Is There a “Right” Structure to Resolve Fiscal Insolvency?

06/19/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing challenges to restoring fiscal solvency in the U.S. territory of Puerto Rico, so that chapter 9 does not apply—nor does that process provide a mechanism to address the territory’s municipalities, much less the existing federal discrimination against Puerto Rico vis-à-vis other Caribbean nations The challenge, if anything, has been heightened by the absence of mixed messages from Congress-where the PROMESA Oversight Board has sent a letter to Puerto Rico’s leaders warning of what the Board described as a waning resolve to deal with a dire financial situation.

Trying to Shock? House Natural Resources Committee Chairman Rob Bishop R-Utah) has notified PROMESA’s oversight board that its failure to approve the Puerto Rico Electric Power Authority’s restructuring support agreement is seen as “very problematic” by some federal legislators: “It appears there is no consensus from the oversight board in favor of certifying the PREPA [RSA] under…PROMESA…This is troubling, as the decision to implement the RSA had already been made by Congress with the passage of PROMESA. The oversight board’s dilatory tactics run counter to the plain language of PROMESA.” At the same time, PROMESA Board Chair José Carrión III stated that Puerto Rico needs to create implementation plans to reduce government spending and ensure adequate liquidity—writing last  Friday at a key time as the Puerto Rico legislature worked to try to reach consensus on a balanced FY2018 budget, in compliance with a board-approved 10-year fiscal plan. Chairman Carrión wrote: “I write to you out of a concern that some of the progress we appeared to have made in the past few weeks as a result of the close and positive collaboration between the board and the administration–and their respective teams of advisors–may be receding and that the necessary resolve to attain the goals set forth in the certified fiscal plan may be waning…It is equally of concern that some of the narrative taking hold in the public discourse fails to characterize adequately the truly dire fiscal situation the Commonwealth is facing.”  Chairman Carrión, in his epistle to Gov. Ricardo Rosselló, Senate President Thomas Rivera Schatz, and House of Representatives Speaker Carlos Méndez Núñez, noted it was an incorrect “narrative” for Puerto Rico’s government to say that if the government generates $200 million in additional cash reserves by June 30th, the PROMESA Board would not mandate a government furlough program and reduction or elimination of the Christmas bonus; rather, to avoid these measures, the Board is mandating a spending-reduction implementation plan in addition to the cash reserve intended to ensure ongoing liquidity—with Chairman Carrión warning that if the plan is inadequate or poorly executed, “Puerto Rico is all but certain to run out of money to fund the central government’s payroll come November or December of this year.” The PROMESA Board also called on Governor Rosselló to explain which public services are essential.

The stern warning—to a government where some of the most essential services are lacking—produced a response from Governor Rosselló’s non-voting representative to the PROMESA Board, Elías Sánchez Sifonte: “This administration has demonstrated an unwavering commitment to face this inherited crisis with the seriousness it deserves,” adding that: “We have also been demonstrating implementation plans to ensure we provide resources to cover essential services as required by PROMESA and in accordance with our Certified Tax Plan,” including progress in the Puerto Rico legislature on the budget proposed by the Governor based upon consultation with the PROMESA Board—a budget the Puerto Rican Senate expects to consider later this week.

The discussions came as U.S. District Judge Laura Taylor Swain, who is overseeing Puerto Rico’s Title III municipal bankruptcy process, taking a page from Detroit’s chapter 9 bankruptcy, named U. S. District Court Judges, including the remarkable Judge Christopher Klein, who presided over Stockton’s municipal bankruptcy trial, to help address critical issues. She also named Judge Barbara Houser of the U.S. Bankruptcy Court of the Northern District of Texas, designating her to lead the mediation team; Judge Thomas Ambro, of the U.S. Court of Appeals for the 3rd Circuit; U.S. District Court Judge Nancy Atlas of U.S. District Court for the Southern District of Texas; and Judge Victor Marrero of U.S. District Court for the Southern District of New York. Judge Swain made clear that participation in any mediation will be voluntary and confidential—and that she will not participate in mediation sessions, and mediators will not disclose information about the parties’ positions or the substance of the mediation process to her—with this process—as was the case in Stockton and Detroit’s chapter 9 cases—ongoing concurrently with trial in her courtroom. Judge Swain added that she plans to make final appointments prior to the June 28th Title III hearing in San Juan, where she will further explain the mediation process.

Who’s in Charge? The PROMESA Oversight Board has warned Puerto Rico’s leaders that the Board is apprehensive of a waning resolve to address the U.S. territory’s dire fiscal situation, with Chairman José Carrión III warning that Puerto Rico needs to create implementation plans for reducing government spending and assuring adequate liquidity at all times. The letter—coming between the emerging quasi-bankruptcy proceedings under Judge Taylor and as the Puerto Rico legislature is attempting to put together a balanced FY2018 budget, in compliance with a board-approved 10-year fiscal plan—came as PROMESA Board Chair José Carrión III urged greater resolve, writing: “I write to you out of a concern that some of the progress we appeared to have made in the past few weeks as a result of the close and positive collaboration between the Board and the administration–and their respective teams of advisors–may be receding and that the necessary resolve to attain the goals set forth in the certified fiscal plan may be waning…It is equally of concern that some of the narrative taking hold in the public discourse fails to characterize adequately the truly dire fiscal situation the Commonwealth is facing.” Chairman Carrión, in his epistle to Gov. Ricardo Rosselló, Senate President Thomas Rivera Schatz, and House of Representatives Speaker Carlos Méndez Núñez, added that there is an incorrect “narrative” that says that if the Puerto Rican government generates $200 million in additional cash reserves by the end of this month, the PROMESA Board would not mandate a government furlough program, nor a cut or elimination of the Christmas bonus. To avoid such a mandate, he added that the PROMESA Board is mandating a spending-reduction implementation plan in addition to a cash reserve plan intended to assure government liquidity, with the Chairman adding that if the plan is inadequate or poorly executed, “Puerto Rico is all but certain to run out of money to fund the central government’s payroll come November or December of this year.” Noting that: “Now we are at a critical juncture that requires that we collectively strengthen…,” the Board demanded that Gov. Rosselló explain which public services are essential.

