The Imbalance Between a City’s Bondholders & Retirees

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January 9, 2014
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Balancing a City’s Debtors in Municipal Bankruptcy. EEPK (Erste Europaische Pfandbrief-und Kommunalkreditbank AG), a Luxembourg-based corporation which holds about $50 million of the city of San Bernardino’s pension obligation bonds, this week filed suit in the U.S. Bankruptcy Court [Erste Europaische Pfandbrief- und Kommunalkreditbank AG v. City of San Bernardino 15-ap-01004, and the bankruptcy case is In re San Bernardino, 12-bk-28006, U.S. Bankruptcy Court, Central District of California (Riverside)] against the city in an effort to secure equal payment or balance in any final plan of debt adjustment submitted to U.S. Bankruptcy Judge Meredith Jury. The suit came in the wake of the city’s interim agreement, released last November, with its largest creditor, the California Public Employees’ Retirement System (CalPERS), under which the city agreed it would fully repay CalPERS and require the city to file its plan to exit bankruptcy by September 2015.(San Bernardino had initially quit paying CalPERS.) In its filing, EEPK was joined by Ambac Assurance Corp.—with both creditors arguing that treating one pension debt differently from the other is legally indefensible. The company, which holds about $50 million in pension obligation bonds, did not name CalPERS in the suit, but charged that “Any payment of the CalPERS pension obligation portion requires equivalent payment of the bondholder pension obligation portion.” The suit was filed in U.S. Bankruptcy Court in Riverside, charging that San Bernardino cannot legally keep up payments to the state’s public retirement system without giving equal treatment to pension-bond holders―presenting a novel legal challenge for CalPERS, which last year lost an argument in federal court over whether it deserved more protection than municipal bondholders. Nevertheless, San Bernardino City Attorney Gary Saenz responds this case is different, because not paying CalPERS fully would be disastrous and the city cannot afford to fully pay both. However, EEPK’s and Ambac Assurance’s attorneys have charged that San Bernardino has already admitted in court that the bondholder pension obligation portion and the CalPERS pension obligation portion are part of the same obligation: “Accordingly, there is no legal basis to differentiate between the Bondholder Pension Obligation Portion and the CalPERS Pension Obligation Portion…Payment of the CalPERS Pension Obligation Portion requires equivalent payment of the Bondholder Pension Obligation Portion…” City Attorney Saenz, however, noting that an official response will go to the court after consultation with the city’s bankruptcy attorneys, said that just because the two debts are similar for one purpose does not mean they should be treated similarly in federal bankruptcy court: “The reason they should not be treated similarly, is because the consequences of treating them similarly are extremely different…We need to have the pension system not be impaired and not have the perception of it being weakened. Chapter 9 (bankruptcy) is designed to have a city to have life and services post-bankruptcy, and in order to do that we need to have an adequate workforce. We need to have CalPERS whole for that.” But EEPK’s attorney had previously expressed apprehension that the city’s interim agreement with CalPERS might leave no money for other creditors, noting: “That deal is really more of surrender…At worst, the city will find there is no feasible plan that could incorporate the deal with CalPERS.” To which City Attorney Saenz yesterday responded: “Yes, the more money I pay to one creditor or one person, the less I have for another…There’s only so much to go around. That’s probably the reason why CalPERS, I believe, is probably going to chime in with the court and suggest there is a significant difference.”

San Bernardino Charter Changes. Almost like part of a strand of DNA, San Bernardino is not only trying to put together a plan of debt adjustment to submit to the federal bankruptcy court under Judge Meredith Jury’s deadline, but, simultaneously, members of the city’s citizen charter review committee are trying to reach consensus on proposed changes—especially in the wake of last November’s election when voters rejected one of the two suggested changes to the city charter, rejecting the proposed change to unlink the current charter provision under which police and firefighters have their pay set as the average of 10 like-sized California cities rather than by collective bargaining. This week, the City Council voted 5-1 to request proposals from a “charter expert” to advise the charter committee, as the committee requested. Proposals, including cost estimates, would come back within 60 days, according to City Attorney Gary Saenz, who plans to write up the request this week. San Bernardino has until the November 2016 ballot before city voters can vote on any additional charter revisions. At its charter review meeting this week, some attendees recommended that instead of working on an amendment by amendment basis, it might make more sense to simply replace the city’s current charter completely, instead of becoming bogged down in trying to identify piecemeal changes.

