The Complex Challenges of Implementing a Municipal Bankruptcy Plan of Debt Adjustment

July 31, 2018

Good Morning! In this morning’s eBlog, we consider post-chapter 9 municipal bankruptcy challenges for the City of Detroit, before turning to learn about good gnus from Puerto Rico.

The Steep Route of Chapter 9 Debt Adjustment. Direct Construction Services, minority-owned firm, which has participated in Detroit’s federally funded demolition program, is suing Mayor Mike Duggan, the city’s land bank, and Detroit’s building authority as well as high-ranking officials from each division—alleging racial discrimination and retaliation. The suit asks the court to award damages and declare the actions of the city, its land bank and building authority as “discriminatory and illegal.” The suit alleges that some contractors had been asked to change bidding and cost figures “to reflect compliance” under the federal demolition Hardest Hit Fund guidelines. Filed in federal court, it charges that Service’s managing member, Timothy Drakeford, was treated unfairly based on his race and that officials in the program conspired to have him suspended for refusing to falsify documents and for cooperating with federal authorities. Mr. Drakeford, who is barred from bidding on federally funded demolition work, is also suing for breach of contract and discrimination against black contractors. The suit charges that some contractors, including Mr. Drakeford, had been asked to change bidding and cost numbers “to reflect compliance” under the federal Hardest Hit Fund guidelines; indeed, the suit alleges it was subsequently suspended—not because of the quality of its work, but rather “because of the refusal to change numbers in bid packages.” The suit adds: “This case arises because of defendants’ breach of contract, concert of action, due process violations, and discrimination on the grounds of race in its implementation of the Hardest Hit Homeowner demolition program, including failure to timely pay black contractors in comparison to their white counterparts, improper and disparate discipline and retaliation.”

This issues here are not new—and have previously been the focus of FBI, state, and city investigations, especially over bidding practices and rising costs. As we have previously noted, the city’s plan of debt adjustment efforts to raze abandoned homes was a particular focus—a program through which federal assistance was misappropriated while the city worked to demolish homes after its bankruptcy—in that case involving federal funds allocated via the Michigan State Housing Development Authority. The suit contends that Direct Construction was awarded three contracts for demolition work by the land bank, and asserts that payments were delayed and harder to obtain from the land bank than for “larger white companies,” such as Adamo and Homrich, two firms awarded the largest percentage of the work to date. The suit asserts Direct Construction was under contract for several demolition packages, but still has not been paid, and references in excess of $143,000 in unpaid invoices, noting: This “repetitive process has gone on for over a year now, with no success,” contending that it had been performing work on two contracts which it had been awarded for a total of 48 homes—before, on December 19, 2016, being hit with an “immediate stop work order” from the land bank, without explanation. A year ago in February, Direct received a letter regarding an Office of Inspector General report, which suggested that photographs submitted for repayment of sidewalk work had been falsified and that the company would not be compensated—a letter followed up the next month by a notice of suspension. (Direct was among a few businesses suspended last year on claims of manipulating sidewalk repair photographs to obtain payment.)

Detroit Corporation Counsel Lawrence Garcia yesterday noted: “The Office of Inspector General found that not only did Mr. Drakeford personally manipulate a photo of a demolition site to conceal tires that had not been removed from the lot, but also gave information that was not truthful to the OIG’s investigators. For the penalties issued with respect to these matters, the Detroit Land Bank, the DBA and the city followed the recommendations of the independently appointed inspector general…These facts more than justify the city’s actions.” Indeed, that office, at the request of the land bank, had initiated investigations in December of 2016 into allegations that sidewalk repair photographs were being doctored. (The land bank mandates that its contractors to take “before and after” photographs of sidewalks, drive approaches, neighboring residences, and surrounding areas to document conditions.) The Office, the following February, flagged Direct Construction over five of its submitted photographs, concluding the photos had been modified to disguise incomplete work; it recommended the company be barred from doing work in the city’s demolition program until at least 2020. (The Michigan State Housing Development Authority began placing greater emphasis on sidewalk replacement photographs in October of 2016, when a new set of practices went into place—at a point in time when federally funded demolition had been suspended for two months after a review by the Michigan Homeowner Assistance Nonprofit Housing Corp.).