Does Accountability Work Both Ways? Unlike chapter 9 bankruptcy cases in Detroit, San Bernardino, Central Falls, Jefferson County, and Stockton—Puerto Rico is unique in that the issue here does not involve municipalities, but rather a quasi-state. There have been no public hearings. PROMESA Chair José B. Carrion has not testified before the legislature. Now Puerto Rico Rep. Luis Raúl Torres has asked the Puerto Rico Finance Committee to invite Chair Carrión to appear to explain to Puerto Rico’s elected leaders the demands the PROMESA Board is seeking to mandate—and to justify the $60 million that the Fiscal Supervision Board is scheduled to receive as part of the resolution of special assignments. That Board, headed by Natalie Jaresko, the former Finance Minister of the Ukraine, is, according to PROMESA Chair Jose Carrión, to be in charge of the implementation of the plan, or, failing that, to achieve the fiscal balance of Puerto Rico and its return to the capital markets. (Ms. Jaresko has agreed to work for a four-year term: she is expected to earn an annual salary of $ 625,000 without additional compensation or bonuses, except for reimbursement of travel and accommodation expenses related to the position he will hold, according to PROMESA Board Chair Carrión, who has previously noted: “I know it’s going to be a controversial issue…We have a world-class problem, and we have a world-class person. This is what the rooms cost.”)

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A Hole in Puerto Rico’s Fiscal Safety Net: Should Congress Amend Chapter 9 Municipal Bankruptcy?

eBlog

Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy—but we especially focus on the fiscal plight of the territory’s many, many municipalities—or muncipios, which, because Puerto Rico is not a state, do not have access to chapter 9 municipal bankruptcy .   

Tropical Fiscal Typhoon. When former President Ronald Reagan signed Public Law 100-597, legislation authorizing municipal into law 29 years ago, no one was contemplating a U.S. territory, such as Puerto Rico—so that the federal statute, in coherence and compliance with the concepts of dual sovereignty, which served as the unique foundation of the nation, provided that a city, county, or other municipality could only file for chapter 9 if authorized by state law—something a majority of states have not authorized. Unsurprisingly, none of us contemplated or thought about U.S. territories, such as Puerto Rico, Guam, etc.: Puerto Rico is to be considered a state for purposes of the bankruptcy code, except that, unlike a state, it may not authorize its municipalities (and by extension, its utilities) to resolve debts under Chapter 9 of the code. Ergo, no municipio in Puerto Rico has access to a U.S. bankruptcy court, even as 36 of the island’s 78 muncipios have negative budget balances; 46% are experiencing fiscal distress. Their combined total debt is $3.8 billion. In total, the combined debt borne by Puerto Rico’s municipalities is about 5.5% of Puerto Rico’s outstanding debt.  

The fiscal plight of Puerto Rico’s municipalities has also been affected by the territory’s dismal fiscal condition: From 2000 to 2010, the population of Puerto Rico decreased, the first such decrease in census history for Puerto Rico, declining by 2.2%; but that seemingly small percentage obscures a harsher reality: it is the young and talented who are emigrating to Miami, New York City, and other parts on the mainland, leaving behind a declining and aging population—e.g. a population less able to pay taxes, but far more dependent on governmental assistance. At the same time, Puerto Rico’s investment in its human infrastructure has contributed to the economy’s decline: especially the disinvestment in its human infrastructure: a public teacher’s base salary starts at $24,000—even as the salary for a legislative advisor for Puerto Rico starts at $74,000. That is, if Puerto Rico’s youngest generation is to be its foundation for its future—and if its leaders are critical to local fiscal and governing leadership in a quasi-state where 36 of the island’s 78 municipalities, or just under half, are in fiscal distress—but, combined, have outstanding debt of about $3.8 billion; something will have to give. These municipalities, moreover, unlike Detroit, or San Bernardino, or Central Falls, have no recourse to municipal bankruptcy: they are in a fiscal Twilight Zone. (Puerto Rico has a negative real growth rate; per capita income in 2010 was estimated at $16,300; 46.1% of the territory’s population is in poverty, according to the most recent 2106 estimate; but that poverty is harsher outside of San Juan.) A declining and aging population adversely affects economic output—indeed, as former Detroit Emergency Manager Kevyn Orr who steered the city out of the largest municipal bankruptcy in U.S. history recognized, the key to its plan of debt adjustment was restoring its economic viability.

U.S. Supreme Court Justice Sonia Sotomayor, who is of Puerto Rican descent, has indicated there should be a more favorable interpretation of the law to make the system fairer to Puerto Rico: to allow the Commonwealth of Puerto Rico to create its own emergency municipal bankruptcy measures—something, however, which only Congress and the Trump administration could facilitate. It seems clear that Justice Sotomayor does believe Puerto Rico ought to be considered the equivalent of a state, i.e. empowered to create its own bankruptcy laws. However, as the First Circuit Court of Appeals has interpreted, Puerto Rico is barred from enacting its own bankruptcy laws: it is treated as a state—in a country of dual federalism wherein the federal government, consequently, has no authority to authorize state access to bankruptcy protection.

Puerto Rico & Municipal Bankruptcy: a process of pain where “failure is not an option.”

eBlog

Good Morning! In this a.m.’s eBlog, we consider the opening under U.S. Judge Laura Swain of the unique, quasi chapter 9 municipal bankruptcy process which opened this week in Puerto Rico, where Judge Swain noted the process “will certainly involve pain,” but that “failure is not an option.”

