Bankruptcy: To Be Eligible or Not to Be, that is the question.

October 5, 2015

Who’s on First in Atlantic City? There was a bankruptcy filing in Atlantic City yesterday: American Apparel is filing for Chapter 11 bankruptcy protection, a filing which came after the Los Angeles corporation reported that its U.S. retail stores will continue to operate and that its international stores are not affected, but a plan which would, pending approval by a federal bankruptcy court, erase more than $200 million in bonds held by the retailer in exchange for equity interests. Lenders will provide about $90 million in debtor-in-possession financing. The company’s board has approved the restructuring plan, which is expected to be completed in about six months—and then will await the court approvals. In contrast, there has been no municipal bankruptcy filing by Atlantic City, notwithstanding the continued silence from Presidential candidate and New Jersey Governor Chris Christie with regard to whether and when he might interrupt his campaign to sign financial relief provisions long since sent to him by the New Jersey legislature to authorize the city’s casinos to make payments in lieu of taxes over the next 15 years and reallocate the casino alternative tax to pay debt service on Atlantic City-issued municipal bonds. In the strange municipal leadership dilemma in which Mayor Don Guardian sits—awaiting action by an absentee Governor and not fully clear about the hydra-headed governance situation where the mostly absentee governor has appointed an emergency manager to act in an ill-defined role as a quasi co-mayor—Mayor Guardian nevertheless is focused on efforts to signally change the city’s fiscal dependence on casinos by diversifying the city’s economic base. Nevertheless, with a $101 million deficit and delayed FY2016 budget (adopted last week), in addition to a withering credit rating; Mayor Guardian has cut the city’s personnel by 400 positions, and worked with his Council to help plug the budget gap—even as he and his fellow elected Councilmembers await Emergency Manager Kevin Lavin’s expected second report, which is to include fiscal sustainability recommendations—recommendations in this strange, two-headed quasi municipal governance situation—and in which the missing Governor’s action will be critical. Notwithstanding his tenuous authority under New Jersey’s unique municipal bankruptcy laws, Mayor Guardian is not just sitting around twiddling his thumbs; rather he is focused on his city’s future, telling the Bond Buyer’s Andrew Coen: “I want to prepare my city for the next recession…Whether that is five or 10 years away, I want to make sure that we’re a lot more than just a resort town so that we become resilient.” That focus, especially since quasi hurricane San Joaquin opted to not vent its physical fury on the city, will be easier in the wake of New Jersey’s Local Finance Board approval of the city’s budget, which opened the way for Atlantic City to proceed with fourth-quarter tax bills and tax-lien sales for some big delinquent properties among current and former casino hotels.

The Anomalies of Municipal Bankruptcy. Hillview, Kentucky, the small (population under 10,000) home rule-class municipality in Bullitt County, Kentucky—a rural farming community just a hop, skip, and jump from Louisville, which filed for chapter 9 municipal bankruptcy in August—the first filing for a municipality since Detroit’s filing more than two years’ ago—might find its filing unavailing. Having ignored the electronically musically and sound advice of retired U.S. Bankruptcy Judge Steven Rhodes, who oversaw the largest municipal bankruptcy in U.S. history, Steven Rhodes, the small city could be digging itself into a deeper fiscal trough, even as it preps to argue before U.S. Bankruptcy Judge Alan C. Stout. Judge Stout will have to determine if the municipality’s filing was done in good faith, in addition to assessing the justifications. The municipality’s largest creditor, Truck America LLC, which has been awarded an $11.4 million judgment against Hillview (with the interest bring the growing amount of said award now up to $15 million) has filed an objection with the U.S, bankruptcy court, arguing the municipality is ineligible because its petition to the federal court which the municipality relied on to file for reorganization “suffers from a fatal flaw: it refers only to the now-repealed Bankruptcy Act.” The objection, which in a sense echoes earlier moody warnings from credit rating agency Moody’s that: “Generally, a municipality must prove that it is not paying its debts on time or is unable to pay the obligations as they become due,” a bar which the credit rating agency had noted would be difficult to overcome, as the municipality had the fiscal capacity to increase its property and occupational license taxes—not to mention the authority and ability to issue bonds to pay for losses in legal judgments, according to the credit rating agency. In its objection to the federal court, Truck America’s attorney wrote that Kentucky courts would likely require that the Kentucky Legislature amend state law (in this instance, §66.400), the Bluegrass State’s municipal bankruptcy statute, under which two municipal entities, both utility districts, have previously filed. Truck America, in its brief, also wrote that Hillview had not negotiated in good faith to settle its court-awarded $11.4 million claim over a contract dispute as required by the bankruptcy code, noting: “Hillview did not file Chapter 9 in good faith to adjust its debts, or to ameliorate bona fide financial distress…Rather, it admits to being ‘fiscally sound’ and filed this case for the specific purpose of minimizing the amount it will be required to pay one creditor—Truck America—on account of a judgment affirmed by Kentucky’s appellate courts,” adding that impairing a single creditor is not a legitimate municipal bankruptcy objective. Interestingly, in its filing, Truck America wrote that the municipality had not complied with Kentucky’s constitution—specifically the provision therein which requires that the state’s municipalities raise taxes in order to pay authorized indebtedness, such as a judgment, within 40 years. If that were not enough of a fiscal nightmare, last August, Hillview Mayor Jim Eadens said the city is exploring malpractice claims against its former attorney. He did not provide any details.

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