Since Mayor Duggan’s election in 2013, the city has razed nearly 13,000 homes—a task that has fiscal and physical consequences—reducing assessed property values and property taxes, but also leaving medical scars: over that time, the percentage of children 6 and younger with elevated lead levels rose from 6.9% in 2012 to 8.7% in 2016, according to state records. Early last year, the land bank repaid $1.37 million to address improper expenses identified by auditors for the state. The land bank last summer reached a settlement with state housing officials to pay $5 million to resolve a dispute over invoices the state determined to be improperly submitted. Detroit’s administration has claimed the city has been transparent with its demolition program and cooperated fully with all inquiries.

Good Gnus. In Puerto Rico, Governor Ricardo Rosselló Nevares and the Labor Secretary Carlos Saavedra are celebrating a turnaround in employment in the U.S. territory: between May and June, some 11,000 people joined the island’s labor market, dropping Puerto Rico’s unemployment rate to its lowest level in half a century. Gov. Rosselló Nevares yesterday reported the unemployment rate to be 9.3%, the lowest rate in the last 50 years, noting: “On this occasion, unemployment drops and the participation rate increases are all numbers going in the right direction.” Sec. Saavedra explained the increase between May and June reflects summer employment programs, but at a level considerably better than in previous years, especially in the commercial and self-employment sectors—and, as he noted: “We have seen a substantial increase in self-employment,” apparently reflecting many involved with repairs and reconstruction for damage caused by Hurricane María, especially electricians, and builders. Economist Juan Lara explained that jurisdictions which have suffered deep economic declines as a result of a natural disaster experience a period of rebound that leads to growth, but cautioned: “[T]his can hardly be maintained in the long-term without a change in the economic model.” He estimated that in the next five or six years, federal investments could keep the economy in positive territory, noting: “The important thing is to remember that these funds do not last forever and that the economy needs sustained redevelopment.”

For his part, Gov. Rosselló stressed that the current economic improvement is occurring without the federal government having released a penny of the more than $1.8 billion in promised HUD assistance. Nevertheless, there can be little question but that the more than $3 billion in insurance claims already paid, according to according to Iraelia Pernas, the Executive Director of the Puerto Rico Insurance Companies Association have had a positive, if one-time, impact. Similarly, the island is anticipating, in August, a large CDBG grant.

Gov. Rosselló Nevares attributed the jobs upturn, interestingly, to emigration: many who were unemployed left Puerto Rico for the mainland, even as he reported the total number of citizens employed has increased, as well as the labor participation rate (not seasonally adjusted), which rose from 40.5% in May to 41.1% last month. percent in June. In the first months following Hurricane María, nearly 200,000 people left Puerto Rico. Many, however, have returned.

Informacion Mejor? PROMESA Oversight Board Executive Director Natalie Jaresko has reported the Board “welcomes the publication” of fiscal information mandated by the Board, after, on July 10th, the Board had sent a letter to FAFAA Executive Director Gerardo Portela Franco, complaining of a failure to submit documents, including documents comparing the General Fund budget to actual spending; PayGo balances; and public employee payroll, headcount, and attendance. The board said that, according to the approved quasi-plan of debt adjustment, the first two documents had been due on May 31st, and the third on June 30th. FAFAA released the PayGo report on July 17, and the other two reports last Friday.  Ms. Jaresko wrote: “The Oversight Board welcomes the publication of the General Fund to Actual Report, the Human Resources Report and the Payroll Report: Full monthly public reporting is essential to increase transparency of government finances, increase accountability, and monitor compliance and progress as per the fiscal plan and budget objectives in order to eliminate Puerto Rico’s structural deficits…The Oversight Board is committed to continuing this important work of monitoring full compliance by the government with reporting requirements, in order to achieve PROMESA’s mandate of restoring fiscal responsibility and market access to Puerto Rico.”

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A Valentine’s Day Message?

St. Valentine’s Day, 2018

Good Morning! In today’s Blog, we consider the continued scrutiny by the PROMESA Board and Puerto Rico’s progress in not just recovering from Hurricane Maria—but also from its quasi chapter 9 municipal bankruptcy. That progress has been achieved through federal assistance, the Board’s vigorous oversight, and, as we note, tax and spending changes undertaken by the government of Puerto Rico.  

