Getting into–and out of Municipal Bankruptcy.

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eBlog, 10/18/16

Good Afternoon! In this p.m.’s eBlog, we consider the nearing end of the longest municipal bankruptcy in U.S. history in San Bernardino; we peer south to the great challenge in Puerto Rico; the seeming inability of East Cleveland to pull itself out of insolvency; the threatened fiscal future of Petersburg, Virginia; and, finally, and finally, we ask if time is running out for Atlantic City.

Momentous Day. U.S. Bankruptcy Judge Meredith Jury Friday noted: “This is a momentous day,” as she ruled that San Bernardino had met most of its chapter 9 municipal bankruptcy requirements already and added that she does “not think the city should worry” that she will not confirm the rest at a later hearing. The day marked the end of nearly four years for a confirmation hearing to confirm settlements with thousands of the municipality’s creditors—and moves ever closer next March’s expected final exit from bankruptcy.  Friday’s hearing marked the first in a series that the city’s leaders anticipate will culminate in the completion of the nation’s longest ever chapter 9 municipal bankruptcy. The city’s plan of debt adjustment, which includes paying certain creditors only one cent for every dollar which they are owed, was for the most part tentatively confirmed Friday; Judge Jury reserved judgment on two substantial issues, which are related:

  • a major dispute between the city and the Big Independent Cities Excess Pool, which provides liability coverage for the city, and
  • potential lawsuits involving individual employees such as police accused of excessive force.

Those issues will be addressed beginning Nov. 15. Noting that: “I can now say that today is a promise and hope for a better future for the city,” Judge Jury praised the city for its progress and said she was convinced by the city’s financial models and declarations to show it could not afford to pay more than 1 percent of its debts to unsecured creditors, opening the way for her to swiftly rule the plan of debt adjustment was feasible — a decision made easier by the absence of arguments objecting to it.

San Bernardino City Attorney Paul Glassman took a moment at the beginning of the hearing to mark the milestone of the first confirmation hearing, telling the court: “The very first hearing in this case back in August of 2012, I told the court that the day that the city entered Chapter 9 (bankruptcy) was a solemn day, but since that day the city has come a long way down a difficult path and has made great strides forward, thanks to the efforts of a number of people, many of whom are in the courtroom today…Surprisingly, your honor, the aspect of a bankruptcy case that’s most often disputed is not disputed in this case,” Glassman said, regarding the plan’s feasibility.

Unsurprisingly, however, the 1 percent payout sat less well with attorney Duane Folke, who appeared in court Friday for the first time on behalf of Paul Triplett, for whom a judgment from another court which had found Mr. Triplett was entitled to $7.7 million after San Bernardino police in 2006 broke Triplett’s jaw, arm, ribs, leg, ankle and foot, leaving him comatose for three days, according to Mr. Folke. Under the city’s plan, because Mr. Triplett is an unsecured creditor, he would receive only $77,000—or one percent of what he was owed under the judgment against the city, leading to the sole objection, with the attorney telling Judge Jury:

“My client, unfortunately, given the fact that he’s facing blindness, cannot accept the settlement as it stands.” In response, Judge Jury said she sympathized, but could come upon no legal reason to argue he did not belong in the unsecured class of creditors, which overwhelmingly voted in favor of the plan—leaving only the option of showing that experts the city hired were wrong when they argued, with extensive documentation, that the city could not afford to pay more than 1 percent to its unsecured creditors: “Here’s what stands between you and your ability to be persuasive to the court: You would need to employ a cadre of experts similar to those the city has employed, probably on the tune of hundreds of thousands of dollars, to refute the evidence that they have presented.”

Other civil rights creditors, with different attorneys, have reached settlements for more than 1 percent, albeit far less than 100 percent of the amount they would be owed.

San Bernardino filed for bankruptcy protection Aug. 1, 2012, swamped by a deficit of more than $45 million — equivalent to 40 percent of the $112 million in revenues the city expects this year — and fearing it wouldn’t be able to make payroll unless a bankruptcy judge stopped creditors from collecting their debts. The chapter 9 filing, however, has been expensive: From 2012 until May 2016, the city spent $18.8 million on bankruptcy-related expenses—attorneys and consultants—according to one of those consultants, Teri Cable of Management Partners.

