Detroit Nears Final Lap; San Bernardino to Vote on Fire Cuts

October 6, 2014
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Nearing the Final Lap. Detroit Emergency Manager Kevyn Orr will resume his seat in the witness stand this morning, after testifying last week that “People thought I would sell off the city,” and that he was “amazed that we reached some of the settlements we did,” making clear that most of the agreements to date would not have happened but for the federal mediation, which was led by Chief U.S. Judge Gerald Rosen. Mr. Orr told the court the Motor City’s services have begun to improve—and even that trash pickup has improved to the point where “people have come up to us and thanked us.” But the main focus of the trial last week was over the rationale for protecting the Detroit Institute of Arts, a possible agreement with holdout creditor FGIC, the last significant obstacle to resolution—a creditor/bond insurer with a $1.1 billion claim against Detroit, and Judge Rhodes’ decision not to halt water shutoffs. The Detroit Free Press has reported that negotiations between FGIC and the city have been focused on a combination of bond proceeds and downtown real estate that might be used to settle the dispute in a manner similar to the agreement reached between Detroit and its most antagonistic bankruptcy creditor, the bond insurer Syncora. Judge Rhodes this morning will turn his focus to Detroit Mayor Mike Duggan and City Council President Brenda Jones, who are scheduled to take the stand as testimony commences momentarily.

Setting Terms and Conditions. The San Bernardino City Council is set to meet today to determine whether and how to impose new terms and conditions of employment on the city’s firefighters, including a previously approved station closure and elimination of so-called “constant staffing.” The key issue is with regard to giving the city authority to determine staffing levels. If the Council so votes, it would formally implement Fire Department reductions from the 2014-15 budget that the Council adopted on a 5-2 vote in June, but which have not yet gone into effect. Under the proposed language, the city would “expressly and exclusively retain(s) its management rights,” including the right to contract out. Today’s vote is scheduled nearly one after U.S. Bankruptcy Judge Meredith Jury, at San Bernardino’s request, rejected the previous bargaining agreement, in effect authorizing the city to replace it with another. The resolution to be considered today finds that passage is critical in order to keep the city’s budget spending balanced, noting: “The failure of the City and the (San Bernardino City Professional Firefighters) to reach agreement regarding the implementation of the 2014-2015 Fire Department budget reductions creates a substantial financial burden impeding the City’s ability to balance the General Fund budget…and continue to provide essential services to ensure the health, safety and welfare of its citizens thereby making it necessary to impose certain terms and conditions of employment.” The city has calculated its reductions for the department have reduced the city’s budget by $2 million from the budget, albeit staff have warned the elected leaders that the four month delay has significantly eroded those potential savings. The reductions include closing Fire Station 10, and removing one unit from the station on E Street north of Highland Avenue. Two planned layoffs have already been rescinded, but four demotions are still underway, although those four are being appealed to the city’s civil service board. The Fire Department did implement its plan to increase dispatcher staffing so that lower-priority calls can be given to the private ambulance company American Medical Response rather than firefighter/paramedics, lowering the total call volume. Pay will continue to be set by City Charter Section 186 as the average of what 10 cities of similar population pay for the same positions. That charter guarantee, which also applies to police, would be eliminated if San Bernardino voters approve Measure Q in November.