Getting Ready to Rumble. Judge Swain has combined two major PROMESA Title III filings made earlier this month by Puerto Rican authorities—one for its general obligation debt, and one for debt which is backed by the Puerto Rico’s Commonwealth or COFINA sales tax revenues. Reuters helps explain, writing: “The island’s initial bankruptcy filing on [May 3] included only its central government, which owes some $18 billion in general obligation, or GO debt, backed by its constitution…The COFINA filing [on May 5] will pull in another $17 billion or so in debt under the Title III umbrella. Overall the island’s government and various agencies have a debt load of $74 billion that they cannot repay.” Unsurprisingly, as Bloomberg notes, a sizeable separation between general obligation and COFINA bondholders has already emerged. Judge Swain’s early decision to merge the two filings for administrative purposes appears to denote a small victory for the PROMESA Board, as some COFINA stakeholders had objected (COFINA bondholders were the first to sue the government of Puerto Rico after the freeze on creditor litigation under PROMESA expired at Midnight May 1st.) They accuse Puerto Rico, Governor Ricardo Rossello and other officials of angling to repurpose the tax revenue earmarked to pay COFINA debt.: they argued that COFINA is a separate entity whose assets, in the form of sales tax revenue, are earmarked only for creditors.” The debt here dwarfs any we have seen in Detroit, San Bernardino, etc.: Puerto Rico, according to the PROMESA Board, cannot even meet 25% of its $900 million necessary to service its municipal debt. And, in some sense, that debt—owed to investors in the 50 states, pales compared to the human obligations at home: NPR’s Greg Allen describes: “retirees who are owed pensions; 180 closed public schools, $500 million in cuts proposed for the university here…So lots of pain to come here—and the governor is going to be releasing a budget later this month, which will show a lot more pain coming. Among the things that are going to happen is, I think, big cuts in health care benefits.” He estimated the trial could exceed the duration of Detroit’s chapter 9, taking as many as five years to conclude. Judge Swain will—as Judge Rhodes had to in Detroit, and as was the very hard case in Central Falls, Rhode Island’s municipal bankruptcy‒Puerto Rico’s $49 billion in government pension obligations. But Puerto Rico’s debt is not just fiscal: the island has a poverty rate of 45%–a level dwarfing what we have experienced in previous chapter 9 bankruptcies. The current case may not affect all of these because some are for the employees of semi-autonomous Puerto Rico entities like the Puerto Rico Electric Power Authority. And, the trial here dwarfs the previous largest U.S. municipal bankruptcy in Detroit, where the stakes involved $18 billion in debt, pension obligations, and other OPEB benefits. The pension obligations have been described as liabilities of as much as $45 billion. On the trial’s first day, Judge Swain heard presentations with regard to whether the case should include mediation—and, if so, which parties should be included: that is, she will have a Solomon-like set of choices, choosing between Puerto’s Rico’s citizens, its municipal bondholders, suppliers owed money, pensioners, and government employees. Judge Swain will also hear presentations with regard to whether—and when‒Puerto Rico should be required to submit lists of its creditors and in what manner and how notice to creditors will be made. The PROMESA Oversight Board attorney Martin Bienenstock said he anticipates other Puerto Rico public entities, including the Highways and Transportation Authority, would soon file for Title III later. The considerations in the court will also have to address how some $800 million set aside in Puerto Rico’s certified 10-year fiscal recovery plan will be apportioned between competing claims–including those of constitutionally backed general obligation debt (GO) and sales-tax backed or COFINA bonds.

Solomon’s Choices: Who Will Define Puerto Rico’s Fiscal Future–and How?

eBlog

Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy. 

Tropical Fiscal Typhoon. U.S. Supreme Court Chief Justice John Roberts has selected Southern District of New York Judge Laura Taylor Swain, who previously served as a federal bankruptcy Judge for the Eastern District of New York from 1996 until 2000 to preside over Puerto Rico’s PROMESA Title III bankruptcy proceedings—presiding, thus, over a municipal bankruptcy nearly 500% larger than that of Detroit’s–one which will grapple with creating a human and fiscal blueprint for the future of some 3.5 million Americans—and force Judge Swain to grapple with the battle between the citizens of the country and the holders of its debt spread throughout the U.S. (Title III of PROMESA, which is modeled after Chapter 9 of the Municipal Bankruptcy Code and nearly a century of legal precedent, provides a framework for protecting Puerto Rico’s citizens while also respecting the legitimate rights and priorities of creditors.) For example, the recent Chapter 9 restructuring in Detroit sought reasonable accommodations for vulnerable pensioners and respected secured creditors’ rights.

The action came in the wake of Puerto Rico’s announcement last week that it was restructuring a portion of its nearly $73 billion in debt—an action which it was clear almost from the get-go that the requisite two-thirds majority of Puerto Rico’s municipal bondholders would not have supported. (Puerto Rico’s constitution provides that payments to holders of so-called “general obligation” bonds have priority over all other expenditures—even as another group of creditors has first access to revenues from the territory’s sales tax.) More critically, Judge Swain will be presiding over a process affecting the lives and futures of some 3.5 million Americans—nearly 500% greater than the population of Detroit. And while the poverty rate in Detroit was 40%, the surrounding region, especially after the federal bailout of the auto industry, differs signally from Puerto Rico, where the poverty rate is 46.1%–and where there is no surrounding state to address or help finance schools, health care, etc. Indeed, Puerto Rico, in its efforts to address its debt, has cut its health care and public transportation fiscal support; closed schools; and increased sales taxes. With the Bureau of Labor Statistics reporting an unemployment rate of at 12.2%, and, in the wake of last year’s Zika virus, when thousands of workers who were fighting the epidemic were let go from their jobs; the U.S. territory’s fiscal conditions have been exacerbated by the emigration of some of its most able talent—or, as the Pew Research Center has noted:  “More recent Puerto Rican arrivals from the island are also less well off than earlier migrants, with lower household incomes and a greater likelihood of living in poverty.”

