Accountability, Transparency, & Governance Issues in Municipal Bankruptcy

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February 13, 2014
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Balancing & Transparency in Municipal Bankruptcy. U.S. Bankruptcy Judge Meredith Jury has ordered a settlement between San Bernardino and the California public retirement system CalPERS to be made public, with Judge Jury stressing the importance of transparency as a major theme at a status conference with regard to San Bernardino’s municipal bankruptcy. Judge Jury also stressed the importance of community input as the city puts together a plan to exit bankruptcy—its so-called plan of debt adjustment. It is another signal too of how different the public process of scrabbling together a plan of debt adjustment can be in Alabama, California, or other states where a city’s elected leaders are responsible—instead of, as in Michigan or Rhode Island, where the state appoints a receiver or emergency manager. Or, as Mayor Carey Davis said: “Your input matters. Without it, we wouldn’t have the ability to take the city in the direction you want it.” In fact, even as San Bernardino leaders are working against an ever faster approaching May 30th deadline to submit its plan of debt adjustment to Judge Jury, the city is simultaneously seeking to be open and public with its citizens and taxpayers. Thus, San Bernardino convened the first and second of a series of town hall meetings Wednesday and last night to discuss a long-term strategic plan with residents. The challenge for the city’s elected leadership is juggling: how to avoid putting the cart before the horse. On Wednesday night, an attorney representing the holder and insurer of $50 million of San Bernardino’s pension obligation bonds, stated the lateness of these meetings was “distressing: Faced with a fast approaching deadline to file a plan, one would have expected the City to create a strategic plan and begin outlining the terms of its bankruptcy plan expeditiously…And yet, months after the [federal bankruptcy] Court set its deadline for the city, creditors recently learned that the City still lacks what it itself describes as a ‘strategic plan.’” Unsurprisingly, the attorney said he was present to request two actions: for San Bernardino to open its plan of debt adjustment development process to public participation, and for creditors to be allowed to present the court with contested legal issues before or alongside San Bernardino’s process of confirming the plan of adjustment. In a sense, what the attorney is proposing is parallel to what Judge Jury has already mandated with regard to the city’s fire union. Nevertheless, even as the city is struggling internally to cobble together its plan under a nearing federally-imposed timeline, it is also juggling with other, complicated deadlines: There are four appeals pending in the U.S. District Court; in addition, the pension bond creditors—Ambac Assurance Corporation and the Luxemburg-based corporation EEPK—have filed suit against San Bernardino, claiming that paying the CalPERS pension obligation portion of the city’s debt legally requires paying the pension obligation bondholder portion equally. It is a kind of a reprise with the trying balancing act about which U.S. Bankruptcy Judge Christopher Klein wrote last week vis-à-vis Stockton. But the discussion also demonstrates the irony—especially say, compared to Detroit—with San Bernardino’s bankruptcy attorney Paul Glassman noting that the attorney for the city’s creditor was arguing for greater transparency, but making such an argument based on a presentation officials made to the public at a City Council meeting, adding that San Bernardino is committed to involving the public. Mr. Glassman added that one could be of the impression that the San Bernardino creditor here was seeking to become more of an obstacle than facilitator, because, by suggesting more litigation, it could appear to reasonable persons more like an attempt to distract the city and prevent it from making its federally imposed deadline: “This appears to be a somewhat cynical attempt to overwhelm the city with litigation… (and) cause chaos and distraction in the case,” adding he was confident the city would timely file its plan of debt adjustment with the U.S. bankruptcy court. At the session, attorneys representing the police union and a retirees’ committee both received permission to file briefs responding to the pension bondholder representatives’ arguments, claiming that they do see the struggle as one of Main Street against Wall Street—or as attorney Steven Katzman, who is representing retirees put it: “My clients have made significant concessions here…(and) there’s a lot of unhappy retirees who are facing significant hardships…as a result Wall Street hasn’t had their healthcare cut.” In this dynamic setting,

