The Route out of Municipal Bankruptcy

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eBlog, 5/2416
In this morning’s eBlog, we consider the late night “road to recovery” bipartisan, bicameral plan in the New Jersey legislature to avert insolvency in Atlantic City—albeit with an ominous silence from New Jersey Governor Chris Christie; we consider the legal challenge of hedge funds to Puerto Rico’s debt moratorium law; and we follow the surprisingly inclusive process of San Bernardino in obtaining citizen input and then approval of its plan of debt adjustment for the U.S. Bankruptcy Court.

A Lifebuoy for Atlantic City. In what Atlantic City last night described as “a road to recovery for Atlantic City,” New Jersey legislative leaders struck a compromise to address the nearly insolvent city—albeit, as Atlantic City Mayor Don Guardian described the agreement: “It’s going to be a tough road for us to meet.” Under the agreement, the state legislature would give Atlantic City 150 days to draft a five-year fiscal plan that includes a balanced budget in FY2017, and the state would provide the city with a state bridge loan to cover its fiscal meltdown in the meantime. In addition, the agreement includes a companion bill which incorporates elements of the so-called PILOT or payment in lieu of taxes legislation which would allow the city’s casinos to make fixed payments in lieu of property taxes and redirects $110 million in casino funds over 10 years to help Atlantic City pay debt and expenses. Under the new plan, the Commissioner of the Department of Community Affairs would approve or reject the city’s five-year plan after 150 days. If the city’s plan failed to achieve fiscal stability, the state takeover proposed by Sen. Sweeney would take effect. The compromise also provides authority for a state takeover if Atlantic City, at any point, fails to follow the five-year plan—although the legislation would permit Atlantic City the right to appeal the commissioner’s decisions to a Superior Court judge. The New Jersey Assembly Judiciary Committee unanimously advanced the legislation with one abstention; the Senate and General Assembly are scheduled to vote on the legislation Thursday. There has, as yet, been no comment from Gov. Chris Christie.

Atlantic City Mayor Don Guardian, who supports the new plan, said he would need time to come up with an exact figure after considering state aid, nevertheless noting the city would still be forced to make “drastic” budget cuts. In a statement, Council President Marty Small said the agreement would offer local officials the right to self-govern and would avoid disenfranchising the city’s residents, albeit adding: “However, a tall task remains in making the necessary cuts that will be extremely painful and tough.” The compromise agreement mandates that, in addition to a balanced budget, Atlantic City would be mandated to pay:
• the full amount in property taxes owed to the city’s school district and Atlantic County,
• schedule repayment of debts to the state, bondholders and other liabilities, and
• increase revenues.

Unsurprisingly, it is not yet clear how deeply the Mayor and Council will have to cut the city’s budget: according to the state, Atlantic City has $550 million in total debt. But the legislation does permit the city to offer early retirement incentives to public workers, possibly saving the city more than $5 million, according to Mayor Guardian. In addition, according to the Mayor, the city would also be mandated to restructure its bonded debt in order to reduce its annual debt service from $38 million to $5 million. The timing of the agreement—assuming, of course, that Governor Christie will support the package—is critical, as the incorporated securitized loan in it will be vital to allowing Atlantic City to continue to operate during the summer months and ensure that the all-important tourism season is not impacted by the threat of looming fiscal collapse. It remains unclear whether Gov. Chris Christie, who has twice rejected fiscal rescue plans for the city, would approve the legislation.

