The Long (seemingly unending) & Costly Road of Municipal Bankruptcy

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December 4, 2014
Visit the project blog: The Municipal Sustainability Project

The Seemingly Unforgiveable Costs of Municipal Bankruptcy. Motor City Mayor Mike Duggan yesterday confirmed that Detroit will have to pay more than $20 million to investment banking firm Miller Buckfire & Co. for its work in Detroit’s municipal bankruptcy in line with the company’s contract, renegotiated last June by Kevyn Orr, which specified the firm be paid a flat $28 million fee for its services in negotiating agreements tied to city water and sewer debt and securing Detroit loans to finance the city’s operations during its municipal bankruptcy and meet some of its obligations to creditors. Mr. Orr’s spokesperson, Bill Nowling, told the Detroit News that Miller Buckfire has been working for the city below “market rate for restructuring services,” adding that the fact the firm twice renegotiated its contract “is unusual for banks to do,” and telling the News that had Detroit been a regular customer, it likely would have owed upwards of $100 million. The numbers matter, because U.S. Bankruptcy Judge Steven Rhodes has given Mayor Duggan standing to challenge the legal bills. For his part, Mayor Duggan yesterday said: “We are in mediation and I’m under a gag order…I’ve expressed my opinion that I think the bills are too high, that they need to come down. There are huge dollars at stake.” As of late October, the bankrupt city had paid Miller Buckfire $5.76 million for its services, which have included negotiating debt settlements with financial creditors and pursuing opportunities for monetizing the city’s water department. Mr. Nowling noted the valuable services rendered by the firm in securing exit (from bankruptcy) financing and a quality of life loan at market rate, and with regard to assisting Detroit to restructure its debt on the Detroit Water and Sewer Department municipal bonds at a “substantial savings,” noting: “This is all a result of the work of our investment bank,” noting that refinancing its debt at a lower interest rate saved the city almost $2 billion in interest payments. Meanwhile, Jones Day, the city’s lead bankruptcy law firm, had billed Detroit $52.3 million as of late October, while Detroit’s accounting firm, Ernst & Young, billed the city some $19.9 million, and restructuring firm Conway MacKenzie billed Detroit’s taxpayers $17.2 million in fees. Mayor Duggan yesterday indicated he has been advised that just the tab for Detroit for legal fees will be at least $177 million before the city’s bankruptcy is over—and assuming there is not, as in Jefferson County (please see below) appeals: “That is money that is not going to services for the people of the city of Detroit…So I didn’t think those numbers were reasonable. In mediation, we’re going to see how the process plays out and I really can’t say anything.” As of late October, the city had $140 million in bills for attorneys and consultants, $130 million of which had already been paid out, according to a city report.

