The Intergovernmental & Governance Challenges to Municipal Sustainability

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June 18, 2015

Visit the project blog: The Municipal Sustainability Project 

S-O-S. Wayne County Executive Warren Evans yesterday, writing that “Wayne County’s fiscal situation will continue to deteriorate without further remedial measures,” requested the State of Michigan to issue, on an expedited basis, a declaration of financial emergency. Mr. Evans wrote to Michigan State Treasurer Nick Khouri to request a preliminary review and declaration of financial emergency, citing several key issues which, he wrote, “threaten the county’s ability to provide necessary governmental services essential to public health, safety, and welfare,” referring to a projection that Wayne County’s accumulated unassigned deficit would grow from $9.9 million in the current fiscal year to $171.4 million by 2019, the county’s junk bond rating, and the judgement levy this month in a pension case that will cost taxpayers an estimated $50 in a one-time property tax assessment this summer on a $100,000 house. The epistle comes in the wake of a stream of warnings Mr. Evans has provided with regard to the County’s structural deficit and its unfunded pension liability—a liability now estimated to be approaching $1 billion—and comes in the first year of neighboring Detroit’s implementation of its municipal bankruptcy plan of debt adjustment in a city where the school system is under a state-appointed emergency manager—and where there are, as we noted yesterday, questions about the state’s legal authority to impose an emergency manager. Mr. Evans, in a release subsequent to the request, reported Wayne County would continue to negotiate with stakeholders under a consent agreement: “Our recovery plan provides a clear path to financial stability for the county, but we are keenly aware that our time frame to get the job done is quickly fading…Throughout this process we are constantly evaluating where we stand and proactively seeking solutions to work ourselves out of this massive deficit. I am requesting this consent agreement because the additional authority it can provide the county may be necessary to get the job of fixing the county’s finances done.” Under Michigan’s law, the state will first determine if a preliminary review is warranted, and, if so, the Treasurer will have up to 30 days to complete a preliminary review and final report—after which the local emergency financial assistance loan board would have 20 days to determine if probable financial stress exists—a finding seemingly likely here, and one which, if made, would trigger Governor Rick Snyder’s appointment of a financial review team, which would have up to 60 days to perform a more in-depth study—a study which could result in the appointment of an emergency manager or a consent agreement or emergency manager.

Under a consent agreement, the county would retain authority to implement pieces of County leader Evans’ plans, although complicated by the existence of constitutionally mandated positions, such as the sheriff and prosecutor complicate the prospects for a workable consent agreement. A consent agreement would be designed to allow the county to maintain a level of local control while providing a plan for managing the financial crisis with state assistance. Mr. Evans said a consent agreement would allow the county to continue negotiations with stakeholders while giving the county the ability, if necessary, to find other ways to achieve cost-savings and address the county’s $52 million structural deficit — a recurring shortfall that stems from an underfunded pension system and a $100 million yearly drop in property tax revenue since 2008: “Our recovery plan provides a clear path to financial stability for the county, but we are keenly aware that our time frame to get the job done is quickly fading.”

Because Wayne County surrounds Detroit, the two municipalities are not just linked geographically, but also fiscally. It is hard to imagine what the impact of insolvency for Wayne County would mean for Detroit’s ongoing recovery and implementation of its federally approved plan of debt adjustment.

