The Transition of Governance in Municipal Bankruptcy

September 22, 2014
Visit the project blog: The Municipal Sustainability Project

Profound Transition. The next two weeks could witness a profound transformation in Detroit from state to federal back to local control. Michigan Governor Rick Scott, under Michigan’s Act 47, effectively took over control of the city on March 13, 2013, with the appointment of Emergency Manager Kevyn Orr. On July 18, 2013, Mr. Orr filed for chapter 9 municipal bankruptcy protection by the federal government—a filing which was accepted by the U.S. Bankruptcy Court—effectively putting the city under federal control—on December 5, 2013. Now, under Act 47’s time frame, Mr. Orr will step down from his Act 47 position effective at the end of this month—so that Mayor Mike Duggan and the Detroit City Council will reassume authority—under the oversight of a new state board. At the same time, with the clock in Judge Rhodes’ courtroom running down, either an agreement with the last remaining major holdout creditor (FGIC), or a decision by Judge Rhodes to approve Mr. Orr’s pending plan of debt adjustment would effectively end the federal judiciary’s control of Detroit. Thus, even as the trial and closed door negotiations under the auspices of U.S. Chief Judge Gerard Rosen, continue; the process of transitioning is accelerating. But this long and difficult process from municipal to state to federal and back to local control promises to be difficult—albeit a process which might provide invaluable lessons for state and local leaders throughout the nation.
Regional Water Agreement. Thus, last Friday—which, under Michigan’s emergency manager law, Act 47, was the deadline for the council to vote on each of the three items proposed by emergency manager Kevyn Orr, the Detroit City Council approved, 7-2, creation of a new regional water authority under which the city would lease infrastructure to suburban communities in exchange for a 40-year, $50 million annual fee and an annual $4.5 million payment assistance fund and the settlement with bond insurer Syncora, but disapproved, unanimously, a proposed transfer of 45,000 city-owned parcels to the Detroit Land Bank. The affirmative vote came just days after Mayor Mike Duggan provided the Council with a detailed presentation and urged them to support the plan. Separately, the council approved a key agreement outlined in Mr. Orr’s pending plan of debt adjustment before Judge Rhodes for a comprehensive settlement with Syncora Guarantee Inc. Under the new, regional water agreement, the annual fee may only be used for Detroit water-related repairs, maintenance, and improvements—and rate increases will be capped at 4 percent over the next 10 years. To gain final approval, the water agreement must gain a nod from the Detroit City Council and at least one of the counties of Wayne, Oakland, or Macomb. The deadline for county officials to vote is October 10th. In response to a governance question, Detroit Corporation Counsel Melvin Butch Hollowell, prior to Friday’s vote, informed and clarified for the Council that the agreement would not create a franchise or violate the Motor City’s charter.
Regional Water Agreement II. Demonstrating the multiple layers of governance now involved in this transition, the prior day, U.S. Bankruptcy Judge Steven Rhodes addressed his own significant concerns to Mr. Orr’s plan on the regional water agreement, sharply questioning how Detroit’s Water and Sewerage Department plans to fund as much as $2 billion in needed infrastructure improvements over the next decade, even as it transforms itself into a regional authority that will receive additional funding from suburban communities—and as the city has been enveloped in fierce disputes with regard to its management: indeed, the Judge has scheduled a hearing for this morning on whether to temporarily delay water shutoffs to Motor City residents with unpaid bills. Thus, Detroit’s ability to finance desperately needed repairs and upgrades of its water and sewer system could become a factor not just for potential future purchasers of Detroit’s and the new system’s municipal revenue bonds, but also whether Kevyn Orr’s pending plan of adjustment before the federal court is feasible. Currently, both the city of Detroit and Detroit Public Schools owe the Detroit Water and Sewer District millions and are behind on payments.
Detroit Land Bank Authority. But the City Council voted unanimously to reject a resolution authorizing the transfer of 45,000 vacant city-owned residential lots to the Detroit Land Bank Authority—with the elected leaders reacting in frustration to what Councilmember Saunteel Jenkins described as an “illusion of inclusion: At least give this body the respect of pretending to allow us to vote yes or no,” telling her elected colleagues that the plan had “already been laid out” and tied the Council’s hands on residential land issues in future years, describi9ng the deal as one where the “goal is to make sure that people around this table are not able to provide input based on what your constituents want.” Similarly, Councilmember Jones called the process “insulting.” Others, including members Mary Sheffield and Raquel Castaneda-Lopez said they couldn’t support the transfer plan as written. But on the land bank issue, the governance challenges were even more complicated, as some believe that the proposal actually came more from Detroit Mayor Mike Duggan than Mr. Orr, as Mayor Duggan has vested significant time and energy in his efforts to put together a strategy to fight blight. So it is not clear this is a federal-state-local dispute; rather it appears to reflect power concerns within the city as it nears returning to local control. Under Act 47, the Detroit City Council now has seven days to propose an alternative that would provide the city with the same or greater benefit. If the Council so acts, its proposal would go to Michigan’s Emergency Loan Board, which would decide between the two plans.
Trial Resumes A Week from Today. Delay. U.S. Bankruptcy Judge Steven Rhodes has agreed to the motion by Detroit and Financial Guaranty Insurance Co. (FGIC) to delay further proceedings in the bankruptcy trial until September 29th in order to give municipal bond insurer and the Motor City’s last remaining major holdout creditor more time to prepare its case against the city’s pending plan of debt adjustment—as well as to permit further federally mediated negotiations.

