September 3, 2014
Visit the project blog: The Municipal Sustainability Project
Day 1. Detroit opened its historic chapter 9 municipal bankruptcy confirmation trial in U.S. Bankruptcy Judge Steven Rhodes’ courtroom yesterday, with U.S. Bankruptcy Judge Steven Rhodes wryly opening the trial by stating: “I’ve already said that the city is done making bad deals.” with Motor City attorney Bruce Bennett testifying our “purpose is no less than to save the city of Detroit: Detroit won’t survive if this isn’t done,” adding that the city had been down for so long and is so fiscally distressed that it cannot hope to continue operating unless the court approves its proposed plan to disgorge some $7 billion of its debts. Mr. Bennett added that the city cannot achieve balance by imposing new taxes, because it is already at its state-imposed limit, adding that new taxes would likely serve more to discourage new businesses and residents vital to the city’s recovery than aid its ailing kitty. Anticipating holdout creditors who hope to use the trial to force Detroit to put its world-class Detroit Institute of Art up for sale, Mr. Bennett cited Michigan law to argue that creditors cannot access municipal assets outside of bankruptcy: “The fact that no city assets can be levied on or sold outside Chapter 9 … is or ought to be a powerful warning to every potential lender and insurer not to lend any money to a municipality based on the expectation that a creditor can compel the sale of an asset….There is no disagreement left, I think, that outside of Chapter 9 (there is) absolutely no access to assets and therefore no expectations of a recovery from them.” Emphasizing the city’s line of defense, Mr. Bennett put it this way: “First big question. What are unsecured creditors’ rights to recover from assets owned by a Michigan city?” Answering his own rhetorical question, he told the court there is no expectation under Michigan law that creditors can access a municipality’s assets. In an interesting moment, Judge Rhodes asked the city whether the Detroit pension funds should be legally considered separate from the city ― or part of the city; he signaled he does not intend to consider evidence on the potential impact of Detroit’s bankruptcy plan on individual retirees—and that he intends to block bids by bond insurers to stop Detroit from introducing evidence of hardship on pensioners and other class of creditors: “The court has ruled before and maintains now that the impact of confirming the plan on any particular creditor or group of creditors or class of creditors is not relevant to whether the plan should be confirmed — and the court intends to enforce that ruling on evidence throughout the trial.”
Two Kinds of Corporate Bankruptcy. The key distinction between municipal corporate (every municipality is defined as a corporation under state laws) and corporate bankruptcy is the importance to ensure the continuity of essential public services in cities, counties, towns, schools, etc., or:
The requirement that the plan be in the “best interests of creditors” means something different under chapter 9 than under chapter 11. Under chapter 11, a plan is said to be in the “best interest of creditors” if creditors would receive as much under the plan as they would if the debtor were liquidated. 11 U.S.C. § 1129(a)(7)(A)(ii). Obviously, a different interpretation is needed in chapter 9 cases because a municipality’s assets cannot be liquidated to pay creditors. In the chapter 9 context, the “best interests of creditors” test has generally been interpreted to mean that the plan must be better than other alternatives available to the creditors.
Procedurally Arguing. Unlike most trials, a unique aspect of municipal bankruptcy is that there is a time limit for the federal court to be in session, so that, as the court resumes this morning, 164 hours remain, allocated so that the Motor City now has just over 79 hours to make its case for its proposed plan of adjustment plan, while objecting creditors have a maximum 85 hours to present testimony and legal arguments of their own (Detroit had actually used some of its allotted time prior to the commencement yesterday, including the August 8th bus tour with Judge Rhodes and several creditor representatives of various Detroit neighborhoods already counted as time on the city’s case clock). Judge Rhodes has also given time allotments ranging from several minutes to five hours for certain unrepresented creditors at the tail end of the hearing, but all testimony is expected to wrap by Oct. 17. Yesterday, Judge Rhodes reminded both sides that he is paying close attention to the clock. It appears Detroit will finish with its presentation of the case by the end of the month—planning to offer witnesses in support of its plan, including: Mayor Michael Duggan, Dan Gilbert, founder-chairman of Quicken Loans Inc.; Chairman Roger Penske of Penske Automotive Group Inc.; CEO Rip Rapson of the Kresge Foundation; COO Annemarie Erickson of the Detroit Institute of Arts; Detroit City Council President Brenda Jones, and Emergency Manager Kevyn Orr. Other possible witnesses include DIA President-CEO Graham Beal and President Sue Mosey of Midtown Detroit Inc., if time allows and the city deems them necessary. With regard to motions, Judge Rhodes yesterday mostly denied motions by attorneys for holdout creditors Syncora Guarantee Inc. and the Financial Guarantee Insurance Co. (FGIC) raised before the trial began including to exclude evidence of terms and conditions of the so-called “grand bargain” with the state and several foundations, as well as evidence of potential hardships to pensioners if the adjustment plan is not approved, but yesterday ruled he will allow the two bond insurers to raise objections on the same grounds during trial as needed. During yesterday’s proceedings, attorneys for the two bond insurers sought to score points with regard to “equity,” testifying that Emergency Manager Kevyn Orr has previously testified that Motor City retirees fare better than the class of bond insurers, who are “unsecured creditors” under the plan, in part because the city was following Judge Rhodes’ own guidance in past statements from the bench to show some compassion in restructuring its pension debt. A critical issue in the trial—and likely appeal to the 6th U.S. Circuit Court of Appeals—is likely to hinge on what “fair and equitable” means with regard to disparate treatment of creditors. Generally, experts seem to believe that chapter 9 bankruptcy law allows a municipality, in its plan of debt adjustment, to discriminate among creditors if the discrimination is not “unfair,” under precedent in the 6th Circuit—as long as there is: a reasonable basis, whether it is possible to confirm an adjustment plan without discrimination, whether the discrimination is proposed in good faith, and how the discriminated class is being treated.
