The Intergovernmental & Governance Tangles of Municipal Bankruptcy

October 9, 2014
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Reconsidering Municipal Bankruptcy. California State Treasurer Bill Lockyer yesterday warned that if the final plan of adjustment submitted by the City of Stockton and approved by U.S. Bankruptcy Judge Christopher Klein next month includes provisions impairing the municipality’s pension obligations to CalPERS, the California legislature could respond by revoking state authority for California cities, counties, and special districts to file for federal bankruptcy protection if they become insolvent, stating: “As a lawyer and a policymaker, I have a different view about the fundamental issues of a state-run pension system and whether it’s even subject to jurisdiction of a bankruptcy court in this circumstance,” he said during his keynote address at the California Debt and Investment Advisory Committee. His comments come in the wake of statements by U.S. Bankruptcy Judges Steven Rhodes, Meredith Jury, and Christopher Klein that the federal chapter 9 law preempts the Michigan and California constitutional provisions protecting contracts, including for pensions—positions with pending challenges before the 6th and 9th U.S. Courts of Appeals. The federal municipal bankruptcy law, chapter 9, bars a municipality from filing for bankruptcy unless authorized by its respective state. Mr. Lockyer added: “If it looks like bankruptcy judges in California are going to be activists in this domain, I wouldn’t be very surprised to see a coalition of teachers, nurses, firefighters, law enforcement people, district attorneys—and the list goes on—all lobby the legislature to change the rules so that no municipality can bring a bankruptcy action in a Chapter 9 proceeding.” Unlike Michigan, Pennsylvania, and Rhode Island—states where the Governors and state legislatures took active roles in helping municipalities both with regard to their pension obligations and recoveries, many believe the state has not only provided no assistance to its cities that are currently in municipal bankruptcy, but also that the legislature’s actions were factors in their respective insolvencies. Perhaps unsurprisingly, Mr. Lockyer offered no guidance with regard to what would happen to a California city or county that became insolvent were the state to bar its right to federal bankruptcy protection—in which case, of course—no pensions or health care benefits would be available.

Nearing the Final Lap. Meanwhile in the Motor City, frantic negotiations under the guidance of U.S. Chief Judge Gerald Rosen with the city’s last major holdout creditor, Financial Guaranty Insurance Co., are reported to be focusing on a possible agreement under which the city could lease most of its public parking facilities to its bond insurers, including FGIC, according to the Detroit News. Under the outlines of the emerging package, FGIC could end up leasing three of the city’s six parking garages, receive riverfront land, and cash to settle its $1.1 billion claim against the Motor City—with the city’s Chief Operating Officer, Gary Brown, telling the paper: “It’s a fluid situation that changes by the day; I wouldn’t be surprised with anything that came out of the bankruptcy with regard to FGIC. Anything is on the table.” Nevertheless, any agreement is still at least days away. The News reports that while the emerging deal would let FGIC recover more than is included in the city’s seventh amended plan of adjustment pending before U.S. Bankruptcy Judge Steven Rhodes (the September 16th version proposes to pay FGIC about 6% of its claim), it would, nevertheless, be less than what rival bond insurer Syncora Guarantee Inc. received in a deal last month. Together, the two bond insurers had insured $1.4 billion in troubled Motor City pension debt that helped former – and now convicted and imprisoned ― Mayor Kwame Kilpatrick prop up the city’s pension funds in 2005. In comparison, the pending debt adjustment plan proposes paying Detroit’s pensioners about 46 cents on the dollar for their $3.1 billion claim.

Certifying. In a related development, Moody’s yesterday warned Wednesday it could downgrade Detroit’s Ca-rated COP’s, or certificates of participation, saying it expects to resolve the outlook when and if the Motor City reaches an agreement with holdout creditor FGIC—which wraps the remaining $1.1 billion of the COPs. The city’s other bond insurer, Syncora, holds some $390 million of the COPs. In its review, Moody’s noted: “In our opinion it is likely that the recovery for creditors will be below 35% and as a result consistent with a C rating.” Adding: “The review will be resolved if and when a settlement with FGIC…is made public.” As part of its effort to seek an exit from bankruptcy, Detroit is suing to repudiate the debt, saying it was issued in 2005 and 2006 with an illegal structure devised solely to avoid state-imposed debt limits. Unlike the city’s agreement with Syncora, however, any agreement with FGIC will require approval by Mayor Duggan and the Detroit City Council.

Where it all Began. Mayhap ironically, the COP’s issue that has become central to Detroit’s emergence from municipal bankruptcy is coming back into sharp relief in the Motor City as jury selection began there yesterday in a case where former and now convicted and imprison Detroit Mayor Kilpatrick is an unindicted co-conspirator in a complex criminal case that is—in bad part—at the root of the city’s insolvency—based upon the issue of what happened to the funds from a $1.4 billion Wall Street deal in which prosecutors allege the money ended up in the pockets of businessmen who bribed pension officials, including former Detroit Treasurer Jeffrey Beasley, with cash, exotic trips and a Christmas basket stuffed with cash. The former Mayor’s name arose repeatedly yesterday as defense lawyers questioned prospective jurors about their views on race, exposure to pretrial publicity, and awareness of the former mayor’s crimes and record-tying 28-year corruption sentence. The trial is being overseen by U.S. District Judge Nancy Edmunds, who sentenced Mr. Kilpatrick and contractor Bobby Ferguson to more than 20 years in federal prison, with the issues spanning the period from 2006 through April 2009. Here the allegation is that the alleged pension fund corruption cheated retirees out of more than $84 million. Federal prosecutors allege city pension officials started approving a series of corrupt investments with businessmen in January of 2006, six months after the Wall Street deal started injecting $1.44 billion into the Detroit pension funds. Further, there are charges that pension fund trustees loaned more than $200 million to businessmen accused of paying bribes and kickbacks, according to federal prosecutors. The businessmen included Georgia resident Roy Dixon, 51, who is charged with embezzling more than $3 million with the help of former Detroit Lions wide receiver Mike Farr and spending some of the cash on an $8.5 million mansion in Atlanta. The four defendants are Beasley, Dixon and two former pension officials: Trustee and former vice president of the Detroit Police Officers Association Paul Stewart and Ronald Zajac, former top lawyer for two municipal pension funds.

The Sharing Economy: Fighting Blight. The City of Detroit and Wayne County have commenced an effort to fight blight that packages several properties, including homes and vacant lots, for sale. Motor City Mayor Mike Duggan and Wayne County Treasurer Raymond Wojtowicz yestoday announced a process being called “Blight Bundle,” under which the two leaders said they intend to encourage the demolition of severely blighted properties and boost the redevelopment of salvageable ones—all as part of a key effort to return tax-foreclosed properties to productive use—and to the property tax rolls. The pair reported that if a bundle of properties fails to receive a bid, the vacant lots involved will be made available for purchase through the Detroit Land Bank Authority. For more details, visit


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