Federalism Writ Large by U.S. Bankruptcy Judge Christopher Klein & Neighboring Fiscal Trouble in Wayne County Could Implicate Detroit’s Recovery

Taking Stock in Stockton. U.S. Bankruptcy Judge Christopher Klein, in resolving the “the single objection to confirmation of the chapter 9 plan of adjustment of debts by the City of Stockton,” wrote that it “necessitates answering the threshold question whether, as a matter of law, pension contracts entered into by the City, including the pension administration contract, may be rejected pursuant to Bankruptcy Code § 365. 11 U.S.C. § 365.” Finding that in the affirmative, Judge Klein came to what he termed the main question: “whether, as matters of law and fact, the City’s chapter 9 plan should be confirmed even though the plan does not directly impair the City-sponsored pensions.” Even though, in its confirmed plan of debt adjustment, Stockton did not seek to impair its obligations to the California Public Employees’ Retirement System (CalPERS), Judge Klein—writing that “Ca1PERS has bullied its way about in this case with an iron fist insisting that it and the municipal pensions it services are inviolable. The bully may have an iron fist, but it also turns out to have a glass jaw. This decision determines that the obstacles interposed by Ca1PERS are not effective in bankruptcy. First, the California statute forbidding rejection of a contract with Ca1PERS in a chapter 9 case is constitutionally infirm in the face of the exclusive power of Congress to enact uniform laws on the subject of bankruptcy under Article I, Section 8, of the U.S. Constitution – the essence of which laws is the impairment of contracts – and of the Supremacy Clause. U.S. CONST. art. I, § 8 & art. VI. Second, the $1.6 billion lien granted to Ca1PERS by state statute in the event of termination of a pension administration contract is vulnerable to avoidance in bankruptcy as a statutory lien. 11 U.S.C. § 545. Third, the Contracts Clauses of the Federal and State Constitutions, as implemented by California’s judge-made ‘Vested Rights Doctrine,’ do not preclude contract rejection or modification in bankruptcy. Finally, considerations of sovereignty and sovereign immunity do not dictate a different result.” The mix of federalism issues and the tremendous struggle pitting bondholders of a city or county versus public employees and retirees—and the related Constitutional issues raised in the Detroit and Stockton cases with regard to whether the federal chapter 9 municipal bankruptcy law can, in effect, preempt a state’s constitution—challenges which had been pending in the 6th and 9th U.S. Courts of Appeal before they were dropped thus received a final parting shot from Judge Klein—but a shot which could have reverberations for Atlantic City and especially Wayne County, Michigan, with his pungent opinion that municipal pension contracts entered into by the city, including the pension administration contract, may be rejected pursuant to bankruptcy code, with the feisty Judge noting: “The California statute forbidding rejection of a contract with CalPERS in a Chapter 9 case is constitutionally infirm in the face of the exclusive power of Congress to enact uniform laws on the subject of bankruptcy under Article I, Section 8, of the U.S. Constitution – the essence of which laws is the impairment of contracts – and the Supremacy Clause.” Nevertheless, Judge Klein noted while Stockton, in its plan of debt adjustment, could have impaired the pension fund, he also noted that Stockton’s plan did achieve significant reductions, including lower pensions for new employees and the elimination of $550 million in unfunded health benefits that employees accepted in exchange for preserving existing pensions. Because Franklin Advisors last November filed an appeal to a three-judge U.S. Bankruptcy Appellate Panel of the Ninth Circuit, the appeals court will have the benefit of Judge Klein’s perspective. (Franklin is challenging Judge Klein’s decision under which it claims it received a loss on the $35 million of bonds it holds — a recovery rate it estimated amounts to about 1% — in contrast to CalPERS which received no haircut at all. For his part, on this issue, in his decision, Judge Klein noted: “[T]he value given up by retirees who accepted the plan is on the order of ten times the value given up by Franklin.”