From the start of the bankruptcy case, U. S. Bankruptcy Judge Steven Rhodes has made it clear that the city must prove that its bankruptcy plan will enable the city to be “viable,” after it emerges from bankruptcy. Part of the hard question—a question which Judge Rhodes can only answer with a yes or no, is whether he can find the city’s proposed plan of debt adjustment to provide for a sustainable future—that is, not just a city that can deliver fire and police protection, but rather one that also must offer other services such as parks and recreation and cultural attractions if the municipality is to retain residents and attract businesses.

Compared to Detroit. How a municipality gets out of municipal bankruptcy can be a long and convoluted process, as can be better understood in watching and comparing San Bernardino—which filed for federal bankruptcy protection a year before Detroit, but which appears to still be months away from putting together its own plan of adjustment, the prerequisite to obtain federal permission to exit bankruptcy. Now some of San Bernardino’s creditors are objecting to the slow process by the city, with a filing with U.S. Bankruptcy Judge Meredith Jury last month noting: “During the past two years, the City has taken advantage, sometimes unlawfully, of a wide variety of perceived benefits derived from the bankruptcy filing…During this time, the City has been free of most of the cumbersome responsibilities required of a reorganizing bankrupt entity surrendering to the jurisdiction of a bankruptcy filing. Even so, the City has made little progress toward the filing of a plan of adjustment. In fact, it appears that the City is comfortable with all the delays occurring in this case.” The police unions’ attorney has suggested, and the fire union has formally requested, a court-imposed deadline for the city to file its plan of adjustment — the plan on how the city will settle its debts and exit bankruptcy. The city’s unions, who filed the notice with regard to the legality of the city imposing benefit cuts and making other changes under the perceived umbrella of the federal process will be heard this week, where, according to San Bernardino City Attorney Gary Saenz, Judge Jury will shed some light with regard to the pace of the process, noting: “What the bankruptcy laws do is provide protection for the city so we can make adjustments to our financial situation and make adjustments to our revenue that we achieve and our costs that we incur, so we can maintain a solvent budget going forward…(Bankruptcy protection) allows the city to continue providing services at a level that we otherwise couldn’t provide if we did not have the bankruptcy protection. I know that people are impatient. I think what people want more than anything is not so much to be out of bankruptcy but for the city to become more solvent or more financially able to move forward.” Mr. Saenz notes that the cost of chapter 9 and its litigation is high — more than $3 million for each 12-month period of bankruptcy so far, sometimes approaching $4 million — but less expensive than not having that protection, but adds: “We have been charged with, and the court is making sure we are, moving toward solvency…And that solvency includes a solvency in terms of our service levels. So as the citizens consider the fact that we’re in bankruptcy, they need to be assured that the focus of the city and of the court is to have a solvent level of service for the citizens.”