For Judge Swain—as was the case in Detroit, Central Falls, San Bernardino, Stockton, etc., a grave challenge in seeking to fashion a plan of debt adjustment will resolve around public pensions. While the state constitutional issues, which complicated—and nearly led to a U.S. Supreme Court federalism challenge—do not appear to be at issue here; nevertheless the human aspect is. Just as former Rhode Island Supreme Court Judge Robert G. Flanders, Jr., who served as Central Falls’ Receiver during that city’s chapter 9 bankruptcy—and told us, with his voice breaking—of the deep pension cuts which he had summarily imposed of as much as 50%—so too Puerto Rico’s public pension funds have been depleted. Thus, it will fall to Judge Swain to seek to balance the desperate human needs on one side versus the demands of municipal bondholders on the other. Finally, the trial over which Judge Swain will preside has an element somewhat distinct from the others we have traced: can she press, as part of this process to fashion a plan of debt adjustment, for measures—likely ones which would have to emanate from Congress—to address the current drain of some of Puerto Rico’s most valuable human resources: taxpayers fleeing to the mainland. Today, Puerto Rico’s population is more than 8% smaller than seven years ago; the territory has been in recession almost continuously for a decade—and Puerto Rico is in the midst of political turmoil: should it change its form of governance: a poll two months’ ago found that 57% support statehood. Indeed, even were Puerto Rico’s voters to vote that way, and even though the 2016 GOP platform backed statehood; it seems most unlikely that in the nation’s increasingly polarized status the majority in the U.S. Congress would agree to any provision which would change the balance of political power in the U.S. Senate.

Is There a PROMESA of Recovery?

eBlog

Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy, after which we journey north to review the remarkable fiscal recovery from chapter 9 municipal bankruptcy of one of the nation’s smallest municipalities.

Tropical Fiscal Typhoon. Puerto Rico is trapped in a vicious fiscal whirlpool where the austerity measures it has taken to meet short-term obligations to its creditors all across the U.S., including laying off some 30,000 public sector employees and increasing its sales tax by nearly 75% have seemingly backfired—doing more fiscal harm than good: it has devastated its economy, depleted revenue sources, and put the government on a vicious cycle of increasingly drastic fiscal steps in an effort to make payments—enough so that nearly 33% of the territory’s revenue is currently going to creditors and bondholders, even as its economy has shrunk 10% since 2006, while its poverty rate has grown to 45%. At the same time, a demographic imbalance has continued to accelerate with the exit of some 300,000 Puerto Ricans—mostly the young and better educated—leaving for Miami and New York. Puerto Rico and its public agencies owe $73 billion to its creditors, nearly 500% greater than the nearly $18 billion in debts accumulated by Detroit when it filed for chapter 9 municipal bankruptcy four years ago in what was then the largest municipal bankruptcy in U.S. history. Thus, with the island’s hedge-fund creditors holding defaulted municipal general obligation bonds on the verge of completing a consensual agreement earlier this week, the PROMESA oversight board intervened to halt negotiations and place Puerto Rico under the Title III quasi municipal bankruptcy protection. That will set up courtroom confrontations between an impoverished population, wealthy municipal bondholders in every state in the domestic U.S., and hedge funds—pitted against some of the poorest U.S. citizens and their future. Nevertheless, as Congress contemplated, the quasi-municipal bankruptcy process enacted as part of the PROMESA statute provides the best hope for Puerto Rico’s future.

Thus the PROMESA Board has invoked these provisions of the PROMESA statute before a federal judge in San Juan, in what promises to be a long process—as we have seen in Detroit, San Bernardino, and other cities, but with one critical distinction: each of the previous municipal bankruptcies has involved a city or county—the quasi municipal bankruptcy here is more akin to a filing by a state. (Because of the dual federalism of our founding fathers, Congress may not enact legislation to permit states to file for bankruptcy protection.) Unsurprisingly, when Puerto Rico was made a U.S. territory under the Jones-Shafroth Act, no one contemplated the possibility of bankruptcy. Moreover, as chapter 9, as authorized by Congress, only provides that a city or county may file for chapter 9 bankruptcy if authorized by its respective state; Puerto Rico inconveniently falls into a Twilight Zone—to write nothing with regard to access to such protections for Puerto Rico’s 87 municipalities or muncipios.

Moreover, while from Central Falls, Rhode Island to Detroit, the role of public pension obligations has played a critical role in those chapter 9 resolutions; the challenge could be far greater here: in Puerto Rico, retired teachers and police officers do not participate in Social Security. Adopting deep cuts to their pensions would be a virtual impossibility. So now it is that Puerto Rico will be in a courtroom to confront hedge funds, mutual funds, and bond insurers, after the negotiations between Puerto Rico and its creditors over a PROMESA Board-approved fiscal plan that allocates about $787 million a year to creditors for the next decade, less than a quarter of what they are owed, was deemed by said creditors to be a slap in the face—with the Board having pressed for a combination of debt restructuring spending cuts in its efforts to revive an economy trapped by a 45% poverty rate—and where the Board had proposed upping water rates on consumers, liquidating its decades-old industrial development bank, and seeking concessions from creditors of other government agencies. Moreover, amid all this, Gov. Ricardo Rosselló, who has recently renegotiated to mitigate politically unpopular fee increases on residents, now finds himself nearly transfixed between desperate efforts to sort out governance, meet demands of his constituents and taxpayers, and negotiate with a federally imposed oversight board, even as he is in the midst of a campaign for U.S. statehood ahead of a plebiscite on Puerto Rico’s political status—and in the wake of being named a defendant in a lawsuit by hedge funds after the expiration of a stay on such suits expired this week. Hedge funds holding general obligation and sales-tax bonds filed the suit on Tuesday, naming Gov. Rosselló as a defendant—albeit, the suit, and others, are nearly certain to be frozen, as the main judicial arena now will fall into a quasi-chapter 9 courtroom epic battle. And that battle will not necessarily be able to fully look to prior chapter 9 judicial precedents: while Title III incorporates features of chapter 9, the section of the U.S. bankruptcy code covering insolvent municipal entities, courts have never interpreted key provisions of Title III—a title, moreover, which protections for creditors which chapter 9 does not.