The Costly & Seemingly Unending Process of Exiting Municipal Bankruptcy. U.S. District Judge Sharon Blackburn yesterday ruled that Jefferson County can appeal her refusal to reject a lawsuit appealing the county’s approved plan of debt adjustment by a group of unhappy sewer customers. In successfully securing approval from U.S. Bankruptcy Judge Thomas Bennett a year ago yesterday―after completing the refinancing of its sewer debt, which was the linchpin of its exit plan, a group made up mostly of local elected officials appealed Judge Bennett’s decision to approve the county’s chapter plan of debt adjustment, telling the federal court the plan would impose unreasonably higher rates for sewer customers for decades to come. In response, Jefferson County had sought to have Judge Blackburn reject the appeal—in large part because, they pled, the appeal was moot, since the county’s bankruptcy exit plan had already been implemented. Judge Blackburn, however, wrote, in rejecting the County’s position: “The fact that the (bankruptcy) Confirmation Order has taken effect ― the new sewer warrants have issued and the old sewer warrants have been retired ― does not extinguish the controversy, although it may limit the scope of relief available.” In her order, however, Judge Blackburn gave permission for Jefferson County to make an interlocutory appeal to the 11th Circuit Court of Appeals with regard to whether the sewer ratepayers’ challenge of U.S. Bankruptcy Judge Bennett’s confirmation of the bankruptcy exit plan is moot, “either constitutionally, statutorily, and/or equitably,” based on consummation of the plan or the sewer customers’ failure to obtain a stay of the sewer refinancing pending appeal. Judge Blackburn, however, acknowledged in her order that an immediate appeal by Jefferson County of her September order could accelerate resolution of the sewer customers’ appeal, “especially if the Circuit Court finds in favor of the County, thus ending the ratepayers’ (sewer customers’) appeal of the Confirmation Order. Although some issues will remain, the heart of the ratepayers’ dispute concerns the constitutionality of certain terms of the confirmation order.” Judge Blackburn, however, denied a separate request by the county to certify another issue for interlocutory appeal – whether, under constitutional and federal law, and without the county’s consent, a federal judge has the authority to strike a selected provision of a Chapter 9 plan of adjustment (the county’s bankruptcy exit plan). Judge Blackburn, in her September order, had ruled that she legally could scrap the schedule for future sewer rate increases called for under that plan. Similarly, in her September ruling, Judge Blackburn had acknowledged that Jefferson County had already issued new sewer warrants to retire the outstanding debt, and that some parts of the county’s approved bankruptcy recovery plan “may be impossible to reverse;” nevertheless, Judge Blackburn had rejected the county’s contention that the appeal was moot just because it had been largely consummated; in addition, she had written she would consider the constitutionality of the plan that cedes the county’s future authority to set sewer rates to the bankruptcy court—in effect the cornerstone of Jefferson County’s exit plan, especially in the wake of its issuance of $1.8 billion of sewer refunding warrants to write down $3.2 billion of outstanding sewer debt in order to exit the nation’s second-largest municipal bankruptcy. Thus, Judge Blackburn, in her opinion, wrote that Jefferson County may frame its appeal to the 11th U.S. Circuit Court of Appeal to ask “whether the ratepayers’ appeal of the confirmation order is moot either constitutionally, statutorily, and/or equitably,” because the plan had been consummated. In addition, Judge Blackburn determined that the appellate court could decide if the appeal were moot because the ratepayers failed to obtain a stay from the U.S. bankruptcy court that would have delayed implementation of the plan as they sought an appeal. Jefferson County Commissioner Jimmie Stephens, who was reelected last month along with four other board members who were involved in the bankruptcy filing—and who was selected by his colleagues on the Board as Board President last month, noted: “Jefferson County looks forward to a speedy resolution of this matter.” The ever prescient godfather of municipal bankruptcy Jim Spiotto noted that the issue before the 11th Circuit is whether federal bankruptcy courts, in confirming a municipal bankruptcy plan of adjustment, can be the final determiner of issues that involve certain rights of citizens and state powers over utilities rates if the plan is not stayed on appeal and implemented, noting that in recent Chapter 11 court decisions, judges have determined that issues on appeal are moot after implementation of a plan that has not been stayed by the court. In addition, he noted there are also provisions in the federal bankruptcy code guiding Chapter 11 cases with respect to state regulatory approval of utility rates under state law. Those cases require that a utility commission approve of rate changes in a confirmed plan or that the plan be subject to the commission’s approval—noting that on the municipal or chapter 9 side of the aisle, Judge Blackburn’s decision seeks to clarify the limits of the federal bankruptcy court’s jurisdiction over sewer rates set by elected leaders of local governments: “The district court appears to be saying that you have constitutional and state statutory rights, and you have the 10th Amendment limitation over the jurisdiction of the bankruptcy court in Chapter 9 as opposed to Chapter 11, therefore can constitutional or a state statutory issue be mooted by the bankruptcy court’s confirmation of a plan and the implementation of that plan precluding any review at the district court or appellate level…The plan [of adjustment] just can’t run over those rights given the limitations of the jurisdiction of the bankruptcy court regarding constitutional and state statutory issues.”

Rethinking State Tax Policies & Transportation Finance. The FBI yesterday charged the Puerto Rico Highways and Transportation Authority Treasurer Silvino Cepeda-Ortiz with accepting bribes―just one day after the Puerto Rico House of Representatives had passed a bill bringing Puerto Rico closer to selling a $2.9 billion bond to support the authority. Mr. Cepeda-Ortiz was charged in United States District Court in San Juan with bribery concerning programs receiving federal funds: according to U.S. Attorney Rosa Emilia Rodríguez-Vélez in Puerto Rico, he solicited and received two kickbacks of $5,000 each for contracts with the authority. Ms. Rodríguez-Vélez stated: “Public officials who abuse their positions of trust for personal financial benefits, undermine the integrity of our public agencies and the availability of federal funds used to finance important projects, such as our highway infrastructure…We will not relent in our efforts to combat this type of corrupt scheme, whereby a public official requests bribes in order to pay for services duly rendered by third parties to an agency.” The arrest came in the wake of an FBI raid last week on the Puerto Rico Aqueduct and Sewer Authority headquarters in which no arrests were made and in the wake of this week’s action by the Puerto Rico House of Representatives to pass, 26-23, a bill to prop up the transportation authority through an oil tax increase. (The tax raise will increase taxes per barrel of oil to $15.50 from $9.25.) Currently all the tax goes to the PRHTA. Revenue from the new higher tax would go to the PRHTA, the Puerto Rico Infrastructure Finance Authority and the Integrated Transportation Authority, which operates Puerto Rico’s public transportation. If the legislation is adopted by the Senate and signed into law, Puerto Rico will replace its existing sales and use tax with a value added tax, paving the way for the territory to finance its commitment to eliminate income taxes for individuals with incomes of less than $35,000 or families with incomes less than $70,000.If adopted, in future years the tax would be adjusted upward for inflation.