“Tomorrow hopes we have learned something from yesterday.” (Quote from John Wayne) Warren Evans, Wayne County, Michigan and Detroit neighbor’s newly elected executive, yesterday warned of a potential municipal bankruptcy filing and state takeover—saying that both options had to be on the table, unless the County acted swiftly to achieve major structural fixes. The county, which encompasses Detroit, is confronting what County Executive Evans termed a “financial Armageddon,” warning that “Even with all of the funds pooled together, we’re going to get to the area where we just don’t have enough to pay the bills.” Noting that one of the prerequisites of seeking federal bankruptcy protection, an outcome he termed “an ugly word,” is “a bad cash picture…if you don’t have the cash it’s one of the triggers.” Evans said restructuring debt for savings is one possibility, but said the county’s main problem is not bond debt but its lack of general fund revenue: “There was a big creditor argument,” he said, referring to Detroit’s bondholders, “but in Wayne County that’s not really the problem. We borrow from ourselves: the general fund takes money from the road fund or the treasurer.” Nevertheless, without a workable deficit elimination plan, it seem more likely than not that the state will step in and take over the county, as it did with Detroit in the months before the city declared bankruptcy, or as Mr. Evans put it yesterday: “All things being equal, I think it could [lead to bankruptcy] but I don’t think it will, because we’re not going to let that happen.” As for emergency managers such as Kevyn Orr being imposed by Governor Rick Snyder, Executive Evans said: “I don’t think they’re circling overhead, but they can all smell the blood on the water…Whether we fix it or someone else fixes it, it’s going to get fixed.” Wayne has roughly $700 million of junk-rated, limited-tax general obligation bonds. Wayne County has suffered for years with a structural deficit and growing unfunded pension debt. Mr. Evans, who was elected last November, previously served as a Detroit police chief and Wayne County sheriff. Yesterday, he warned: “The bottom line is everything is on the table, there’s no sacred cows,” adding: “The Governor has said he would like to sit back and see Wayne County take care of it, but if we don’t do what we need to do, he will come.” He noted the County has shifted money from other funds into its general fund for years to cover chronic revenue shortfalls, and that the County’s pension funded status has fallen to 45% from 95% ten years ago; he warned the County will need to find roughly $70 million a year to cover the structural general fund shortfall and begin to shore up the pension fund. The dire report card—on an issue which could have repercussions for Detroit’s fiscal and economic recovery, came in the wake of the County Executives frenetic series of meetings with unions and other “stakeholders” over the last few weeks and in the midst of renegotiating at least 25 labor contracts. To make matters more serious, Wayne County is threatening to unravel a breakthrough deal that settled Detroit’s bankruptcy case unless it receives land or more than $30 million — money the city needs to finance Detroit’s revitalization under its federally approved plan of debt adjustment—the agreement, revealed via a bankruptcy court filing yesterday, indicates that Wayne County and Detroit are fighting over a nearly 40-year-old agreement to redevelop the landmark former Detroit Police Department headquarters at 1300 Beaubien in downtown Detroit. The tiff between the city and surrounding county could threaten to unravel a hard-fought bankruptcy settlement the Motor City reached with its fiercest bankruptcy creditor, bond insurer Syncora Guarantee Inc. to emerge from municipal bankruptcy late last year. The Wayne County Executive’s office, nevertheless, yesterday said it would exercise its option to control redevelopment of the land under the 1976 agreement with the city: “Wayne County is not seeking compensation from the city of Detroit, but rather specific performance,” albeit the statement left unclear exactly what the County would define as “specific performance.” Detroit’s bankruptcy attorney Heather Lennox, in a filing yesterday, noted: “The Wayne County objection was filed approximately 117 days after the court-ordered deadline to file such objection, and more than two months after” U.S. Bankruptcy Judge Steven Rhodes permitted Detroit to back out of the Wayne County deal. (The 1976 county-city agreement was supposed to be fulfilled in two phases. The first phase was completed and involved Wayne County acquiring land next to police headquarters and building the Andrew C. Baird Detention Facility. The second phase is unfulfilled, according to counselor Lennox: Detroit never demolished the headquarters after the Detroit Police Department moved two years ago into the former MGM Grand Casino site downtown, and Wayne County never paid for the headquarters site.


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