Fiscal Imbalances.  While states, cities, and counties operate in regular order, the federal shutdown, far into the federal fiscal year, illustrated the challenge to state and local governments of the unpredictability of federal funding that state and local governments would otherwise count upon. Now, in the wake of Congress’ vote to suspend the national debt ceiling, the package included nearly $100 billion in disaster aid, as well as extend a number of expired tax provisions, including a Jan. 1, 2022 extension of the rum cover-over for Puerto Rico and the U.S. Virgin Islands—an extension projected to generate an estimated $900 million for the two U.S. territories, as well as a related tax provision which would, at long last, allow low-income Puerto Rican muncipios to be treated as qualified opportunity zones: that disaster aid includes $4.9 billion to provide 100% federal funding for Medicaid health services for low-income residents of Puerto Rico and U.S. Virgin Islands for two years and $11 billion of Community Development Block Grants for the two territories, including $2 billion of CDBG money to rebuild Puerto Rico’s electrical grid. Puerto Rico anticipates it will be the recipient of as much as $18 billion—with an option to access a line of credit of as much as $4 billion—albeit, to the extent the territory can continue to demonstrate its lack of liquidity. Those amounts, including $4.8 billion in Medicaid, and $11 billion from HUD, however, are subject to conditions of both the federal government and the PROMESA Board. HUD Deputy Secretary Pamela Hughes Patenaude last week stated HUD would award $1.5 billion to assist in the repair of damaged homes and business structure, while FEMA has already awarded $300 million, half of which is via a loan. In addition, the aid includes $14 million in the Women, Infants & Children (WIC) program assistance. The package provides some $14 million for the Army Corps of Engineers to award contracts to U.S. electric companies to repair the power grid. Importantly, the FEMA funding will provide not just for improvements in the island’s public power system, but also for repairs: Puerto Rico has guestimated it will require $ 94.4 billion to rebuild the island’s public infrastructure.

Puerto Rico’s non-voting Representative in Congress, Jenniffer González, noted the next disaster relief resolution may be discussed in Congress later this Spring—at which point she anticipates the critical focus Will be on Puerto Rico and the U.S. Virgin Islands. She noted: “Speaker Paul Ryan told me that there is going to be a fourth bill on supplementary allocations for Puerto Rico with specific projects for transportation and electric power.” U.S. Senator Marco Rubio (R-Fla.) noted that claims of states such as Florida and Texas were very helpful in recent efforts in favor of funds for Puerto Rico; however, he warned that Congress needs to allocate additional funds for disasters regularly: “There are other places that, by then, will have needs.”

Negocios. Meanwhile, with regard to the fiscal storm, the fiscal amendments Governor Ricardo Rosselló presented to the PROMESA this week presented a more positive outlook for creditors to reach an accumulated surplus of $3,400 million, even as his offer retained virtually unchanged the terms of fiscal measures and severe cuts in government revenues over the next 5 fiscal years. The plan the Governor presented, moreover, did not comply with the requirements to reduce the pensions of government retirees, nor to eliminate additional labor protections for private sector workers, after the notification of violation of the federal PROMESA law—demands calling for a series of amendments, including a 25% reduction in pensions exceeding $1,000 per month (in combination with social insurance), in addition to the elimination of a series of protections for private sector employees. Indeed, in an interview with El Vocero, Gov. Rosselló replied that his administration is neither contemplating reductions to pensions nor including legislation to eliminate the employer’s obligation to pay the Christmas bonus and compensation for unjustified dismissal or to reduce the requirements for vacation leave and sick leave, stating: “We are not contemplating reductions in pensions.” As for eliminating labor protections, the Governor made clear: “We have not included that in the reform of human capital… certainly, it is an area that is important for us to work: how do we raise labor participation in Puerto Rico? How do we encourage them to transition to work? “

The most dramatic modification of the tax plan proposed by Gov. Rossello is the elimination of the aggregate deficit of $3,400 million for the FY2022 budget, since the previous version of its fiscal plan was in default with the objective of eliminating structural deficits: as early as FY2019, he projects the government will achieve a surplus of $750 million, thanks in large part, according to the Governor, to the federal assistance provided by Congress. Even though it had been estimated that the aid to date has reached $16.5 million, Puerto Rican authorities assert only $12,800 million has been incorporated as a result of supplementary allocations in the fiscal plan—allocations related to the FEMA $ 35.3 billion in the public assistance program and $21 billion in private insurance. The Governor noted his administration plans to spend $13 million of disaster recovery funds for Hurricane Maria, enabling, he added, a GDP growth projection of 8.4%. He also noted he expects a reduction in the rate of emigration from Puerto Rico down to 2.4%.