The Rich Chocolatey Road to Recovery! Moody’s has awarded one of the nation’s smallest municipalities, Central Falls, aka Chocolate City, Rhode Island, its second general obligation bond upgrade in two months, a sign of the former mill city’s ongoing recovery from municipal bankruptcy—an upgrade which Mayor James Diossa unsurprisingly noted to be “very important.” Moody’s noted that its upgrade “reflects a multi-year trend of stable operating results and continued positive performance relative to the post-bankruptcy plan since the city’s emergence from Chapter 9 bankruptcy in 2012,” adding that it expects the city will enhance its flexibility when its plan of debt adjustment period ends at the end of next month—at which time one of the nation’s smallest cities (one square mile and 19,000 citizens) will implement a policy of requiring maintenance of unassigned general fund reserves of at least 10% of prior year expenditures. In its upgrade, Moody’s reported the upgrade reflected Central Falls’ high fixed costs, referring to its public pension obligations, OPEB, and debt service–costs which add up to nearly 30% of its budget—and what it termed a high sensitivity to adverse economic trends compared with other municipalities, with the rating agency noting that a sustained increase in fund balance and maintenance of structural balance could lead to a further upgrade, as could a reduction in long-term liabilities and fixed costs and material tax-base and growth.

 

The Art & Commitment of Municipal Fiscal Recovery

eBlog, 04/11/17

Good Morning! In this a.m.’s eBlog, we consider the ongoing recovery of the city of Flint, Michigan, before heading east to one of the smallest municipalities in America, Central Falls, Rhode Island, as it maintains its epic recovery from chapter 9 municipal bankruptcy, before finally turning south to assess recent developments in Puerto Rico. We note the terrible shooting yesterday at North Park Elementary School in San Bernardino; however, as former San Bernardino School Board Member Judi Penman noted, referring to the police department: “It is one of the most organized and well-prepared police departments around, and they are well prepared for this type of situation.” Indeed, even if sadly, the experience the city’s school police department gained from coordinating with the city’s police department in the wake of the December 2, 2015 terrorist attack appeared to enhance the swift and coordinated response—even as calls came in yesterday from the White House and California Gov. Jerry Brown to offer condolences and aid, according to San Bernardino Mayor Carey Davis.

Could this be a Jewel in the Crown on Flint’s Road to Fiscal Recovery? In most instances of severe municipal fiscal distress or bankruptcy, the situation has been endemic to the municipality; however, as we have noted in Jefferson County, the state can be a proximate cause. Certainly that appears to have been the case in Flint, where the Governor’s appointment of an emergency manager proved to be the proverbial straw that broke the camel’s back at an exceptional cost and risk to human health and safety. The fiscal challenge is, as always, what does it take to recover? In the case of Flint, the city’s hopes appear to depend upon the restoration of one of the small city’s iconic jewels: the historic, downtown Capitol Theatre—where the goal is to restore it to its original glory, dating back to 1928, when it opened as a vaudeville house: it was listed on the National Register of Historic Places in 1985, but has been empty now for more than a decade—indeed, not just empty, but rather scheduled to become still another parking lot. Instead, however, the property will undergo a $37 million renovation to become a 1,600-seat movie palace and performance venue, which will provide 28,000 square feet of ground-floor retail and second-floor office space; an additional performance space will be created in the basement for small-scale workshops, experimental theater, and other performances. Jeremy Piper, chairman of the Cultural Center Corp., a Flint lawyer, will manage the new performing arts venue in the cultural center; he will also serve as co-chair of a committee that is raising the last $4 million of the $37 million needed to bring the theater back to life. The goal and hope is that the renovated theater will, as has been the experience in other cities, such as New York City’s Lincoln Center for the Performing Arts, help serve as a foundation for Flint’s fiscal and physical recovery. The new theater is intended to become the focal point of 12,000, 13,000, or 14,000 people coming into downtown Flint for a performance and then going out for dinner—that is, to benefit and revive a downtown economy. Indeed, already, the venture firm SkyPoint is planning to open a large fine-dining restaurant on the ground floor and mezzanine timed to the rejuvenated theater’s reopening—SkyPoint Ventures being the company co-founded by Phil Hagerman, the CEO of Flint-based Diplomat Pharmacy Inc., and his wife, Jocelyn, whose Hagerman Foundation (the author, here, notes his middle name, derived from his great grandfather, is Hagerman) donated $4 million toward the Capitol’s renovation. In 2016, the Flint-based C.S. Mott Foundation announced a grant of $15 million for the Capitol Theatre project as part of $100 million it pledged to the city in the wake of the water crisis. The project also received $5.5 million from the Michigan Strategic Fund.