Judge Jury pronounced her satisfaction with San Bernardino’s transparency at this point, except with regard to an agreement between the city and CalPERS, noting that some parts of the agreement—including that the city will pay the full amount it owes CalPERS, about $14 million, over two years—had already been released to the public. Because of that, the city’s argument that it would be misleading to release the agreement without the context of the full Plan of Adjustment did not, according to the judge, make sense―she gave the city until March 26th to submit the full agreement in public court records, along with any desired explanation of context—a date which appears to be consistent with the city’s progress: City Attorney Gary Saenz said he hoped a draft of the city’s full plan of debt adjustment would be publicly presented to the City Council with all the necessary context by then.

Based upon the two nights of public meetings, the next steps with regard to how to incorporate and implement the direction ahead will be the task of a “core group” with further input from residents, followed by the steady development of a “strategic plan” city leaders say they intend to use to develop the city’s plan of debt adjustment, but also to guide the city for years to come. The city has scheduled two more such community input meeting for the end of this month.

The Extreme Costs of Municipal Bankruptcy. Meanwhile, in the frigid north, the noted rhythm guitar playing U.S. Bankruptcy Judge Steven Rhodes yesterday determined that the Motor City’s $178 million bankruptcy tab for its outside legal and accounting advisors is reasonable considering the case’s complexity, the city’s “extreme financial challenges,” and substantial discounts given by law firms and consultants. The judicial announcement yesterday could mark one of the final chapters of Detroit’s historic municipal bankruptcy—and Judge Rhodes’ illustrious career: he is set to retire this month. Nevertheless, the extraordinary legal and accounting costs―which will be nearly $200 million the city is unable to dedicate to its future, came almost simultaneously with the announcement the Detroit water and sewer system is considering major rate increases to offset flat revenues as it prepares to transition into a new regional authority created as a key step during the city’s work to successfully put together its now approved plan of debt adjustment. Under the plan, Detroit residents could be hit with not just the costs of the legal bills, but also a nearly 17% increase in sewer rates, with suburban customers facing an average 11.3% increase in water rates under proposed increases the Detroit Water and Sewerage Department released yesterday, albeit the board of water commissioners still needs to approve the rates. The rate increases are aimed to offset lower-than-expected revenues due to flat or declining water sales and delinquent payers, including some financially troubled suburbs, according to reports—and come just a week after Judge Rhodes filed a court document noting that additional mediation sessions have been set for the city and suburbs to hammer out remaining disputes in the creation of the Great Lakes Water Authority. As much as Judge Rhodes might wish to retire, his ability to create electronic rhythm will likely be tested: Oakland Executive L. Brooks Patterson and Macomb County Executive Mark Hackel have complained about the rate increases, lower-than-expected revenues, and the department’s lack of financial transparency. The agreement calls for Macomb, Oakland, and Wayne counties to lease for at least four decades the bulk of the water and sewer department, with Detroit retaining control of the Motor City’s infrastructure. In return, the counties would pay Detroit $50 million a year in lease payments, money that the city can only use for system upgrades. Nevertheless, Judge Rhodes appears optimistic that the fees served their purpose, as he noted: “The city is now on a path to success precisely because of the expertise, skill, commitment, endurance, personal sacrifice, civility and proficiency of all of the professionals in the case, including most certainly those whose fees are subject to review in this opinion.” As high as the fees were, the Judge’s order for mediation between the city and all attorneys and other professionals who worked for the city in December produced discounts from all the key parties—saving the city millions of dollars. In his 48-page ruling, Judge Rhodes wrote that his findings reflect numerous complex issues in the case and the final consensual agreements crafted largely in court-ordered mediation, adding: “In its eligibility opinion near the beginning of the case, the court made detailed, and frankly, depressing findings about the city’s fiscal and service delivery insolvency…Those findings reflected the awesome challenges that the professionals in the case faced, embraced, met and overcame. They understood from the beginning the profound personal stake that each of the 700,000 residents of the city of Detroit had in the outcome of their work…But now is the time to appreciate and credit that accomplishment and all of the effort and skill of those professionals in achieving it. The city is now on a path to success precisely because of all the professionals in the case, including most certainly those whose fees are subject to review in this opinion.” The law firm Jones Day earlier defended its total bill of $7.9 million as “entirely reasonable” and argued it was one of the few firms capable of handling “cutting edge” issues posed by the biggest municipal bankruptcy case in U.S. history: the firm agreed to a 24% reduction in the fees it intended to charge Detroit taxpayers—with Jones Day attorney Heather Lennox telling the federal court Detroit stands to realize an estimated $10 billion or more in economic benefits, and that her firm helped Detroit slash total liabilities by about 50 percent, unsecured liabilities by 75 percent, which lets Detroit avoid a projected $3.9 billion deficit over the next decade—and, according to Counselor Lennox—enabling Detroit to reinvest $1.7 billion over the next decade on public safety and other services. Among the top paid professionals were: investment banking firm Miller Buckfire, $22.82 million; restructuring firm Ernst & Young, $20.22 million; and operational restructuring firm Conway MacKenzie, $17.28 million.