Vulture Challenge. Hedge funds Brigade Capital Management LLC, Tasman Fund LP, Claren Road Asset Management, Fore Multi Strategy Master Fund, Sola, Ultra Master, Solus Opportunities Fund, and four funds holding more than $750 million of Puerto Rico Government Development Bank debt have revived a suit in the U.S. District Court [3:16-cv-01610-FAB], accusing the government of Puerto Rico of “changing the rules of the game” by amending its debt payment moratorium law. The litigants argue that Puerto Rican statutes Law 21 and Law 40 violate the Contract and Takings Clauses of the United States Constitution and the Puerto Rico Constitution. The funds say they also violate the Commerce, Bankruptcy, and Supremacy Clauses of the U.S. Constitution, contravene Section 903(1) of the Bankruptcy Code, and unconstitutionally close the doors to the federal courts. The hedge funds, which had reached a preliminary agreement on a restructuring plan earlier this month, filed their amended complaint late last week requesting that portions of Puerto Rico’s commonwealth debt payment moratorium law be declared null and void—in effect seeking to preempt Law 21, which Puerto Rico Gov. Alejandro García Padilla signed last month, which provides him authority to suspend payments on debt backed by the Puerto Rican government, the Government Development Bank (GDB), and other public agencies through next January—and which imposes a stay on legal challenges to any debt moratoriums. Gov. Padilla made use of the new law early this month to institute a freeze on GDB principal payments due on the 2nd—a date on which the Bank paid about $23 million in interest; the bank had reached agreement with local credit unions that held some of the debt due that day. In addition, the hedge funds reached a preliminary agreement for restructuring the debt under which they would accept what are termed “face discount notes” equal to 47% of the original notes’ value: the notes would pay 5% interest, though some of that interest would be paid through new notes until FY2020, and, in addition, provide for entering into a 30 day forbearance from taking actions against the GDB, according to the amended complaint. The apple cart, however, was upset, according to the litigants, when the legislature on May 5th adopted a revision of its moratorium law. The revised legal complaint charges that the revised law provides that local depositors and creditors will have better recoveries than non-local depositors and creditors and directs the receiver to “preserve and prioritize the safety, soundness and stability of depository financial institutions and their deposits,” and provides that debts owed to Puerto Rico resident institutional holders of GDB bonds would be preferred. In response, Puerto Rico Gov. García Padilla noted; “A small group of Wall Street hedge funds and vulture funds yesterday filed a lawsuit in federal court seeking to hinder the provision of services that Puerto Ricans receive from the government. This will affect the ability of the commonwealth to have police on the streets, teachers in schools, and nurses in hospitals…The economy of the island will not survive additional austerity measures and certainly not survive the commonwealth having to close in order to pay billions of dollars in bonds maturing this year. We will vigorously defend our limited legal tools and will not tolerate being placed in a legal-straitjacket.”

The Last Full Measure? With U.S. Bankruptcy Judge Meredith Jury having imposed a Memorial Day deadline for San Bernardino to submit its plan of debt adjustment, the San Bernardino City Council has voted 6-1 to approve its plan, with only Councilman John Valdivia in opposition. Notwithstanding, City Attorney Gary Saenz warned the city’s creditors will still be able to object to its provisions, and advised the city will continue to negotiate in efforts to avoid expensive litigation. Counselor Saenz indicated he hoped Judge Jury would render her decision in about a year. San Bernardino County Supervisor Josie Gonzales, who represents much of the City of San Bernardino, told the Mayor and Council: “I, no different from the people in this room, value this moment as part of what will become your legacy in great history…Do not think of yourselves today. Think of 25 or 30 years in the future and let it be said that on May 18, 2015, the leadership of San Bernardino was strong, and honest, and ready to introduce the future.”

The plan, which details proposed reductions to creditors — including the investors who hold nearly $50 million in pension obligation bonds, whose principal is slated to be reduced to only $500,000 — and internal changes that the city’s consultants and others say will allow it to deliver services for less, was put together by experts hired by the City, notes “strongly and clearly that San Bernardino must address the reform of its system of governance and management. San Bernardino is an outlier in comparison to other cities of its population size in the State as it does not employ a true Council/Manager form of government. It also has an elected City Attorney, a peculiarity shared by only eleven other cities in California (mainly very large cities), and an unusual and unwieldy Charter. All of this has led the Core Team to recommend that the existing Charter be repealed and replaced with a Charter that clearly spells out responsibilities for policy (Mayor and Common Council) and administration and management (city manager) so the government can operate effectively and efficiently. The current Charter so impairs the operation of the City that it has been forced to seek an interim operating agreement (see Attachment I) even to be able to develop and implement this Plan. This fact was dramatically illustrated by a strategic planning committee which unanimously told the Mayor, majority of the Common Council, City Attorney and City Manager, that operations and management needs fundamental reform. The City intends to establish a Charter committee to draft a new Charter and place that new City Charter on the November 2016 ballot for consideration by the voters, or sooner if possible.”

Nevertheless, putting Humpty Dumpty back together again entails hard political choices, so, unsurprisingly, the Council heard testimony from those bitterly opposed to the plan—especially with regard to the provision to outsource the city’s fire and refuse services—or, as one citizen put it: “Today is the day the City Council committed suicide for San Bernardino.” The plan, which lays out proposed reductions to creditors — including the investors who hold nearly $50 million in pension obligation bonds, whose principal is slated to be reduced to only $500,000 — and internal changes which San Bernardino’s consultants and others claim will allow it to deliver services for less, proposes to make employees a priority over outside groups, because the city wants to ensure it can keep a workforce. The plan also proposes full payment of the city’s obligations to CalPERS, some $14 million, making the state public pension agency one of the city’s only creditors not to be substantially impaired in the city’s plan.

In a key step, the city had shared its proposed plan with what it described as a “core group” of citizens chosen to represent various communities in the city, many of whom spoke in support of it before the Council.

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