City Attorney Saenz expects San Bernardino’s Plan of Debt Adjustment to be ready by spring 2015, consistent with a timeline Mayor Carey Davis proposed and the City Council approved last July. Similarly, while both San Bernardino and Detroit have been confronted with the federal-state challenge with regard to state constitutional provisions barring any reductions in pensions—and whether the federal bankruptcy law can override the respective state constitutions; there has been a signal difference in the processes between the bankruptcy processes in California between Stockton and San Bernardino—a municipality more comparable in size than Detroit to San Bernardino. Or, as a CalPERS spokesperson wrote: “San Bernardino filed its bankruptcy following the declaration of a fiscal emergency without going through the pre-filing mediation process that Stockton went through…So San Bernardino did not get the head start that Stockton got by meeting with creditors and a neutral mediator prior to the bankruptcy filing.”
Modified Firefight. Last Friday, U.S. Bankruptcy Judge Meredith Jury slightly modified her previous order with regard to San Bernardino’s authority to modify or reject its current contract with the firefighters union. In effect, the modified federal court order allows the city to fill that void with a new firefighter contract of its choosing; however, Judge Jury did not provide explicit authority for San Bernardino to impose a new contract, directing that the municipality must comply with relevant laws, and striking parts of the city’s proposed order containing that language. In addition, Judge Jury wrote that the municipality’s firefighters’ attorneys were right that San Bernardino had originally asked for more before backing off that request: “The city is disingenuous when it says it didn’t ask for more…Until I got the reply papers on the supplemental request … I certainly had the impression they were asking for me to do more than just reject (the contract).” The order says the city’s motion was granted in part and rejected in part, which doesn’t change its legal effect. Attorneys for both the firefighters’ union and the city had submitted proposed orders interpreting the tentative ruling she had given orally a week before, leading Judge Jury to note: “Each party got some of it right, from my perspective, and some of it wrong.” The next status conference in the city’s bankruptcy case was scheduled for Nov. 6.