What Is a Territory to Do? Resident Commissioner Pedro Pierluisi, Puerto Rico’s Representative in Congress, yesterday announced he had secured 10 additional cosponsors of H.R. 727, the Puerto Rico Statehood Admission Process Act, a bipartisan bill to provide statehood to Puerto Rico as of January 1, 2021―once a majority of the electorate in Puerto Rico votes in favor of admission in a federally-sponsored vote―giving the bill 61 cosponsors—48 Democrats and 13 Republicans. In a November 2012 referendum in Puerto Rico, sponsored by the local government, voters soundly rejected Puerto Rico’s current territory status and expressed a clear preference for statehood. H.R. 727 would authorize a vote to be held in Puerto Rico within one year of the bill’s enactment—that is, no later than the end of 2017. The ballot would consist of a single question: “Shall Puerto Rico be admitted as a State of the United States?” In 2014, at Pierluisi’s initiative, and over the objections of the Governor of Puerto Rico and his allies, Congress enacted a $2.5 million appropriation to enable Puerto Rico to conduct the first-federally sponsored vote in its history, so long as certain conditions are met. Under H.R. 727, the admission vote authorized by the bill may be funded with the $2.5 million that Congress approved. This is appropriate because a straightforward vote on admission clearly satisfies the conditions that the federal government established in the appropriations law. Commissioner Pedro Pierluisi this week re-introduced legislation that would empower the government of the U.S. territory of Puerto Rico to authorize one or more of its government-owned corporations, if they were to become insolvent, to restructure their debts under Chapter 9, the municipal bankruptcy provisions of the U.S. Bankruptcy Code: the Puerto Rico Chapter 9 Uniformity Act. As proposed, the bill would deem Puerto Rico to be a “State,” “except for the purpose of defining who may be a debtor” under Chapter 9. Here, the intent appears to be that, if approved, Puerto Rico would be authorized to authorize its public utilities or instrumentalities to file for municipal bankruptcy protection. The action comes in the wake of multiple investment firms which own Puerto Rico’s municipal bonds suing Puerto Rico in U.S. federal district court, arguing that its enacted Recovery Act violates both the U.S. Constitution and the Puerto Rico Constitution—and last week’s U.S. district court decision holding that the Recovery Act is preempted by the U.S. Bankruptcy Code and is therefore invalid under the Supremacy Clause of the U.S. Constitution. Now, as Commissioner Pierluisi put it: “In the wake of the district court’s decision, it is more clear than ever that Congress should act swiftly to amend the U.S. Bankruptcy Code to empower the government of Puerto Rico to authorize its insolvent government-owned corporations to restructure their debts under Chapter 9. If Congress does not act, government-owned corporations in Puerto Rico will be left without any legal framework-at either the federal or territory level-to adjust their debts.”

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