The Unique Federalism of Municipal Bankruptcy

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December 17, 2014
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Federalism Writ Large

As we observe the interplay of the three different levels of government in addressing municipal bankruptcies across the nation, one of the most striking issues is the extraordinary disparity in state roles and the unforeseen, but extraordinary role of the federal judiciary branch. While the federal municipal bankruptcy law, chapter 9, bars a municipality from eligibility to file for federal protection absent state authorization; the state—if it so authorizes—then can also define how it wishes to play (or not to play). Thus, in the wake of Central Falls, Rhode Island’s bankruptcy filing, the state not only appointed a former Rhode Island Supreme Court Judge, Robert Flanders, to serve as the city’s receiver, but undertook significant state actions to provide intervention and assistance in an effort to help other severely distressed municipalities from having to enter into bankruptcy. Central Falls had served as a wake-up call. In contrast, in the case of Jefferson County, U.S. Bankruptcy Judge Thomas Bennett wrote: “All those who attribute Jefferson County’s bankruptcy case…and plight only to the conduct and actions by the county are ill informed…The State of Alabama and its legislature are a significant, precipitating cause…” In the case of Detroit, the deft (and astute) intervention by U.S. Chief Judge Gerald Rosen appeared to play a unique role in facilitating a significant state role, as Michigan Governor Rick Snyder and bipartisan leaders of the Michigan legislature converted Judge Rosen’s hastily scribbled diagram into what become the so-called “Grand Bargain”—a development that seemed to be the key to the Motor City’s successful exit from bankruptcy. But in California, as in Alabama, the state not only appears to have contributed to some of the severe fiscal stress that precipitated the string of municipal bankruptcies, but also has been virtually irrelevant to any and all efforts to municipal bankruptcy recovery. Rather, it is the federal judiciary—especially in its intermediary role—that seems to be contributing to defining a new, constructive role.

A Friendly Federal Hand. With the judicious assistance of court-appointed mediator, U.S. Judge Gregg Zive of the Federal Bankruptcy Court in Reno, Nevada; San Bernardino finally has what City Attorney Gary Saenz describes as a “work plan” to prepare its plan of adjustment to address not only the city’s 200 creditors, but also to put together its plan of debt adjustment so that San Bernardino could exit bankruptcy and create a path to a sustainable future. Not only that, but the plan has been reviewed by the entire City Council — not just the small team that previously was allowed to know details of the confidential mediation where much of the city’s bankruptcy plan has been ironed out. Mr. Saenz noted: “That [gag]order (by Judge Zive) has now been revised so that Council will now be part of those negotiations and will significantly become a part of bankruptcy team discussions…However, as mediation with creditors continues, your council representatives will be subject to the confidentiality order and will not be at liberty to discuss particulars.” Mr. Saenz said the council will now meet regularly with the bankruptcy team, whereas, previously, the majority of the council was not permitted to be involved in these critical discussions about whether and how to shape the city’s plans to exit municipal bankruptcy and create the architecture for a sustainable future—or, as Councilmember Henry Nickel noted yesterday: “You’re making decisions with very, very incomplete information…That, I think, really inhibits the ability to make fully considered decisions.” Interestingly, Judge Zive’s gag order encompassed not just San Bernardino elected officials, but also U.S. Bankruptcy Judge Meredith Jury. Mr. Saenz yesterday said the City Council met Monday with Management Partners, the consulting company San Bernardino hired last November and which played a key role in helping former Stockton City Manager Bob Deis and the city’s elected officials to put together Stockton’s plan of adjustment—providing the key for the city to successfully exit municipal bankruptcy last month. Thus, Mr. Saenz told the Council: “They now stand united in their pledge and commitment to support the city manager and his team to ensure the work plan is fully executed…We are at this time confidently poised to develop and present a comprehensive recovery plan that will take us through and out of bankruptcy.” Mr. Saenz added: “As we proceed through development of our recovery plan of adjustment, the public will be provided more and more information regarding its particulars, so that, ultimately, all stakeholders, citizens, business community and even creditors will commit to and support the plan.”

Michigan Takes on Urban Blight. Michigan Governor Rick Snyder yesterday announced the state is splitting $75 million in federal funding between 12 cities, including nearly $50 million for Detroit, in its latest effort to take on blight: “This is another important step in Michigan’s comeback, which has become a national example for what can be accomplished when federal, state and city partners work together with a shared vision to solve a problem…As a result of this collaboration, these cities will be better places to live, work, play and invest.” The effort is being funded under the U.S. Department of Treasury’s Hardest Hit Fund program. Last October, the U.S. Treasury approved Michigan State Housing Development Authority’s reallocation of $75 million to its blight elimination program: the $75 million is part of nearly $500 million Michigan was allocated in 2010 through a federal program to help homeowners hit hard by the national housing crisis, with the state creating an evaluation system which includes residential housing vacancies and requiring each applicant municipality to submit blight plans, estimate project costs, and provide a timeline for the work. U.S. Treasury Deputy Secretary Sarah Bloom Raskin noted: “This partnership demonstrates a commitment to revitalizing our cities and to addressing the damaging effects caused by vacant and blighted properties…Removing blighted properties is an important step in stabilizing neighborhoods, and we look forward to continuing our efforts to assist hardest hit communities around the nation.” In its application, the Motor City successfully applied for $50 million of the current $75 million allotment to provide for 3,100 demolitions, or significantly less than 10% of its more than 40,000 vacant structures. (The feds have already has awarded Detroit’s Land Bank $52 million to tear down at least 3,300 of them. Another $420 million — saved by the city as part of its federally approved plan of debt adjustment — also will be used to raze vacant houses and clear lots. The city’s land bank is averaging about 200 demolitions a week. The included communities are: Detroit, $50 million ($47.4 million in second-round funding combined with $2.6 million in reserves from the first round); Lansing, $6 million; Jackson, $5.5 million; Highland Park, $5 million; Inkster, $2.25 million; Ecorse, $2.19 million; Muskegon Heights, $1.8 million; River Rouge, $1.3 million; Port Huron, $1 million; Hamtramck (a municipality wholly within the boundaries of Detroit), $952,000; Ironwood, $675,000; and Adrian, $375,000. According to officials, each blight partner must spend 25 percent of all funds in the first six months, 70 percent of funds within 12 months, and 100 percent within 18 months. U.S. Treasury requirements state any remaining funds as of New Year’s Eve, 2017, must be returned to their office.

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