Justifying One’s Exit from Municipal Bankruptcy

October 22, 2014
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Nearing Home? U.S. Bankruptcy Judge Steven Rhodes yesterday outlined several issues he would like to see addressed in the city’s closing arguments, advising the Motor City’s lead attorney, Bruce Bennett, that he would like him to discuss the section of the federal bankruptcy code, chapter 9, which addresses the “reasonableness of fees,” and “how it can work here.” In addition, Judge Rhodes instructed Mr. Bennett that he should specifically note which settlements the federal court is being asked to approve and whether the court needs to approve the city’s exit financing. Judge Rhodes also requested that the city “spend as much time as you think is necessary on the issue of the justification for the discrimination among the classes of unsecured creditors, adding that “At the same time, however, while you do that, I want to indicate to you that I’m less concerned about the numerator and denominator than I am about the business side, the business justification side of that analysis.” That guidance came after Judge Rhodes had previously queried Kevyn Orr on the related issue of the State of Michigan’s role: “What advice would you give to the Financial Review Commission with respect to its responsibilities?” Mr. Orr testified that the new state commission needs to understand how to improve public safety in Detroit; it will need a deep understanding of redevelopment plans; it will need a means to ensure keeping Detroit within its budget; and he told the court the staff of the commission will need a comprehensive understanding of Detroit’s human resources challenges. Earlier, yesterday, Ernst & Young consultant Guauray Malhotra testified that he believes Detroit’s cash position in the future will be “sufficient” to operate and meet its debt obligations, testifying that the Motor City’s planned exit financing issue with Barclays is now likely to be $275 million, down from $325 million: “It is the city’s view to borrow less because of the overall cost of that financing that has to eventually be paid.” Martha Kopacz, an independent financial expert hired by Judge Rhodes to review the feasibility of the plan, is expected to testify today, on what could be the last day of the trial, with closing statements set to begin next Monday.

The Last Hurdle? As Detroit’s bankruptcy trial winds down, the federal court yesterday devoted most of its time focusing on the details of the city’s recent, federally mediated settlement with its final, major holdout creditor, municipal bond insurer Financial Guaranty Insurance Co., with Detroit emergency manager Kevyn Orr and an Ernst & Young financial consultant testifying with regard to additional details about the agreement—an agreement which provides for significant real estate and cash, including the current site of the Joe Louis Arena, where the Detroit Red Wings skate, located on prime riverfront Detroit land adjacent to the Motor City’s convention center—sites which will be developed by FGIC into a 300-room hotel with condominiums and retail space. Under the cash part of the deal, FGIC is expected to recover approximately 13% on its $1.1 billion claim against the city, receiving $141 million from proceeds of a note issue and $20 million in settlement credits. Judge Rhodes asked Mr. Orr to estimate the monetary value of the real estate portion of FGIC settlement, noting: “Ultimately I’d like you to testify either what the value of the real estate is FGIC has an option to acquire here, or tell me the city doesn’t think it’s necessary for the court to have that to determine the reasonableness of the settlement.” After taking a break to confer with his attorneys, Mr. Orr came returned to the stand and said the Joe Louis Arena currently had either no value or even “negative” value, and that its worth would only be realized after it was demolished and the new project built—leading Judge Rhodes to follow up: “[T]he city’s position is that the costs associated with attempting to market all of that property either equals or exceeds what the city could sell it for in the market?” In response, Mr. Orr testified “Yes…Because you have to demolish it. You have to remediate it, so that’s true, your Honor,” going on to describe the federally mediated resolution with the city last major holdout creditor as a “peace accord, more or less” which Mr. Orr believed would bring some certainty to the bankruptcy exit process—and save Detroit significant legal fees, because, as part of the agreement, Detroit will drop the suit it filed at the beginning of the year seeking to invalidate the $1.5 billion of certificates of participation insured by FGIC and Syncora Guarantee Inc., adding that if the insurer had succeeded in its countersuit on the COPs or on its objection that the city’s plan unfairly discriminated against it, then the Motor City would have had to in Mr. Orr’s words, “hit the rest button and go back to plan development…It would have been fairly catastrophic from my perspective.” The Detroit City Council is expected to vote today or tomorrow on the FGIC agreement, which, because it was put together under Michigan’s state emergency management law, means that even if the council rejects it, officials can go to the state emergency loan board for its approval.