It Ain’t Over Until It’s Over. While going through municipal bankruptcy can be fiscally and governmentally draining, it turns out that emerging from municipal bankruptcy—even once a U.S. Bankruptcy Court has approved a municipality’s plan of adjustment, might not suffice. So it is that in the wake of U.S. District Judge Sharon Blackburn’s rejection last September of Jefferson County’s contention that the appeal of U.S. Bankruptcy Judge Thomas Bennett’s decision approving the county’s—at the time—exit from the largest municipal bankruptcy in U.S. history just might not prove to be the last word. In rejecting Jefferson County’s argument that the appeal was moot, Judge Blackburn also said that she would consider the constitutionality of the county’s approved adjustment plan that cedes the county’s future authority to oversee sewer rates to the federal bankruptcy court. So it was that this week. Jefferson County’s attorneys argued in the 11th U.S. Circuit Court of Appeals that investors in the financing that enabled the county to exit bankruptcy nearly two and a half years ago should not have the “rug pulled out from under them” by losing a prime security feature they relied upon in deciding to loan the county money—referring to the security feature of the federal bankruptcy court’s oversight of Jefferson County’s plan of adjustment for the 40 years that the sewer refunding warrants remain outstanding—a key provision of the county’s plan of debt adjustment. As the godfather of municipal bankruptcy, Jim Spiotto, notes, what transpires in this appeal will have broader implications for all municipal bond market investors who rely on security enhancements, such as promised rate covenants or court oversight as part of their investment decisions: “To the market, hopefully the result [of Jefferson County’s case] will be a reaffirmation that rate covenants will be and should be enforced, and if you make a promise, especially in a Chapter 9 plan, it should be enforced as any contractual promise is.” In its 93-page brief, Jefferson County attorneys requested oral arguments to examine the constitutional, statutory, and equitable principles of the case which “are particularly important to governmental entities that may consider Chapter 9 relief now or in the future, as well as to the municipal debt market.” The issue underlying the appeal centers on whether proper legal steps were taken when Jefferson County’s bankruptcy plan was appealed to the U.S. District Court in Alabama by 13 residents and elected officials on the county’s sewer system, described as the “ratepayers” in court documents, who, Jefferson County attorneys argued, had failed to obtain the required legal “stay” suspending the plan while the appeal proceeded. Without any barriers to re-enter the bond market, Jefferson County proceeded to issue $1.8 billion in sewer refunding warrants in December 2013 that allowed the county to write down $1.4 billion in related sewer debt and exit bankruptcy. With the sewer refunding warrants long since sold to new investors, the complex plan of adjustment cannot be unwound, the attorneys wrote. Mr. Spiotto notes that the issue here comes down to an interpretation with regard to what chapter 9 permits and whether the bankruptcy court’s supervision is actually the act of setting rates or insuring that the county complies with the covenants that it promised. In its petition for an appeal before the 11th Circuit, Jefferson County wrote that neither its court-approved plan of adjustment or Judge Bennett’s confirmation order “changes the substantive law of the state of Alabama with regard to the enforcement of rates established pursuant to contract or legislation…Rather, the plan merely retains the bankruptcy court as an available forum in which such substantive law may be enforced, using the same remedies available in Alabama state court…In no event will the bankruptcy court ever set sewer rates; it is simply a forum to enforce the plan and related contracts – just as an Alabama state court could.” As Mr. Spiotto notes: here, no person—or court—is attempting to usurp the right of the state or a municipality under state law: “At the same time, no state or municipality should believe that it can make a promise and not live up to it: Whether you give it as Detroit did as a statutory lien or you have the court involved there are different roads to the same summit.”

Who has standing in a municipal bankruptcy case–and whether taxpayers, citizens, citizen groups, and major businesses in a municipality should have a role e in connection with the plan of debt adjustment, was a question I posed to U.S. Bankruptcy Judge Steven Rhodes for an interview with State Tax Notes. Judge Rhodes, in his response, wrote:

  1. This is perhaps among the most difficult questions in chapter 9. One practical reality is that every resident and business in a municipality that is going through a bankruptcy case has a direct and personal stake in the outcome of the case, although that stake may or may not be a financial stake in the strictest sense. But another practical reality is that the case has to be manageable. Most cases therefore deny standing to residents, concluding that the municipality’s democratically elected leadership adequately represents the residents’ interest in the case. That was my conclusion in a previous chapter 9 case called Addison Community Hospital District.

But the question is more complex where, as in the Detroit case, the management of the case is in the hands of an un-elected agent of the state and not the municipality’s elected leadership. In the Detroit case, I decided that a looser application of the traditional standing requirements was needed and so I invited the public to participate in the eligibility and confirmation phases of the case.  I maintained the manageability of the proceeding in other, more creative ways.