The ambitious effort comes as Michigan has paid $12 million to outside attorneys for work related to the Flint drinking water crisis, but out of which nearly 30% has gone to pay criminal and civil defense attorneys hired by Gov. Rick Snyder—an amount expected to climb as the lead poisoning of Flint’s drinking water has proven to be devastating for Flint and its children, but enriching for the state’s legal industry: Jeffrey Swartz, an associate professor at Western Michigan University-Cooley Law School, notes: “It’s a lot of money…I can see $10 million to $15 million being eaten up very quickly.” He added, moreover, that the state is still “on your way up the slope” in terms of mounting legal costs. The approved value of outside legal contracts, not all of which has been spent, is at least $16.6 million, adding that the Michigan Legislature may want to appoint a commission to review the appropriateness of all outside legal bills before they are approved for payment: already, Gov. Rick Snyder’s office has spent a combined $3.35 million for outside criminal and civil defense lawyers; the Michigan Department of Environmental Quality has spent $3.65 million; the Department of Health and Human Services has spent $956,000; and the Treasury Department has spent $35,555, according to figures released to the Free Press. In addition, the state has paid $340,000 to reimburse the City of Flint for some of its civil and criminal legal defense costs related to the drinking water crisis, which a task force appointed by Gov. Snyder has said was mainly brought on by mistakes made at the state level. Yet to be equitably addressed are some $1.3 million in Flint legal costs. Michigan Attorney General Bill Schuette, whose investigation is still ongoing, has charged 13 current or former state and municipal officials, including five from the Dept. of Environmental Quality, the Dept. of Health and Human Safety, the City of Flint, and two former state-appointed emergency managers who ran the city and reported to the state’s Treasury Department; no one, however, from Gov. Snyder’s office has been charged.

The Remarkable Recovery of Chocolateville. Central Falls, Rhode Island Mayor James A. Diossa, the remarkable elected leader who has piloted the fiscal recovery of one of the nation’s smallest cities from chapter 9 municipal bankruptcy, this week noted: “Our efforts and dedication to following fiscally sound budgeting practices are clearly paying off, leaving the City in a strong position. I would like to personally thank the Council and Administrative Financial Officer Len Morganis for their efforts in helping to lead the comeback of this great City.” The Mayor’s ebullient comments came in the wake of credit rating agency Standard and Poor’s rating upgrade for one of the nation’s smallest cities from “BB” to “BBB,” with S&P noting: “Central Falls is operating under a much stronger economic and management environment since emerging from bankruptcy in 2012. The City of Central Falls now has an investment grade credit rating from S&P due to diligently following the post-bankruptcy plan in conjunction with surpassing budgetary projections.”

One of the nation’s smallest municipalities (population of 19,000, city land size of one-square-mile), Central Falls is Rhode Island’s smallest and poorest city—and the site of a George Mason University class project on municipal fiscal distress—and guidebook for municipal leaders. Its post-bankruptcy recovery under Mayor Diossa has demonstrated several years of strong budgetary performance, and has “fully adhered to the established post-bankruptcy plan,” or, as Mayor Diossa put it: “S&P’s latest ratings report is yet another sign of Central Falls’ turnaround from bankruptcy.” Mr. Morganis noted: “The City of Central Falls now has an investment grade credit rating from S&P due to diligently following the post-bankruptcy plan in conjunction with surpassing budgetary projections,” adding that the credit rating agency’s statement expressed confidence that strong budgetary performance will continue post Rhode Island State oversight. S&P, in its upgrade, credited Mayor Diossa’s commitment to sound and transparent fiscal practices, noting the small city has an adequate management environment with improved financial policies and practices under their Financial Management Assessment (FMA) methodology—and that Central Falls exhibited a strong budgetary performance, with an operating surplus in the general fund and break-even operating results at the total governmental fund level in FY2016. Moreover, S&P reported, the former mill town and manufacturer of scrumptious chocolate bars has strong liquidity, with total government available cash at 28.7% of total governmental fund expenditures and 1.9 times governmental debt service, along with a strong institutional framework score. Similarly, Maureen Gurghigian, Managing Director of Hilltop Securities, noted: “A multi-step upgrade of this magnitude is uncommon: this is a tribute to the hard work of the City’s and the Administrative Finance Officer’s adherence to their plan and excellent relationship with State Government.” The remarkable recovery comes as one of the nation’s smallest cities heads towards a formal exit from chapter 9 municipal bankruptcy at the end of FY2017. S&P, in its upgrade, noted the city is operating under a “much stronger economic and management environment,” in the wake of its 2012 exit from municipal bankruptcy, or, as Mayor Diossa, put it: “Obviously we’ve had a lot of conversations with the rating agencies, and I was hoping we’d get an upgrade of at least one notch…When we got the triple upgrade, first, I was surprised and second, it reaffirmed the work that we’re doing. Our bonds are no longer junk. We’re investment level. It’s like getting good news at a health checkup.”  S&P, in its report, noted several years of sound budgeting and full adherence to a six-year post-bankruptcy plan which state-appointed receiver and former Rhode Island Supreme Court Justice Robert Flanders crafted. The hardest part of that recovery, as Judge Flanders noted to us so many years ago in City Hall,was his swift decision to curtail the city’s pension payments—cuts of as much as 55 percent—a statement he made with obvious emotion, recognizing the human costs. (Central Falls is among the approximately one-quarter of Rhode Island municipalities with locally administered pension plans.) Unsurprisingly, Mayor Diossa, maintains he is “fully committed” to the fiscal discipline first imposed by Judge Flanders, noting the municipality had a general fund surplus of 11% of expenditures in FY2016, and adding: “That reserve fund is very important.” He noted Central Falls also expects a surplus for this fiscal year, adding that the city’s expenses are 3% below budget, and that even as the city has reduced the residential property tax rate for the first time in a decade, even as it has earmarked 107% of its annual required contribution to the pension plan and contributed $100,000 toward its future OPEB liability.

The End of an Era? Mayor Diossa, recounting the era of chapter 9 bankruptcies, noted Pennsylvania’s capital, Harrisburg, in 2011; Jefferson County, Alabama; Stockton, Mammoth Lakes and San Bernardino, California; and Detroit: “I think Central Falls is a microcosm of all of them…I followed Detroit and heard all the discussions. They had the same issues that we had…sky-high costs, not budgeting appropriately,” adding his credit and appreciation—most distinctly from California—of the State of Rhode Island’s longstanding involvement: “The state’s been very involved,” commending Governors Lincoln Chafee and Gina Raimondo. Nevertheless, he warns: fiscal challenges remain; indeed, S&P adds: “The city’s debt and contingent liability profile is very weak…We view the pension and other post-employment benefit [OPEB] liabilities as a credit concern given the very low funded ratio and high fixed costs…They are still a concern with wealth metrics and resources that are probably below average for Rhode Island, so that’s a bit of a disadvantage…That adds more importance to the fact that they achieved an investment-grade rating through what I think is pretty good financial management and getting their house in order.” The city’s location, said Diossa, is another means to trumpet the city.