Unsurprisingly, he warned, the most difficult challenge will be what he termed the FY2020 Medicaid fiscal cliff –the year when the current Congressional appropriated funds will be exhausted. To address that abyss, he said the government has intensified cuts to government programs, as well as adopted measures to increase revenues, resulting, he asserted, in a positive or surplus balance of $800 million for FY 2023, noting: “Stabilization (the surplus) continues with other structural measures and impacts that have: the reduction in expenditures by government items and the rightsizing (shrinking) that is being done.” It appears that the $800 million projected surplus was included in the analysis of the sustainability of the public debt, an element which will be considered by the PROMESA quasi-bankruptcy court for the payment arrangement to the creditors—or, as he put it: “The discussion with the creditors will go by Title III, in everything that has not been agreed by Title VI. It is a numerical exercise, without differentiating creditors, about the numbers that reflect the fiscal plan, and that will certainly be part of the elements of judgment…that the judge would use in her determinations.”

The Governor noted that cuts to agencies such as Education, Corrections, Health, as well as across the board via shrinking services and utilizing tighter payroll control have succeeded in increasing revenues by $29 million; nevertheless, he added, because the new revenues failed to meet the anticipated goals, the agency, Mi Salud, will continue to be required to face an FY2022 reduction of some $795.

Fiscal & Physical Imbalances

Lincoln’s Birthday, February 12, 2018

Good Morning! In today’s Blog, we consider the outcome of last week’s actions to avoid another federal government shutdown, we consider the ongoing fiscal and physical plights of Puerto Rico.

Fiscal & Physical Imbalances.  Puerto Rico’s non-voting Member of Congress, Jenniffer Gonzalez, and Gov. Ricardo Rosselló have met with a group of New Progressive Mayors to describe the terms of the new federal assistance under the just passed $16 billion recovery assistance approved by Congress—funds ranging from what Secretary of Public Affairs Ramón Rosario Cortés noted would “range from construction to agriculture programs that will allow each municipality to develop its economy and create jobs.” The Secretary anticipates there will be a second meeting with associate mayors. Naguabo Mayor Noé Marcano said that the allocation of these funds represents “a unique opportunity” to repair and/or build infrastructure projects (including roads and bridges) and housing: “Part of the projects that we-at a given moment-had planned as improvements to the municipalities, we understand that this is the best opportunity.”

That could mean a new fiscal chance for this small muncipio of just over 23,000, one founded on July 15, 1821 near the mouth of the Daguao River—founded with the intent of providing a defense for the region from the Caribe Indians, based upon, 27 years earlier, the request of several influential neighbors of the Spanish Crown: on January 9, 1798, the erection of the Naguabo parish was authorized—but construction did not commence on its church until 1841. The muncipio’s name originated from the cacique and chieftainship named Daguao—as the territory was originally populated by Taíno Indians. Naguabo is also known as Cuna de Grandes Artistas (the birthplace of Great Artists) and Los Enchumbaos, “the Soaked Ones.”

For his part, Mayor William Aliceo of Aibonito, the City of Flowers, with the city’s appellation derived from the Taíno word “Jatibonicu,” the name of a Cacique leader of the region; a name also used to refer to a river in the area—and, in addition, a name used by the tribe of Orocobix. At the same time, there is a legend that tells of a Spanish soldier, Diego Alvarez, who, on May 17, 1615, reached one of the highest peaks in the area: upon taking in the view, he exclaimed: “Ay, que bonito!” The exclamation eventually led to the name of the region. Nearly two centuries later, Pedro Zorascoechea, in 1630, was one of the early Spaniards to settle on the island—apparently establishing one of the first fincas or ranches in the region; however, it was not until 1822, when Don Manuel Veléz presented himself before the government, representing the inhabitants of the area, to request that Aibonito be officially declared a town—a request which then Governor Miguel de la Torre granted on March 13, 1824.

