a total debt of more than $321 billion, including more than $200 billion in unfunded pension obligations, Illinois is in an increasingly dire financial condition. A modest pension reform enacted last year could help a little, but it is under a legal challenge, based on a provision in the state constitution that protects even unaccrued pension obligations. The Illinois Supreme Court has already reinterpreted that provision, in July, to protect health-care benefits.
“A federal bankruptcy law covering Illinois (or New York or New Jersey or California) would trump any state constitutional provisions or court decisions and permit the restructuring of unfunded pension obligations. It would also give a hopelessly overextended state breathing room to return its finances to balance. The prospect that unsustainable pension promises could be restructured would give lawmakers and public employees in every state a much greater incentive to avoid making unrealistic promises.”

Action by Congress, however, to enact federal legislation for state bankruptcy would confront a number of legal impediments—especially the issue of dual sovereignty, which precludes the Federal Government from imposing a mandatory bankruptcy procedure on the states—dual sovereignty being one of the defining features of our nation’s constitutional blueprint. Put differently: states, upon ratification of the Constitution, did not consent to become mere appendages of the federal government, but, rather, entered the Union “with their sovereignty


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