Opening statements are expected to continue this morning.
Outside the Courtroom. Even as Detroit’s historic trial clock has started running, the city began private negotiations over the weekend in an effort to resolve some of its challenges with holdout creditors through the trade of some of the Motor City’s assets — including, potentially, its airport (the Coleman A. Young Municipal Airport), a stake in the Detroit-Windsor Tunnel, or other real estate—with only the Detroit Institute of Arts not an options for any discussion, with Emergency Manager Kevyn Orr, according to his spokesperson, telling the Detroit News: “We sense a renewed approach by Syncora to engage in mediation, but I can’t talk about details.” The discussions – if they were to succeed—would remove the gravest challenge to the city’s exit from bankruptcy, as Syncora and FGIC are at risk of losing more than $1 billion. Having incurred Judge Rhodes unhappiness, the issue for all sides is whether they might come out better outside, rather than inside the federal courtroom. — are two of the biggest obstacles blocking Detroit’s path out of bankruptcy. Syncora and the Motor City agreed to last-minute private negotiations—to be overseen by Chief U.S. District Judge Gerald Rosen.
Addressing Urban Blight. The Detroit City Council yesterday deferred a decision with regard to whether to transfer approximately 39,000 parcels to an outside agency which is acquiring and selling off troubled properties, but the Council will take up whether to transfer the vacant residential lots—lots which the Detroit Land Bank Authority would eventually sell to residents at a planned price of $100 each, with an end goal of getting those properties back on the city’s property tax rolls. After a lengthy discussion, council members remarked there were too many unanswered questions with regard to how property owners would be eligible to take the vacant land and whether the potential move would cede too much of the City Council’s authority under the City Charter, with Councilmember James Tate noting: “There’s got to be something where the council plays a role in the disposition of land, because that is a part of our charter-mandated power…I don’t believe we should be asked to repeatedly cede those powers and be OK with it because it’s called progress.” Last April, the council transferred about 12,000 parcels to the Detroit Land Bank Authority, with most of those structures set for demolition, albeit several are being used for the city’s auction initiative. Approximately 100 homes have been auctioned thus far under the program.
Post Municipal Bankruptcy. Last Thursday, post municipal bankruptcy Jefferson County, Alabama released its auditor’s letter on the MSRB’s EMMA site, but the epistle is not especially dispositive with regard to how the county’s recovery is proceeding, because it does not take into account the impact of Jefferson County’s approved (by U.S. Bankruptcy Judge Thomas Bennett) plan of adjustment. Much of what is in the report is consistent with the financial information available at the county’s bankruptcy confirmation hearing and is a restatement of what was presented, although in a formal auditor’s report. Thus, the real crunch period is in the 2019 to 2023 period for the sewer system, not the county as a whole. While the financial information in the audit is based on conditions that existed as of Sept. 30, 2013, as pointed out in the auditor’s letter, the county opted to forego the management’s discussion and analysis required by Governmental Accounting Standards Board as it has for at least the last six years. Birmingham-based Warren Averett, the county’s long-time auditor, confirmed that no adjustments to the financial statements have been made as a result of the county emerging from bankruptcy last December 3rd. The document does make clear Jefferson County is still facing expenses related to lawsuits and financial claims from its Chapter 9 filing. The audit does not mention sanctions the court is currently considering against the county and several of the county’s attorneys based on allegations that information was withheld during the long-running suit. An appeal of Jefferson County’s bankruptcy exit is still pending in federal court. The judge in the case ordered briefs following a hearing in late July, but has yet to rule as to whether the challengers may proceed with their case.