The Exceptional Governing Challenges in Municipal Bankruptcy

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June 17, 2015
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Getting Down & Dirty near L.A. The San Bernardino City Council yesterday, in the wake of a session which some of its members described as “dysfunctional,” voted 4-3 not to act on a proposed short term contract for street sweeping. Unlike Michigan or Rhode Island—states where an emergency manager usurps elected authority (albeit with a new Michigan Appeals court decision—please see below—the extent of such state usurped control is in some question)—San Bernardino’s elected officials have had to be not just responsible for voting to approve the city’s plan of debt adjustment to submit to U.S. Bankruptcy Judge Meredith Jury, but also to continue to govern whilst the city’s future is being determined in her court. Nevertheless, in the interim, the Mayor and Council bear the responsibility to keep the city operating—including making determinations with regard to what public services are essential. Thus the nearly transfixing issue with regard to street sweeping swept the council into confusion: it appears that the city’s Public Works Director, Tony Frossard, had reassigned street sweepers several weeks ago to pick up trash, determining that refuse collection was a priority and that the ongoing departures of city employees left too few people to do both—a decision which, apparently, was not conveyed to either the city manager or Councilmembers—who were apparently only informed of the decision last week—leading to this week’s public session and divided vote, after City Manager Alan Parker had hurriedly sought street sweeping proposals from three companies, with the services to be provided for the next four months—at which time San Bernardino would expect to select a firm to assume annual responsibility for refuse collection, street sweeping, and other duties, consistent with the city’s outsourcing proposals in its plan of adjustment awaiting consideration by the U.S. Bankruptcy Court. In the wake of such confusion, the Council voted to defer any action until July 6th, with councilmembers expressing frustration with regard to both the timeliness and breadth of information they had received—as well as the short notice on which to act—or, as Councilmember Henry Nickel put it: “I don’t know whether these crises are being engineered or people are dropping the ball…Either way, it’s unacceptable.” It turns out that managing a municipal bankruptcy and governing a municipality is challenging, and, in San Bernardino, it appears to be adding stress between staff and elected officials: As Councilmember Virginia Marquez put it: “If we have not been told about the street sweeping, are there other issues we have not been told about?…I don’t like being in the dark.”

The city is, in a sense, caught between state law (municipalities are responsible for having trash picked up every seven days, while streets must be swept at least once per year) and its already submitted plan of debt adjustment, wherein, as City Attorney Gary Saenz wrote: “As the Recovery Plan makes clear, our first priority has to be the delivery of adequate municipal services…the pain will be shared among all stakeholders; employees, retirees, citizens (in the form of impaired service levels until the City can retain its footing) and capital market creditors. Only by undertaking the difficult process of refashioning the City into a modern municipal corporation can we be successful in creating a solvent future.” In fact, the plan is specific with regard to the issue at hand: it proposes to continue—or increase—the city’s pace of outsourcing some essential public services, to rewrite the city’s charter, as well as to continue to reduce the size of the city’s workforce, noting: “Contracting out of various services currently being provided ‘in house’ by the City is a keystone of this Plan…These include, but are not limited to, fire suppression, EMT services, and solid waste management collection/disposal,” with much of the outsourcing proposed to begin this year—including business license administration, fleet maintenance, and other services. With regard to the charter, the plan refers to the “interim charter agreement” under which city officials have already agreed to work, adding that the city expects the Council-appointed charter review committee to draft a proposed new charter and “place such proposed new Charter before the voters on the November 2016 ballot (or earlier if possible).” (In California, state law restricts proposed charter amendments to the November ballot in even-numbered years.) The forecast portion of the document forecasts that police and firefighters will continue to receive salary increases of 3 percent annually—an issue on which the city is mandated by its charter, in order to comply with the requirement to continue paying the average of what 10 like-sized cities pay for those positions. Salary compensation for non-safety employees is forecast to grow by 2 percent annually. Under the proposed plan, holders of $50 million in pension obligation bonds would receive an unsecured note and be paid based on a reduced principal of $500,000. Payments on that principal would begin in the sixth year after the Plan of Adjustment became effective. No payments would be made on bonds and certificates of participation issued in 1996 and 1999, respectively, for five years. Then, based on a new maturity date of 2035, only the interest would be paid for years six through 10, then interest and principal would be repaid through the term of the lease.

Going to School on Municipal Bankruptcy. Detroit Public Schools Emergency Manager Darnell Early yesterday testified before the Detroit City Council that the Motor City’s recovery from municipal bankruptcy will fail absent a turnaround of its education system—a system with falling enrollment and a deficit of more than $160 million: “We all have a vested interested in seeing Detroit Public Schools emerge from its financial difficulties, just as the city was able to emerge from the largest municipal bankruptcy in United States history…Without it, the city will be incomplete.” Mr. Early said his goal, not unlike his former counterpart Kevyn Orr, was to return the city’s school district from state back to local control, but testified: “we’re not there yet.” His appearance before the Council comes in the wake of his proposed restructuring plan for the 47,000-student district–a plan Mr. Early said would both save $10 million a year and give principals more autonomy when its fully implemented by July 2016, adding: “This is very important work because it involves the future of not only our city, but the future of our children…Failure is not an option, because we’re talking about failing our children. We’re talking about failing our community.” He vowed there would, despite falling attendance, be no school closures in the upcoming academic year, but that he had proposed reducing its current 60 departments to 16 offices overseen by five divisions, as well as recruit four deputy superintendents to lead its other divisions: academics and school support, strategy, talent management, and finance and operations. There is much work to be done: the Detroit Public School System spends $1,963 per student on administration, one of the highest figures in the state among districts with more than 1,000 students.

