Post Municipal Bankruptcy Ruling Challenges

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November 14, 2014

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Unsung Contributors. It is one incredible accomplishment to get out of municipal bankruptcy, but the price of exiting can be burdensome. Unsurprisingly, Motor City Mayor Mike Duggan is alarmed at the amount of fees Detroit taxpayers will have to pay lawyers and consultants — the bulk of whom are neither taxpayers nor residents of Detroit, who guided the city through its historic bankruptcy proceedings. The tab: as much as $200 million or enough to potentially jeopardize Detroit’s fiscal capacity to meet the terms of its now federally approved plan of debt adjustment. Detroit deputy city attorney Charles Raimi this week requested that U.S. Bankruptcy Judge Steven Rhodes provide more time for the city to review fees charged by Jones Day, the law firm that shaped and argued the city’s petition in federal court, as well as the fees charged by Detroit’s other firms which provided financial and restructuring advice to the city―none, notably, selected or hired by the city or its elected leaders—but rather by the State of Michigan through its appointment of an emergency manager. Nevertheless, Judge Rhodes has ordered confidential mediation over the fees paid to the professional firms, with those discussions scheduled to commence the week after next. Bill Nowling, a spokesman for emergency manager Kevyn Orr, notes that those fees are encompassed in the city’s court-approved plan of adjustment—a plan also approved by Mayor Duggan and the city council, stating: “They’re entitled to their opinion on this. The trial is over, so the only fees that are left are the fees incurred in November, and any fees incurred in implementing the plan. I just think it’s without merit to suggest the fees are going to reach $200 million.” From the city’s perspective, as a spokesperson for Mayor Duggan put it: “Every dollar spent on consultants is a dollar that could be spent to hire a police officer. We will work with the court to handle this through mediation in a timely manner.” Some of the attorneys and consultants working on the case agreed to work at discounted rates, with many billing the city at between $500 and $1,000 an hour. One exceptional consultant from New York with eons of experience in municipal fiscal distress donated his time. Robert Fishman, the U.S. court-appointed fee moderator has not ascertained when he will complete his final tally for bankruptcy expenses.

Unappealing. Late Wednesday, the City of Stockton’s holdout creditor Franklin Advisors filed an appeal (Case 12-32118) of U.S. Bankruptcy Judge Christopher Klein’s forthcoming order confirming Stockton’s First Amended Plan For The Adjustment of Debts of the City of Stockton, telling the federal court: “The appeal raises important questions regarding the nature, extent, and scope of a municipality’s ability to impose an adjustment of bond debt upon a dissenting creditor in a Chapter 9 proceeding, while at the same time leaving vastly-larger liabilities for unfunded pensions untouched and unadjusted.” In its appeal, Franklin’s attorneys wrote that the federal bankruptcy court had failed to show that the plan was in the best interest of creditors, writing that Stockton could pay Franklin far more than it did from future revenues: “Indeed, there are no facts establishing that a one-cent recovery for Franklin is ‘all that could reasonably be expected’ or that the amount of the city’s probable future revenues devoted to the payment of Franklin’s claim under the Plan — i.e., $0 — is ‘fair.’” Franklin’s attorneys, in the firm’s brief, write that Stockton’s initial proposal or “ask” proposed future payments representing a present value recovery of more than 50% to Franklin—far above what Franklin claims to be closer to 1% under the plan approved by Judge Klein. Further, Franklin, in its brief, asserts that the future payments to be received by all other material creditors under the plan have a present value exceeding 50%, so that Franklin is the “only material creditor in this case — or to Franklin’s knowledge, any other successful Chapter 9 case — to receive no meaningful recovery at all.” The challenge also raised the big kahuna issue pitting the California constitution against the federal chapter 9 municipal bankruptcy law―an issue on which both U.S. Bankruptcy Judge Steven Rhodes in the Detroit case and Judge Klein have orally ruled the federal municipal bankruptcy law trumps the respective Michigan and California constitutions. Franklin notes in its challenge that this issue is in the interest of every California municipality and every municipal bondholder, as it sought a stay in Judge Klein’s confirmation order. Franklin has expressed apprehension that if Judge Klein’s confirmation order were allowed to stand without any review by an appellate court, important questions would remain unanswered: “The potential consequences of this are unpredictable, but potentially significant…It is well worth the wait of a few additional months to ensure that whatever those consequences may be, they are the result of a legally sound decision regarding confirmation of the plan.” Franklin had objected to taking a significant loss on the $35 million of bonds it holds — a recovery rate it estimated amounts to about 1% — even as Stockton’s plan of debt adjustment proposed no reductions at all in its contributions to the California Public Employees’ Retirement System or CalPERS—and settlements were reached with all other major creditors.

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