I followed up: Should a debtor propose a plan of debt adjustment which requires the debtor to take action that is contrary to state law including disregarding the pledge or dedication of revenues to the debt payment required under state law? In reply to which, Judge Rhodes said: “Yes, if it is necessary to restore or maintain adequate services. Although the Fifth and Fourteen Amendments generally prohibit bankruptcy from impairing property rights, nothing in those amendments or the bankruptcy code prohibits a plan from impairing creditors’ statutory or contract rights under state law.”

The Fate of a U.S. Territory. As Congress readies a hearing next week to consider whether Puerto Rico should be eligible for statehood, pressure continues in a separate committee in the House with regard to whether Puerto Rico should have the same authority as all other states with regard to municipal bankruptcy—that is, the authority to enact legislation which would permit any of its 157 municipalities to file for federal bankruptcy protection. In the latter issue, the struggle is with regard to H.R. 870, legislation proposed by  Rep. Pedro Pierluisi (D-P.R.), which is pending before the House Judiciary Committee—and which has the strong support of Puerto Rico Gov. Alejandro García Padilla. As pending, the bill would allow nearly insolvent governmental authorities, including the islands cities to formally reorganize under U.S. Bankruptcy court supervision—if authorized by Puerto Rico. The legislation, unsurprisingly, is opposed by funds which invest in Puerto Rico bonds, including Franklin Municipal Bond Group and OppenheimerFunds, Inc.: the funds recognize that municipal bondholders—in the event of a municipal bankruptcy—are more likely than not to take a haircut. Thus, they oppose any efforts to grant Puerto Rico the same powers granted to every state, claiming the municipal bankruptcy process is filled with uncertainty. The issues are even more complex from a governance perspective, however: should the bill be amended so that Puerto Rico, itself, could seek access to chapter 9, or should the bill be adopted as proposed, authorizing Puerto Rico to consider whether its municipalities should have access to municipal bankruptcy. Gov. Padilla supports the legislation as drafted; however, municipal distress veteran and long-time specialist Dick Ravitch, who has experience not just from his leadership in averting bankruptcy for New York City in the 1970’s, but more recently during his volunteer service in Detroit’s bankruptcy, has been pressing Congress to modify the bill so that Puerto Rico would itself have access to the U.S. bankruptcy court to reorganize its own debts. Mr. Ravitch fears that the territory, because it has issued so much debt, cannot conceivably repay it all, noting: “I do not believe the economy in Puerto Rico can prosper without a significant restructuring of all the debt.” That position contrasts the veteran municipal distress expert with Rep. Pierluisi, who yesterday released a statement cautioning that Congress would not support the bill to allow the restructuring of the island’s general obligation bonds, stating: “To lobby to amend H.R. 870 to enable Puerto Rico to restructure its general obligation debt is unwise and unnecessary as a matter of public policy.” The questions and issues with regard to equitable treatment for cities in Puerto Rico comes as the House Natural Resources Subcommittee on Indian, Insular, and Alaska Native Affairs has scheduled a hearing for next Wednesday on H.R. 727, proposed legislation to provide a path to statehood for Puerto Rico: the bill would authorize a U.S. sponsored vote to be held in Puerto Rico within one year of its enactment—the gist of which would be whether or not Puerto Rico should become a state. Should that vote be authorized—and the voters in Puerto Rico approve it, then the new state would automatically gain the authority to determine whether its municipalities ought to have access to chapter 9 municipal bankruptcy. Such a decision would also eliminate any authority by Congress to determine the new state’s access to federal bankruptcy, as Puerto Rico would become a sovereign. Former Puerto Rico Gov. Luis Fortuño said the statehood bill is getting a hearing because Rep. Don Young, the Alaska Republican who chairs the panel, is a friend to Puerto Rico and remembers when Alaska was a territory prior to 1959.

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