There are many players at the table, because the stakes for Detroit’s future loom so high—and the challenges are intergovernmental. Even though Mr. Early is a state-appointed emergency manager, just as Kevyn Orr was for the city, Gov. Rick Snyder has proposed his own plans for reconstructing Detroit’s public education system, including restructuring the guidelines for appointments to the school board, so that Gov. Snyder and Mayor Mike Duggan would be responsible for appointing the city’s school board to run a new debt-free public school district, with a six-year timetable back to electing a more traditional school board. Some of that governance stress became evident yesterday when Councilman Gabe Leland urged Mr. Early to not leave the school district’s elected board members out: “As you go about your work, I hope that you can build relationships…particularly with the Board of Education here in the city of Detroit, who were elected by the residents of this city…The residents that this city elected have no voice on that board, and to the extent you can build those relationships and make them part of the decision-making process, I think we all win.”

Reining in Colas? The Wayne County Commission, as early as tomorrow, could take up a proposal to eliminate the fund the nearly insolvent county administers to provide what the county terms the 13th check to its retirees—in this case given as a bonus in lieu of cost-of-living increases. The decision came on a 9-3 vote, with two abstentions, to move the measure forward to full commission—and came at a public hearing, but one at which no members of the public spoke. Deputy Chief Executive Officer Richard Kaufman told the Commissioners that the elimination of the fund, the Inflation Equity Reserve Fund, would not achieve annual savings to Wayne County, but that it would enhance the county’s fiscal health. The issue arose in the wake of a court decision fining Wayne County $49 million, because the court determined the County did not make its required annual pension contribution in 2010—a judicial order which led to the imposition of a one-time property tax assessment for this summer of about $50 for a house assessed at $100,000. Nevertheless, the possibility of taking away inflation adjustments raised apprehensions about the potential consequences for public retirees on low or modest incomes, with some on the Commission suggesting the consideration of a sliding scale that would eliminate the bonus for those with higher pensions. However, Deputy COO Kaufman was adamant: “The administration doesn’t believe we have any money to fund a 13th check.” County officials expect eliminating the so-called 13th check would help enhance the sustainability of the county’s public pension fund—currently estimated at an estimated 44-45% level, advising the elected leaders that if it were eliminated, the assets would be transferred to the general pension fund, telling the members they would prefer to ensure the health of the entire pension system rather than worry about the bonus check—and reminding the elected leaders that Wayne County currently faces an unfunded pension liability of $850 million to $940 million.

Is There an Emergency with Michigan’s Emergency Manager Law? The State of Michigan Court of Appeals—in the first case addressing the extent of the power or authority granted to state-appointed emergency managers—state-appointed managers in place of elected municipal leaders, to date, in five school districts and 12 municipalities in Michigan—has now, in the first judicial examination of the state’s power to, in effect, suspend democracy in a city, county, or school system, ruled that emergency managers cannot simply ratify actions imposed by local officials; rather they must closely follow local ordinances when imposing their own orders, with the court noting: “Our decision today only highlights that authority for a closer look at the statutory boundaries of the EM’s power.” Indeed, in overturning the lower court, the panel wrote that its decision had been “premised on its understanding of the EM’s authority as broad, substantial, and complete,” noting the need for a “closer look at the statutory boundaries of the EM’s power.” The decision (Kincaid et al v. City of Flint) arose from a challenge to a former Flint emergency manager’s order imposing steep water and sewer rate increases, with the appeals court here reversing the trial court’s dismissal of that case, the three judges writing: “The EM is a creature of the Legislature with only the power and authority to do what is granted by statute…That authority was not as broad as defendant argues.” One firm, Miller Canfield, noting it was the first case to analyze the extent of an Emergency Manager’s authority, wrote: “[P]previously [there was an] undefined limit on an EM’s powers and by implication narrowed the EM’s authority to ‘act for and in the place and stead’ of local officials.” In the specific instance of the City of Flint, the ruling means the loss of revenue generated by the water and sewer rate increases a former emergency manager imposed—creating a fiscal sustainability issue for the city and an ironic question with regard to whether or not Flint will appeal the ruling to the Michigan Supreme Court. In Flint’s instance, prior to the state’s imposition of an Emergency Manager, the City finance director had recommended increasing the municipality’s water and sewer rates, a recommendation subsequently approved by the city council and the mayor. In the nonce, the state appointed Michael Brown to take over the city as emergency manager—whereupon Mr. Brown ratified the finance director’s rate increase, imposing water and sewer rate increases of 12.5% and 45%, respectively. The actions led Flint City Councilmember Scott Kincaid and other residents to file suit, alleging the city did not follow local ordinances in imposing said increases, including adhering to a 30-day waiting period, among other things, and that an EM could not ratify an action imposed prior to his or her appointment. In a press conference Monday, Councilmember Kincaid and other plaintiffs said they hope to reach a settlement with the city to end the lawsuit.

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