The Uncertainties of Fiscal Challenges. Natalie Jaresko is the newly named Executive Director of the PROMESA federal control board overseeing Puerto Rico’s finances, who previously served during a critical time in Ukraine’s history from 2014 to 2016 as it faced a deep recession, and about whom PROMESA Board Chair Jose Carrion noted: “Ukraine’s situation three years ago, like Puerto Rico’s today, was near catastrophic, but she worked with stakeholders to bring needed reforms that restored confidence, economic vitality and reinvestment in the country and its citizens. That’s exactly what Puerto Rico needs today;” came as Ms. Jaresko yesterday told the Board that with the tools at its disposal, Puerto Rico urgently needs to reduce the fiscal deficit and restructure the public debt, “all at once,” while acknowledging that the austerity measures may cause “things to get worse before they get better.” Her dire warnings came as the U.S. territory’s recovery prospects for the commonwealth’s general obligation and COFINA bonds continued to weaken, and, in the wake of last week’s moody Moody’s dropping of the Commonwealth’s debt ratings to its lowest rating, C, which equates with a less than 35% recovery on defaulted debt. Or, as our respected colleagues at Municipal Market Analytics put it: “[T]he ranges of potential bondholder outcomes are much wider than those, with a materially deeper low-end. For some (or many) of the commonwealth’s most lightly secured bonds (e.g., GDB, PFC, etc.) recoveries could hypothetically dip into the single digits. Further, any low end becomes more likely the longer Puerto Rico’s restructuring takes to achieve as time:

1) Allows progressively more negative economic data to materialize, forcing all parties to adopt more conservative and sustainable projections for future commonwealth revenues;

2) Allows local stakeholder groups—in particular students and workers—to organize and expand nascent protest efforts, further affecting the political center of gravity on the island;

3) Worsens potential entropy in commonwealth legislative outcomes;

4) Frustrates even pro-bondholder policymakers in the US Congress, which has little interest in, or ability to, re-think PROMESA and/or Federal aid compacts with the commonwealth.”

On the other hand, the longer the restructuring process ultimately takes, the more investable will be the security that the island borrows against in the future (whatever that is). So while the industry in general would likely benefit from a faster resolution that removes Puerto Rico from the headlines, the traditional investors who will consider lending to a “fixed” commonwealth should prefer that all parties take their time. Finally, if bleakly, MMA notes: “In our view, reliable projections of bondholder recovery impossible, and we fail to understand how any rating agency with an expected loss methodology can rate Puerto Rico’s bonds at all…Remember that the Governor’s Fiscal Plan, accepted by the Oversight Board, makes available about a quarter of the debt service to be paid on tax-backed debt through 2027, down from about 35% that was in the prior plan that the Board rejected. As we’ve noted before, the severity of the proposal greatly reduces the likelihood that an agreement will be reached with creditors by May 1 (when the stay on litigation ends), not only increasing the prospect of a Title III restructuring (cram down) un-der PROMESA, but also a host of related creditor litigation against the plan itself and board decisions both large and small. The outcomes of even normal litigation risks are inherently unpredictable, but the prospects here for multi-layered, multi-dimensional lawsuits create a problem several orders of magnitude worse than normal.

The Key Lessons Learned after a Decade of Municipal Bankruptcies

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eBlog, 04/07/17

Good Morning! In this a.m.’s eBlog, we consider Detroit’s first steps to address the blight which crisscrossed the city leading to its municipal bankruptcy. Then we look to New Hampshire to assess whether the state legislature will preempt municipalities’ authority to set election dates. Then we slip south to assess fiscal developments in the efforts to recover from insolvency in Puerto Rico. Finally, we assess and consider some of the broader issues related to municipal bankruptcy.

Post Chapter 9 Recovery. One of Detroit’s first tests with regard to whether it can find new use for the vast stretches of land it cleared of blight went into effect this week when development teams announced by  Mayor Mike Duggan, along with partners: The Platform, a Detroit-based firm, and Century Partners announced they would be investing an estimated $100 million to rehab the architectural jewels in the city’s downtown—the Fisher and Albert Kahn buildings, with the two organizations declaring they will take the lead in overhauling 373 parcels of vacant land and houses in the Fitzgerald neighborhood on the northwest side, where they will coordinate with other firms on a $4 million development plan to rehab 115 vacant homes over two years, create a two-acre park, and landscape 192 vacant lots—with the work occurring in neighborhoods wherein the Detroit Land Bank took control of most of the properties and razed some abandoned homes. Mayor Duggan and other officials described the plan as a kind of reverse gentrification—or, as Mayor Duggan framed it: “We are going to keep the families here while improving the neighborhoods,” making his announcement on an empty lot which is scheduled to become a city park and include a greenway path to nearby Marygrove College: the city leaders hope to transform the neighborhood into a “Blight-Free Quarter Square Mile,” and, if the model works, seek to propagate it other neighborhoods.

Granite State Preemption or Cure? House Speaker Shawn Jasper wants to give New Hampshire towns that postponed their municipal elections due to a snowstorm a way out of facing potential lawsuits from voters who may have been disenfranchised. Speaker Jasper had proposed letting towns ratify the results of their elections by holding another vote, offering a bill to give towns which moved Election Day the option of letting townspeople vote to ratify, or confirm, the results on May 23rd. However, in the wake of about five hours of testimony, the House Election Law Committee voted 10-10 on the Jasper plan, so that a tie vote killed the Speaker’s amendment, leaving 73 towns on their own to address potential legal problems resulting from their decisions to hold their elections on days other than March 14th. The fiscal blizzard in the Granite State now depends upon whether state legislators determine whether or not a special election is needed with regard to those results. New Hampshire Deputy Secretary of State David Scanlan noted: “The concept is not entirely new…what is different is that it is applying to an entire class of towns that decided to postpone.”