September 19, 2014
Visit the project blog: The Municipal Sustainability Project

Trial Delay. U.S. Bankruptcy Judge Steven Rhodes yesterday agreed to the motion by Detroit and Financial Guaranty Insurance Co. (FGIC) to delay further proceedings in the bankruptcy trial until September 29th in order to give municipal bond insurer and the Motor City’s last remaining major holdout creditor more time to prepare its case against the city’s pending plan of debt adjustment—as well as to permit further federally mediated negotiations. To date, the insurer’s main challenge to the feasibility and equity of emergency manager Kevyn Orr’s proposed plan has been against the “grand bargain,” the proposal to raise more than $800 million from donors and the state in return for protecting the Detroit-owned, world class art collection from a fire sale to pay off the bankrupt city’s debts—and an issue which consumed much of yesterday’s day in the federal courtroom (please see below). FGIC has much at risk: the bond insurer confronts claims of $1.1 billion from pension debt investors who could face severe financial losses under the terms of the city’s most recent plan of adjustment under which those investors would receive about 10 percent of what they are owed—with the remainder falling upon FGIC to reimburse under the terms of its insurance obligations.
The Fine Art of Municipal Bankruptcy. Meanwhile, yesterday’s session before U.S. Bankruptcy Judge Steven Rhodes carried over Wednesday’s challenge to the so-called grand bargain put together by Michigan Governor Rick Snyder, bipartisan leaders of the Michigan legislature, and all with the deft ministrations of U.S. Judge Gerald Rosen. Yesterday, Michael Plummer, the founder of Artvest Partners LLC, testified that the world-class collection at the Detroit Institute of Arts could allow Detroit to be just like Brooklyn, providing a way for the Motor City to emulate Brooklyn’s success in cultivating a community of artists that would help revitalize Detroit: “Artists are driven by cheap real estate.” Michael Plummer testified, as he sought to paint a grim portrait of the consequences to Detroit’s future if the Detroit Institute of Arts were compelled by the federal bankruptcy court to sell its most valuable or best-known works of art. Artvest’s report to the city, submitted in July, projected that that if the DIA’s collection was liquidated to raise cash as part of the resolution of the Motor City’s municipal bankruptcy resolution, it would likely bring in between $1.1 to $1.8 billion. But if the museum were forced sell its works of art, its reputation as one of the nation’s top museums would evaporate: “The items that are the most treasured in the museum are the ones that have the most commercial value…So if you were to denude it of those most commercial items, you would diminish its reputation as an international institution with standing,” adding that the museum’s “attendance would drop significantly. It would more or less fall off the map in terms of international individuals who would come to visit. It would most likely lose its donor base,” because, he testified, donors would stop giving because “they would feel their gifts are not being protected.” An important part of his presentation yesterday related to the city’s future – that is, the ability to finance a sustainable, fiscal recovery―the ability to draw hundreds of thousands of visitors into the city. He cited Brooklyn as a good model for Detroit, because its renewal was based partly on artists moving out of expensive real estate in Manhattan to the more affordable borough. That created a cultural shift in New York, he said. Mr. Plummer warned that if the city’s proposed plan was rejected, and Detroit was forced to sell its famed art from the Institute as FGIC is insisting, “artists would have no reason to move here.” But Edward Soto, an attorney representing FGIC, yesterday challenged Detroit’s claim that its municipally owned collection cannot be sold without first fighting a years-long court battle with the institute and Michigan’s attorney general. In response, Mr. Plummer testified that, au contraire, Detroit had a valid reason to be apprehensive, because, he said, sales of other large collections have been held up for five years or longer by similar disputes. The DIA’s Vice President, Annmarie Erickson, testified the Institute would strongly oppose any effort to be forced or compelled to sell its artwork, because it believes the collection, including the pieces owned by the city, are held in public trust and cannot be sold just to pay debt, telling the court that the museum is restricted in its rights to sell parts of its collections to only those instances where such sales are necessary in order to raise money to purchase other artwork. When Judge Rhodes followed up by asking Ms. Erickson how valuable the museum is to the education of children, to the social enjoyment of families who visit the museum, particularly the 60,000 local children who visit annually as part of school programs, and for Southeast Michigan as a whole; Ms. Erickson responded that the museum helps the city’s children develop critical thinking skills, and helps visiting families learn about art. She also testified that a liquidation of the treasured Detroit Institute of Arts collection would be a “devastating blow” to the museum’s reputation, donor base, and future funding, adding: “It helps people find connections with art; it helps people find personal meaning with art.”

Who Owns the DIA? Yesterday’s judicially artistic inquiries raised the question of whether the city of Detroit owns the museum and whether the city should sell some or all of the museum’s most valuable works to pay off creditors, in what has become among the central and most controversial questions of the largest municipal bankruptcy in U.S. history. Ed McCarthy, who represents bond insurer FGIC, presented a number of documents during yesterday’s hearing in an effort to demonstrate that the city owns the museum. Though the DIA began as an independent nonprofit in 1885, it quickly turned to the City of Detroit for financial help and, in 1919, it became a city department. In 1998, the DIA regained full control of its operations and is charged with running the museum in accordance with industry standards. But the operating agreement, which runs through 2018, makes no specific provisions for a municipal bankruptcy, leading Mr. McCarthy to ask: “Has the DIA looked at the potential impact on the museum of renting or leasing its collection?” Ms. Erickson responded that no, “We have not looked into that.” However, she testified that if creditors were successful in compelling Detroit to sell the DIA’s art, the city’s efforts to gain closure and exit from municipal bankruptcy would, instead, become mired in additional lawsuits: “We would be in litigation to protect the collection…It is an obligation that we cannot shirk,” telling Judge Rhodes the museum and its art collection are inseparable: “You cannot untangle the museum and the collection. They are one and the same…We are the collection…safeguarding that collection…is the foundation of what we are; we cannot unwind the two.”

From the start of the bankruptcy case, U. S. Bankruptcy Judge Steven Rhodes has made it clear that the city must prove that its bankruptcy plan will enable the city to be “viable,” after it emerges from bankruptcy. Part of the hard question—a question which Judge Rhodes can only answer with a yes or no, is whether he can find the city’s proposed plan of debt adjustment to provide for a sustainable future—that is, not just a city that can deliver fire and police protection, but rather one that also must offer other services such as parks and recreation and cultural attractions if the municipality is to retain residents and attract businesses.


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