Gambling on a City’s Future. Atlantic City Mayor Don Guardian is scheduled to address a New Jersey Assembly committee about the city’s future and the gambling industry—a city which is on the precipice of bankruptcy in the wake of experiencing some 8,000 workers lose their jobs so far this year after four of the city’s 12 casinos closed. Garden State Senate President Stephen Sweeney and state Sen. James Whalen have proposed a plan that would give the city certain revenue and casinos predictable tax bills: the plan would let casinos collectively pay $150 million in lieu of taxes for two years, and then $120 million a year after that, assuming gambling revenue stays at a certain level. As the aptly named Mayor Guardian prepares to testify this morning, New Jersey’s political and business leaders have become increasingly engaged in discussion about the future of New Jersey’s gaming industry and Atlantic City in particular. Yesterday, New Jersey Senate President Stephen Sweeney introduced several bills as part of these ongoing efforts to address the transitions in Atlantic City and New Jersey’s gaming industry, including:
• S2572 – Major Changes to Casino Property Taxes: Atlantic City’s casinos pay the majority share of the city’s property taxes, based on the assessed value of the property. Over the last several years, many casinos have successfully appealed the assessed value of their properties, because of the sharp downturn in Atlantic City’s gaming market—ergo, the amount of property tax revenues to the City of Atlantic City (which then must distribute a share to the School District and Atlantic County) has declined. The bill would dramatically change the property tax structure for Atlantic City casinos: It would provide that every casino property in Atlantic City would be exempt from traditional property taxes: the casinos will be organized into the Casino Operators’ PILOT Council (PILOT standing for Payment In Lieu Of Taxes). The members of the Council would agree to make a PILOT payment to the City of $120 million in 2015, adjusted for inflation thereafter. However, if annual gross gaming revenue were between $2.6 billion and $3 billion, the PILOT payment would increase to $130 million; $150 million if revenue were between $3 billion and $3.4 billion; and $165 million if revenue were between $3.4 billion and $3.8 billion. If revenue fell below $2.2 billion, the amount would be proportionally decreased.(Each casino’s share of the payment would be calculated by a formula that takes into account, in equal parts, (a) the amount of land in acres owned by the casino; (b) the number of hotel rooms and (c) the property’s gross gaming revenue. For next year and 2016 only the casinos would be obligated to pay an additional $30 million per year. If new casinos open or existing casinos close, the formula would be adjusted to reflect that.
• S2573 – Mandatory Health Benefits for Casino Employees: would require that a casino licensee submit proof to the Division of Gaming Enforcement that “all agreements it has entered into with each majority representative of its employees for collective bargaining purposes provide for suitable health care benefits and suitable retirement benefits for all full-time employees covered by such agreements.”
• S2574 – Aid to Schools: this bill would create a new form of state aid called Commercial Value Stabilization Aid: this aid would be made available to the Atlantic City school district. If the Commissioner of Education determined, based on a needs assessment, that the aid were warranted, then the Commissioner could authorize state aid to defer the school portion of the municipal tax levy. This aid would only be available until such time as assessed property values in Atlantic City return to the levels they were at in 2008.
• S2575 – Reallocation of Investment Alternative Tax: this bill would reallocate Casino Reinvestment Development Authority (CRDA). Currently, in addition to an 8% gross revenue tax, Atlantic City casinos pay 1.25% of gross gaming revenue to the CRDA. Until 2011, the funds collected by CRDA were used to invest in various projects around the state. Since that time, the funds are to be used exclusively to fund projects in Atlantic City. This bill would reallocate all CRDA funds paid by casinos to the City of Atlantic City for the next 15 years and would require that the City use those funds exclusively to pay down its municipal debt.
• S2576 – Elimination of the Atlantic City Alliance: this bill would eliminate this non-profit corporation funded by the casinos to serve as a public-private partnership to market Atlantic City.

When it Rains, it Pours. Garden State Superior Court Judge Julio Mendez yesterday ruled that Atlantic County’s government broke its own pay-to-play rules by giving a contract to an accounting firm that made political contributions to the county sheriff in his 2013 campaign for the state Senate. Judge Julio Mendez also disqualified Ford-Scott & Associates from receiving any contracts from Atlantic County for four years, but denied county Democrats’ request to block payment for work on a county auditing contract that the Ocean City-based firm has already finished. Judge Mendez, in his ruling, found “that the political contributions made by Ford-Scott to the State Senate campaign of Sheriff (Frank) Balles are subject” to the county’s pay-to-play ban, which the Board of Chosen Freeholders passed in 2007. The decision came in the wake of the suit by County Democratic leaders last May, claiming that the $4,600 contribution by Ford-Scott to a county official and an $88,000 county auditing contract for the firm violated Atlantic County’s 2007 pay-to-play law—a law, which they said was designed to ban the practice of rewarding political donors with government contracts.

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