Let there be light! The old adage is necessity is the mother of invention, so it was yesterday in Judge Rhodes’ courtroom that one of Detroit’s consultants, Gaurav Malhotra, testified the Motor City will be getting into the metal scrapping business to help finance the city’s recovery by salvaging millions of pounds of copper from thousands of its moribund streetlights. As the city replaces lights over the next seven years with brighter lamps which use less power, it expects to collect as much as $25 million through sales of the copper it excavates and recovers from the older lines. Mr. Malhotra told Judge Rhodes he estimated there could be as much as 13.5 million pounds of copper, worth about $40 million, in the old streetlight system—not an inconsiderable sum to incorporate into Detroit’s revised, eighth—and presumably final—plan of debt adjustment, with the guesstimated $40 million pledged to help finance the plan’s proposed decade-long rebuilding plan—whilst at the same time shining light on some of the city’s dimmest lit and most blighted neighborhoods in a critical effort to reduce violent crime.

Copping a Lower Credit Rating. Moody’s on Monday lowered its ratings on the Motor City’s $1.5 billion of certificates of participation or so-calls COPs to C from Ca, writing that the city’s recovery or debt adjustment plan’s proposed settlements with insurers would put recoveries well below 35%. The drop came in the wake of Detroit’s settlement with holdout creditor Financial Guaranty Insurance Co. last week with regard to FGIC’s insurance on some $1.1 billion of COPs—and in the wake of its warnings at the beginning of this month that it might downgrade the debt depending on the terms of any settlements with either FGIC or the city’s then other and similar holdout creditor, Syncora. In the wake of the two resolutions, worked out under the closed door federal ministrations of U.S. Judge Gerard Rosen by means of agreements involving cash and downtown real estate, estimates are that the cash recovery for the two insurers will in the range of about 13 percent of their claims against the city, leading Moody’s analyst to note: “Reported terms of the FGIC settlement, along with the Syncora settlement terms laid out in the city’s Seventh Amended Plan of Adjustment (now updated to the Eighth to incorporate the more recent settlement with FGIC), support our expectation of a recovery rate falling well below the 35% to 65% recovery rate range that would be consistent with a Ca rating.” The Detroit City Council has already voted to approve the agreement with Syncora, and is scheduled to take up the proposed agreement with FGIC later this week. Should the Council reject the newer agreement, the Mayor could seek approval from Michigan’s state emergency loan board.

Harried in Harrisburg. Harrisburg, Pennsylvania, which opted out of filing for federal bankruptcy protection and has slowly crawled out of fiscal distress under a debt recovery plan approved by the Commonwealth Court of Pennsylvania plan last September, nevertheless continues to confront recovery stumbles and remains under the state’s Act 47 program for distressed municipalities. Yesterday, its Treasurer, Timothy East, became the state capitol city’s second treasurer to resign in two months. Mr. East, who had filed for personal bankruptcy in 2011—a filing which is still open, told the city’s Patriot-News he was unsure whether city officials could get him bonded. The City Council had approved Mr. East over five other candidates late last month to serve out the remaining 15 months of his predecessor’s—a predecessor who had resigned after the Dauphin County District Attorney charged him with stealing money from two nonprofits: Lighten Up Harrisburg, a program designed to fix street lights, and the gay-and-lesbian advocacy group Equality Pennsylvania. In addition, the Dauphin County District Attorney had subsequently filed an additional theft charge in connection with $2,750 that went missing from a political action committee for which he was treasurer—with the former treasurer reportedly claiming to authorities he used the money for personal college and medical expenses, according to court records. Mr. East’s personal financial issues were not subject to scrutiny by the city when he applied, because background checks only require notice of any criminal records. In his application, Mr. East had not disclosed the information with regard to his personal finances. Harrisburg officials briefed the City Council last week about his personal finances. Harrisburg, Pennsylvania’s 49,000-population capital, narrowly avoided municipal bankruptcy last year by crafting a financial recovery plan which erased more than $600 million of debt. A city’s treasurer, because she or he needs to be bonded, may create a risk that insurance companies may be leery of approval in instances where a treasurer has already declared personal bankruptcy—especially in this instance, where the abrupt departure of Harrisburg’s former city treasurer, John Campbell, also meant the city had to get re-bonded—already a costly and precarious undertaking in light of the capitol city’s near bankruptcy and receivership. Harrisburg had secured a bond for the city, but now awaits hearing back from insurance companies in the wake of the trials and tribulations of Mr. East. In his job interview with the city late last month, Mr. East counted among his skills that he understood cash management operations, tax collection, and proper system controls, according to the Patriot-News, and he said he thought his most important leadership quality was the ability to inspire others. His personal bankruptcy filing was dismissed last year after he fell short on his required payments, but his attorney was successful in getting it reinstated last January. In Harrisburg, the city treasurer is a part-time position which pays $20,000 a year.

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