Hurricane Maria’s eye tore through the region’s hills on September 20th: it was especially fierce along the exposed ridgelines, whipping in at a hundred and fifty-five miles an hour: it tore apart wooden houses; along the road leading up to Aibonito from San Juan, normally a two-hour drive, Maria tore a panorama of ruined houses and businesses, toppled and twisted trees, and downed utility poles. Mayor Aliceo said he would like to use part of the recovery funds for agriculture, roads, and electrical infrastructure: “In Aibonito, we have a project submitted to the U.S. Army Corps of Engineers for the canalization of the Aibonito River. And with poultry farming, which was well affected by Hurricane Maria, I’m interested (the funds) will find a way to help Aibonito’s poultry farmers, given the million-dollar losses they’ve had.”

The federal allocation came just prior to Puerto Rico’s resubmission of its revised fiscal plans to the PROMESA oversight Board—plans due today, with Puerto Rico’s representative, Christian Sobrino, simply advising the board that the plans comply with the public policy of the government, noting: “[W]e will comply with the stipulated date for the delivery of the fiscal plans. It has been an intense job, but the government will comply with the appointed time. The plans will continue in accordance with the Governor’s public policy of protecting the most vulnerable and that this document serves as a tool of fiscal responsibility and at the same time a path of long-term socio-economic development for the island.”

Nevertheless, uncertainty reigns, especially in the wake of the federal government shutdown. With last week’s Congressional approval of a package to keeps federal agencies running through March 23rd, the date of certainty has now been pushed off while House and Senate appropriators in Washington, D.C. work on final 2018 spending bills. The package suspends the debt ceiling through March 1, 2019, provides $89.3 billion in disaster aid, and extends a number of expired tax provisions, including a Jan. 1, 2022 extension of the rum cover-over for Puerto Rico and the U.S. Virgin Islands, which is projected to generate an estimated $900 million for the two U.S. territories. In addition, a related tax provision calls for all low-income communities in Puerto Rico to be treated as qualified opportunity zones. The disaster aid includes $4.9 billion to provide 100% federal funding for Medicaid health services for low-income residents of Puerto Rico and  the U.S. Virgin Islands for two years, $11 billion in CDBG block grants for the two territories, including $2 billion of CDBG money to rebuild Puerto Rico’s electrical grid—with Resident Commissioner Gonzalez reporting that, in total, $16.55 billion of the disaster aid is earmarked for Puerto Rico.

With the new allocations to mitigate last year’s natural disasters, the federal government has already authorized just over $140.7 billion within the past six months to be distributed mainly between Texas, Florida, California, Puerto Rico, and the US Virgin Islands—with Puerto Rico’s government projecting its share will be approximately $18 billion, plus access to a credit line of $4 billion—albeit, to access that line, the U.S. territory would be mandated to prove lack of liquidity. Of the total, almost $16 billion will surely go to the island from the funds allocated in the budget bill and to mitigate disasters—provided the territory complies with the conditions of both the federal government and the PROMESA Oversight Board. The projected package includes $4.8 billion for Medicaid and $11 billion for CDBG: last week, HUD Deputy Secretary Pamela Hughes Patenaude announced, during a visit to San Juan, that HUD will award $1.5 billion to help repair damaged houses and businesses. In addition, another $ 300 million, half of which would be allocated as a loan, has been allocated to match the FEMA project’s cost. The package includes $6 billion, funds under the U.S. Army Corps of Engineers, provided to U.S. electric companies to repair the power grid. FEMA has stated, moreover, its intent to grant an additional $13 billion to the island.

Puerto Rico’s Federal Affairs Executive Director, Carlos Mercador, notes that an official damage estimate from federal agencies is still pending; Commissioner González notes that Congress’ next disasters relief resolution may be discussed in Congress between April and May, noting: “Speaker Paul Ryan told me that there is going to be a fourth bill on supplementary allocations for Puerto Rico, with specific projects for transportation and electric power.”