October 3, 2014

Visit the project blog: The Municipal Sustainability Project 

Taking Stock in Stockton. On Wednesday, U.S. Bankruptcy Judge Christopher Klein provided a cogent and clear oral perspective at the conclusion of hearing arguments from all the parties in the city of Stockton’s chapter 9 municipal bankruptcy case with regard to the City’s proposed plan of debt adjustment.  Judge Klein, mayhap hoping his comments would spur further negotiations and agreement between the city and its key, objecting creditor Franklin, announced he would delay his decision on the city’s proposed bankruptcy exit plan until October 30th in order to have more time to think about all that he heard in Wednesday’s hearing. Nevertheless, his oral comments made him the third federal judge, after U.S. Bankruptcy Judges Meredith Jury in the San Bernardino municipal bankruptcy and Judge Steven Rhodes in Detroit to make clear that the federal municipal bankruptcy law preempts state constitutional provisions protecting pension promises. Judge Klein held that the CalPERS contract between Stockton and the giant state public pension authority is an executor contract subject to the federal municipal bankruptcy law and that the state statutory lien is unsecured under Chapter 9 (using supremacy clause and statutory analysis), leading him to welcome the city to reconsider whether it wishes to modify its proposed plan of debt adjustment or find different arguments to justify its plan and inequitable proposed treatment of certain creditors from others. Judge Klein pointed out the parties can agree to a modification to the city’s proposed plan before it is confirmed, even while making clear his concerns about the city’s current proposed plan, which would protect CalPERS, the $296 billion pension fund, from any debt adjustments, while imposing steep reductions on creditor Franklin. Under the proposal, CalPERS would be fully reimbursed and paid, while two Franklin funds would receive only about 1% of the unsecured portion of the $36 million they are owed. Judge Klein stated that California’s public employee retirement law “is simply invalid in face of the U.S. Constitution….making clear that CalPERS’ contracts with cities can be canceled like other agreements that can be modified in federal court under the U.S. Bankruptcy Code. With Judge Klein scheduled to issue his opinion at the end of this month, the city’s pension obligations are clearly in the front of his concerns with regard to both the equity as well as whether such obligations would render the city’s future fiscally sustainable—should he determine that the plan does not provide for a long-term recovery, he would have little choice but to send the municipality back to the drawing board.

Financing an Exit from Municipal Bankruptcy. Meanwhile, on the same day, Judge Klein’s Motor City counterpart, Judge Steven Rhodes heard testimony with regard to Detroit’s future fiscal sustainability under its proposed plan of debt adjustment, where the city’s key investment advisor testified that a smaller debt load and additional financial oversight included in the Motor City’s pending plan of debt adjustment are among the factors increasing confidence in the city among capital lenders. The advisor, Kenneth Buckfire, president of Miller Buckfire & Co., testified that those components, and “unprecedented” financing the city secured in the wake of filing for bankruptcy, are increasing confidence in what he told the court was “the new Detroit,” adding that the city is winning back the confidence of the municipal market and will enjoy lower interest rates if Judge Rhodes approves the city’s plan to eliminate $7 billion of debt—adding that would potentially enable Detroit to borrow from traditional municipal bond investors at an interest rate of less than 5%, because, he testified, the city’s plan of debt adjustment will prove Detroit is no longer financially distressed: “I would argue the credit of Detroit will be better than other major cities that have not dealt with their high levels of pension liabilities,” adding the lending coming to Detroit was “unprecedented: This is the first city that’s ever secured post-petition financing for a municipal case.” Mr. Buckfire ticked off key financial accomplishments proposed under the plan, including reducing Detroit’s unsecured liabilities from $10 billion to $3 billion, which he told the court marked an “enormous change” in the city’s credit quality. He further testified that the Mayor and Council have adopted a new governance mechanism that, he added: “gives creditors confidence there will be effective supervision.” Nevertheless, he warned that uncertainty over tax revenues could pose what he termed a “fundamental risk” to the Motor City’s financial outlook: “Tax revenue stability will be most crucial element of the (city’s) credit story…If you are not generating cash, you cannot pay back your debt.”  Mr. Buckfire told the court that approving the city’s plan with regard to the treatment of retiree pension obligations and post-retirement health care liabilities was “crucial,” because it “eliminated risk that contribution costs would have to be dealt with in annual budgets and have an impact on city’s ability to reinvest and fix its debt service obligations.”