Potholes in the Motor City. It is one incredible accomplishment to obtain federal approval to exit from municipal bankruptcy, but quite another to implement a city’s plan of debt adjustment, fully recover, and to restore a sense of public integrity. So it was that a former Detroit treasurer and two others were found guilty of conspiracy Monday in a case alleging they defrauded the bankrupt city’s pension funds by accepting kickbacks and bribes in exchange for approving $200 million in corrupt deals. The three, former Detroit City Treasurer Jeffrey Beasley, former pension trustee Paul Stewart and pension fund lawyer Ronald Zajac, were accused of weakening a retirement system that faced takeover during the city’s landmark bankruptcy case. They face up to 20 years in federal prison and will be sentenced in late April. Some of the potholes to recovery could be gleaned this week in the Motor City, where Detroit’s Police and Fire pension fund fired an attorney yesterday in the wake of a bribery scandal that cost retirees almost $100 million. Unsurprisingly, members reported they had lost confidence in General Counsel Joseph Turner, and voted 9-7 to fire both Mr. Turner and his law firm, Clark Hill. Critics maintained that Mr. Turner’s continued involvement in the pension board raised questions about the Motor City’s ability to move past a history of corruption, mismanagement, and bad investments that played such a key role in hurtling it into the nation’s largest municipal bankruptcy in history. Nevertheless, Clark Hill will continue to represent the pension fund in matters related to the city’s bankruptcy case, and some ongoing lawsuits, according to pension fund spokesman Bruce Babiarz. For his part, Mr. Turner had testified during the two-month trial that ended last month with guilty verdicts against former Detroit Treasurer Jeffrey Beasley, ex-pension trustee Paul Stewart, and his own predecessor, Ronald Zajac, the former pension system’s general counsel in a corruption and pay-to-play scandal that drained more than $97 million from Detroit’s retirement system. According to a federal indictment, Mr. Turner, whose firm led the retirement system’s fight against pension cuts during Detroit’s bankruptcy case, contributed cash during birthday parties for pension board members before receiving a pay raise. During the corruption trial last month, in December, former Treasurer Beasley testified that Mr. Zajac handed him a birthday card at the January 2007 party filled with $100 bills―90 such bills.

The U.S. Congress & Municipal Bankruptcy. Rep. John Conyers (D-Mi.) on Tuesday introduced legislation, HR 96, to amend chapter 9 of title 11 of the United States Code to enhance protections for employees and retirees in municipal bankruptcies: the proposed bill would erect new barriers in the way of municipalities’ rights and authority to restructure their debt through bankruptcy. The bill, Protecting Employees and Retirees in Municipal Bankruptcies Act of 2015, would, according to the Congressman, provide protection for public employees and pensioners who have dedicated their lives to helping their fellow citizens: “When a municipality files for bankruptcy, its employees and retirees who have devoted their lives to public service — such as police officers, firefighters, sanitation workers and office personnel — risk having their hard-earned wages, pensions and health benefits cut or even eliminated…My legislation addresses this risk by requiring the municipality to engage in meaningful good faith negotiations with its employees and retirees before the municipality can apply for Chapter 9 bankruptcy relief.” The bill would increase the cost and authority of a city or county to file for federal bankruptcy protection by amending current federal municipal bankruptcy provisions by changing the rules and imposing a higher bar by means of modifying the current provision in the law mandating that a municipality negotiate “in good faith” with its creditors prior to having authority to file for protection before a federal bankruptcy court, proposing that “good faith” with regard to municipal, school, or county employees be interpreted as laid out in the National Labor Relations Act―a stricter standard which would impose not just greater barriers, but also higher costs on a municipality confronting insolvency than is currently applied by U.S. bankruptcy courts. The bill proposes a new federal unfunded mandate by barring a municipality’s proposed plan of debt readjustment from cutting municipal employee or pension benefits without the permission of the beneficiaries. In addition, the proposed legislation would amend chapter 9 to impose a different standard in determining when negotiations with creditors are futile: the bill proposes that the revised threshold would be “impossible,” as opposed to current law where the current standard is “impracticable.” Finally, the bill would federally mandate that a city, county, or school board would be required to demonstrate by “clear and convincing evidence” that it had met the filing eligibility requirements. In his introductory remarks, Rep. Conyers said the bill would speed the bankruptcy appeals process and ensure that municipal employees have a voice in the proceedings.

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