Puerto Rico. Gov. Alejandro García Padilla has warned that any efforts to avoid insolvency in the U.S. territory of Puerto Rico will come at a steep price: addressing the first session of the PROMESA oversight board, Gov. Padilla said that even if Puerto Rico’s 3.4 million residents continued to reduce spending—and even if the island’s creditors were to agree to less than full restitution of the nearly three quarters of $100 billion they are owed, the island would  still “need the assistance of the federal government to bring this economic and humanitarian crisis to an end,” as he urged the board’s seven members to join him “in one voice before Congress” to seek help. The first session focused on the Governor’s fiscal plans—it expects next to turn to whether that plan will serve—or needs to be changed, with the oversight board trying to first understand the territory’s debt structure. At the session, Puerto Rico Treasury Secretary Juan Zaragoza provided a detailed description of revenues coming into the Puerto Rico Treasury—as well as what steps the government has been taking to more efficiently collect revenues; he testified there were about $1 billion worth of unpaid bills outstanding, and that the government had written about $350 million in checks but had not yet sent them. Board member Carlos M. García, former president of Puerto Rico’s Government Development Bank and founder and chief executive officer of BayBoston Managers LLC, a minority-owned private equity firm, questioned Gov. Padilla’s fundamental premise that Puerto Rico’s government lacked sufficient fiscal resources to govern, noting: “You’re currently at high tax collections, and you’re currently not paying debt service…Why does the government not have enough money to pay vendors or provide essential services?” In response, Gov. Padilla said that his fiscal plan called for Puerto Rico to

  • improve its financial reporting,
  • to merge branches of government to end duplication,
  • to ease certain regulations, and
  • to court investors, especially those interested in financing infrastructure and energy projects.

Gov. Padilla also told the Board that current efforts to collect more tax revenue and reduce government spending would continue; however, he pled with the board not to “double down on austerity: You will soon realize that any reduction in spending implies intolerable effects in aggregate demand, and will further throw Puerto Rico into a death spiral that will directly affect creditors’ recoveries across the board.” Absent federal assistance, the Governor warned, Puerto Rico could end up with a total accumulated debt of $59 billion over the next 10 years. In contrast, enhanced Medicaid and Medicare, as well federal tax changes to address discrimination against the territory compared to other Caribbean countries could help Puerto Rico become more competitive as an offshore manufacturing site for United States companies.

Seemingly unfocused upon, was the mismatch of fiscal capacity versus desperate human need: Puerto Rico, just 762 miles from Cuba, which has a population 3.5 times the population of Puerto Rico, currently has only 14 Zika cases—Puerto Rico has in excess of 25,955 confirmed Zika cases. It has 3.7 times the rate of unemployment; nearly six fold a murder rate, and nearly a 65 percent higher infant mortality rate—compared to Cuba’s 14 percent.  

Do You Recall or Remember at All? East Cleveland’s Mayor Gary Norton and City Council President Tom Wheeler will be on next month’s ballot, but to be recalled—not re-elected. The Cuyahoga County Board of Elections and East Cleveland City Council Clerk’s office on Friday certified more than 600 petition signatures to force a recall vote—a vote likely to be scheduled for December 6th—but which, for the virtually insolvent city, is projected to cost between $25,000 and $30,000; moreover, the election will come just 10 months before the next mayoral primary election and while the city is locked in merger negotiations with the city of Cleveland. The residents needed about 560 valid signatures to force a special recall election. The clerk sent Mayor Norton a letter late last Thursday informing him of the election: under the East Cleveland charter, if Mayor Norton does not resign by Wednesday, he will face a recall election within 60-90 days. Unsurprisingly, the Mayor does not plan to resign. In a phone interview Saturday he characterized the election as a waste of funds the nearly insolvent municipality can ill afford:  “East Cleveland will select its next mayor 10 months after this needless recall election…This is a horrible expenditure of funds given the city’s current financial provision, and beyond that, switching a single mayor or single councilman will have no impact on the city’s financial situation and the city’s economy.” Mayor Norton said the money the election will cost will have to be cut from other city services, pointing to possible cuts in police and fire: “There’s little to nothing left to cut in the city.” The election—if held—would be the third attempt at a recall. Indeed, an amendment to East Cleveland’s charter meant to limit the ease with which residents can trigger a recall is currently being reviewed by the board of elections: it has yet to be finalized and signed off on for the November ballot. Mayor Norton refused to say whether he was going to run for re-election next year, and declined to answer why voters should vote to keep him as mayor in December.