Blighted Neighborhoods. Billionaire Dan Gilbert, the chairman and founder of Quicken Loans and the undoubtedly biggest civic booster for the Motor City this week testified before Judge Rhodes that Detroit cannot reduce crime, create jobs, or improve schools without first addressing its blighted neighborhoods: “Blight is like cancer,” he told the court, adding that as part of the city’s proposed plan of debt adjustment, a critical element proposes an investment of about $440 million over the next four to six years—with some $850 million coming from the city’s proposed plan for investment in its future fiscal sustainability and the balance from philanthropic foundations, federal grants, or future borrowings.  Detroit emergency manager Kevyn Orr put Mr. Gilbert and billionaire Roger Penske on the city’s witness list in support of its plan: together the two have invested millions of dollars into the city and volunteered on revitalization boards. Gilbert-affiliated ventures own more than 60 buildings in downtown Detroit with more than 9 million square feet of space, including the building that houses the city’s two main newspapers.

The Last Holdout.  The Motor City this week formally asked the federal bankruptcy court to dismiss the objections of its last remaining significant creditor, Financial Guaranty Insurance Co., which is seeking to recover on what it is owed from the nearly $1 billion investors lent Detroit’s unfunded pension systems—but which the city has challenged under its plan claiming the transaction should, instead, be deemed illegal. Detroit has brought suit to invalidate about $1.4 billion of debt issued in 2005 and 2006 to prop up the pension systems, under what the city testified was an arrangement “on the edge of the law.” However, FGIC’s attorney told Judge Rhodes FGIC should be allowed to try to recover the money on behalf of investors because Motor City leaders hid their knowledge that the deal was illegal. Judge Rhodes said he would decide later whether to let FGIC pursue its claim even if the city is successful in its efforts to get the debt thrown out.

Can Municipal Bankruptcy Exit Be Undone? U.S. District Judge Sharon Blackburn has allowed an appeal of Jefferson County, Alabama’s municipal bankruptcy in the wake of questioning the constitutionality of a premise the county used to close on $1.8 billion in 40-year sewer refunding warrants as part of its Chapter 9 exit plan last December. Judge Blackburn denied a motion to consolidate two other appeals, holding those must go forward as separate proceedings. The premise involved a sewer warrant arrangement that was the key to enabling the county to gain approval of its plan of debt adjustment from U.S. Bankruptcy Judge Thomas Bennett last December—ending what at the time was the largest municipal bankruptcy in U.S. history and to eliminate some $3.1 billion in debt. However, Calvin Grigsby a former broker-dealer, a financial advisor and attorney representing group of local residents and elected officials who are ratepayers on the county’s sewer system were successful in overcoming Jefferson County’s claim that a challenge of its plan of debt adjustment was moot, because it could not go back in time and “unwind” it. While Judge Blackburn agreed that some portions of Jefferson County’s exit plan could be “impossible to reverse;” nevertheless, she wrote that the portion that cedes the county’s future authority to set sewer rates to the federal bankruptcy court was not one of those parts: “If, as the ratepayers contend, this part of the confirmation order is unconstitutional, this court may so declare and prohibit enforcement of that term.”[1] David Carrington, president of the Jefferson County Commission indicated the County was reviewing Judge Blackburn’s decision. Jefferson County’s attorneys had argued that the appeals were constitutionally and equitably moot, because the county’s plan of debt adjustment had not only been approved by U.S. Bankruptcy Judge Thomas Bennett, but was already in place. The County maintained that the only issue that the court could decide was whether the federal bankruptcy court’s denial of the appellants’ claim against Jefferson County for $1.63 billion sought on behalf of about 130,000 sewer system customers could be raised. (The $1.63 billion is the amount that Mr. Grigsby alleges sewer system ratepayers were overcharged due to the illegal issuance in 2002 and 2003 of the sewer warrants and related swaps.) The unexpected decision once again thrusts federalism into the midst, here especially with the underlying plan’s provisions which provide for an unprecedented provision in Jefferson County’s plan of debt adjustment under which a federal court, under the terms, retained authority—in the event future Jefferson County Commissioners did not vote to increase rates to ensure payment to the system’s bondholders—to order the rates to be increased.

[1] Bennett v. Jefferson County, U.S. District Curt, No. Div. of Alabama, #2:14-CV-0213-SLB, September 30, 2014.


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