Not the Odor of Verbena. The appointment of a receiver to take charge of Petersburg’s utility funds could result in the city being declared in default on more than $12 million in bonds and other obligations. Petersburg has hired a law firm (Sands Anderson) to help it fight an order issued last week by Petersburg Circuit Court Judge Joseph M. Teefey Jr. appointing a special receiver to make sure residents’ wastewater payments are not used for other purposes: the Judge’s order was issued in response to a lawsuit filed by the South Central Wastewater Authority in which the regional sewage treatment agency alleged that Petersburg was more than $1 million behind on its payments for wastewater treatment. Last Friday, the city’s law firm requested a stay or vacate of the order, asserting “The ordering of receivership itself, without an immediate vacation, stay or discharge, automatically causes an event of default in a multitude of significant city bonds and other obligations,” including: $7.4 million in Water and Sewer Revenue Bonds issued through the Virginia Resource Authority (VRA); $3 million in Stormwater System Revenue Bonds; and $1.275 million in Recovery Zone Economic Development Bonds issued in a “pool” through the Stafford County Industrial Development Authority and the city of Staunton. (Petersburg’s contracts for all of those bonds include clauses which specify that the appointment of a receiver is automatically an “Event of Default,” according to the motion. The details of the city’s agreement with VRA make the appointment of a receiver especially problematic, according to the motion: “The city pledged all of its revenues from the city’s utility system to VRA as bondholder, providing a preferential lien to VRA on all such revenues…VRA has an existing lien on such revenues (and counsel to SCWWA acted as bond counsel to the city and VRA in such financing).” Under the agreement, according to the motion, “Payments that the city receives for the use of the wastewater and/or sewer utilities are used to make bond payments to VRA.” In addition, the city’s motion claims: “Because SCWWA does not possess a lien on the revenues and, at law, is a general unsecured creditor of the city, there is no legal justification for SCWWA to receive the preferential treatment that the receiver order provides to it.” In addition, the municipality’s motion asserts: “If the receivership is not vacated and the multitude of bond defaults described herein are triggered, it is expected that any short-term or long-term debt restructuring to facilitate…cash-flow relief for the city to meet its past-due and ongoing payment obligations will be extremely difficult to obtain.” In the filing, the city asserts that a receiver is not necessary, because Petersburg is not disputing the fact that it is behind on its payments to the wastewater authority: “The delayed payments are not the result of a dispute between the parties; the issue is simply one of the city needing to obtain the funding necessary to pay its debts, both to SCWWA and to other creditors. The city’s cash-flow problems are well known [to] the court, SCWWA and the public at large.”

For his part, Judge Teefey responded to the motion the day it was filed by declining to stay or vacate his previous order—instead setting a date for a hearing on the city’s motion: in his new order, Judge Teefey noted that his appointment of a receiver was issued as an emergency order, which meant that the appointment would automatically expire after 30 days unless SCWWA requested an extension, writing; “This court has not received plaintiff’s request to extend the special receiver appointment, but the court finds no harm to either party to place the defendant’s motion on the docket for a hearing,” as he set a hearing date for the last day of this month.

In an earlier order, Judge Teefey named a Richmond attorney as the receiver, at the request of the wastewater authority. , which had filed a lawsuit on Sept. 21st seeking such an appointment. South Central is a regional agency of which the cities of Colonial Heights and Petersburg and the counties of Chesterfield, Dinwiddie, and Prince George are members. It provides wastewater treatment for all five localities at its facility on Pocahontas Island in Petersburg: the authority’s lawsuit claimed that Petersburg officials were using residents’ utility payments to cover the city’s other costs instead of using them to reimburse the authority for its services. As the largest user of the authority’s services, the city also provides the largest share of its funds. The authority said Petersburg “has failed to pay for any wastewater services provided after May of 2016.” According to court documents, the authority claims the city was already falling behind on its payments as long ago as 2011. Not mentioned in the city’s court filing: A bond default would almost certainly result in another downgrade in Petersburg’s bond rating. Credit-rating agency Standard & Poor’s already cut its rating on the city’s debt by three notches in August, to BB from BBB, with a “negative outlook.” Petersburg’s previous BBB rating is the lowest rating considered “investment grade” by bond buyers, according to the American Association of Individual Investors. The new BB rating is “low grade” and “somewhat speculative,” according to the association. Anything lower would generally be considered “junk” status.

Tax Attacks? Atlantic City Mayor Don Guardian has warned New Jersey that a municipal tax hike would be “devastating,” writing in response to New Jersey Local Government Services Director Tim Cunningham, who had imposed a deadline of today for the city to submit a new budget—critical in his demand that the current proposed budget does not seek tax increases—and asks for too much state aid. In his response, the mayor wrote that city taxpayers had already been faced with a 50 percent tax increase over a two-year period, increases that “taxpayers should have had a decade to absorb…A tax-rate increase would have a devastating effect on the remaining residents and businesses of the city,” adding: “More importantly, it is not necessary.” Atlantic City introduced a $242 million budget in August—a budget down nearly 10 percent from FY2015, but one which assumed $106 million in state aid. The proposed budget counted on a $117 million tax levy, itself below last year’s $132 million—even though the municipal tax rate was constant, the city’s ratable base has continued to decline steeply from $20 billion in 2008 to about $6.6 billion today. (Atlantic City’s FY2016 estimated tax rate is $3.71 per $100 of assessed value, including municipal, county and school taxes.) For his part, Director Cunningham also criticized Atlantic City for requesting $37 million in state Transitional Aid, a figure which he called “far more than the Division has available to provide to the city or ever indicated that the city should expect to receive.” Director Cunningham noted he had responded to the city’s introduced budget in late August “outlining fundamental concerns,” but that, however, he had yet to receive a response. In addition to submitting an FY2016 budget, Atlantic City has until the first week of next month to draft a five-year fiscal-recovery plan if it is to avoid a state takeover.

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