In the past, the Legislature has voted to “cure” individual election defects. Speaker of the House Shawn Jasper, (R-Hudson, N.H.) noted: “Well, the fact that a bunch of towns moved the day of their town election was unprecedented…And so as a result of doing that, those towns that moved had to start bending other laws to make other issues related to the election work…The Legislature is just granting the authority to allow the towns to correct any defects that may exist,” he added, listing changed time listings, lack of proper notice, and absentee ballot date issues as possible defects in the process. All of those questions, of course, have fiscal consequences—or, as Atkinson Town Administrator Alan Phair put it; “Well, I don’t know the exact cost, what it would be, but I do know that in our case we certainly don’t have the money budgeted to (hold a special election), because we obviously just budgeted for one election…We would certainly go considerably over and have to find the money elsewhere to do it.” Under the proposed amendment, towns and school districts which postponed would hold a hearing, at which the respective governing body would vote on whether to hold a special election with one question: whether or not to ratify results, where a “no” vote would kick out anyone elected in a postponed vote, while nullifying warrant articles, with elected roles to be appointed until the next election. Salem Town Manager (Salem is a town of just under 30,000 in Rockingham County) Leon Goodwin said his elected leaders were of the opinion that its postponement was legal, so that the municipality is moving forward on projects voted on last month, noting: We’re moving on as if the votes were accepted even though there is a cloud hanging over us from Concord,” adding that town counsel advised the town moderator that it was legal to move elections. Yet, even as he remained confident the election issue will be resolved, he cautioned that the town has not budgeted for an additional election; Windham (approximately 14,000) Town Manager David Sullivan said the municipality’s town Counsel would sign off on the town’s fire truck bond, notwithstanding bond counsel elsewhere in the state advising that ratification of the elections would be necessary.

Municipal authority to act has been hampered by different state House and Senate approaches: while the two bodies have been moving on parallel tracks in the wake of state officials’ questioning the authority of town moderators to reschedule the March 14 voting sessions of their town meetings, the Senate this week passed SB 248, a bill introduced to ratify actions taken at the rescheduled meetings; however, the bill passed with a committee amendment which deletes all of the original language and provides instead for the creation of a committee to “study the rescheduling of elections.” Senators acknowledged that the bill was not likely to pass through the House in that form—asserting the intent was simply to get a bill to the House for further work. Subsequently, a floor amendment was introduced to restore the bill’s original language, ratifying all actions taken at the rescheduled meetings; however, that amendment failed on a party-line vote, with all nine Democrats voting in favor and all fourteen Republicans voting against, leaving most unclear how this could have become a partisan issue. The question comes down to what level of control local officials should have over local elections. The Speaker described the outcome thusly: “I think it was a case of 10 people (on the committee) thinking that what happened was legal;” however, he maintained that the postponed votes were not legal, adding: “The sad thing is that for school districts with bond issues that passed in those meetings, I don’t see a path forward for them,” adding: “I think if you’re afraid of snowstorms, you ought to move your meetings, probably to May,” noting that state officials are forbidden by law from moving state primary and general elections, as well as the first-in-the-nation presidential primary. Unsurprisingly, town moderators and attorneys who work with them on municipal bond issues disagreed with the Speaker’s interpretation that the postponed elections were illegal and his belief that the only way to rectify the issue was for them to act to individually ratify them, with many arguing they acted legally under a state law which allows them to postpone and reschedule the “deliberative session or voting day” of a town meeting to another day; however, the Speaker maintains that law applies only to town meetings, while town elections are governed under a different statute, which provides: “All towns shall hold an election annually for the election of town officers on the second Tuesday in March.” He also noted that the state’s official political calendar, which has the force of law, states that town elections must be held on March 14, adding: “Without trying to place blame, laws are sometimes very confusing if you look only at parts of them,” noting: “I don’t believe for one second that moving the election was legal.”

The Speaker added that still another state law provides that at special town meetings, no money may be raised or appropriated unless the number of ballots cast at the meeting is at least half the number of those on the checklist who were eligible to vote in the most recent town meeting, albeit adding that such meetings do not apply to the current situation, because they are not elections. The state’s Secretary of State said that after three weeks of research, he was able to report on voter turnout at town elections for the past 11 years, advising that 210 towns held elections in March, and 137 of them “followed the law” by holding their elections on March 14th, while 73 towns had postponed their elections by several days. Now Speaker Jasper asks: “Why would we give over 300 individual moderators the ability to do that when our Secretary of State doesn’t have the ability to do that for a snowstorm in our general election or our presidential primary?” The Speaker notes: “I think we need to provide a way to ensure that we don’t clog up the courts, and we don’t have people spend a lot of their own money to fight this, and the towns don’t have to spend a lot of money fighting it.”

Un-positive Credit Rating for Puerto Rico. Moody’s Investors Service has lowered the credit ratings on debt of the Government Development Bank and five other Puerto Rico issuers, with a total of approximately $13 billion outstanding, and revised down the Commonwealth’s fiscal outlook, and the outlooks for seven affiliated obligors linked to the central government to negative from developing, with the downgrades reflecting what the agency described as “persistent pressures on Puerto Rico’s economic base that indicate a diminishing perceived capacity to repay,” noting that while it continues to “believe that essentially all of Puerto Rico’s debt will be subject to default and loss in a broad restructuring, the securities being downgraded face more severe losses than we had previously expected, in the light of Puerto Rico’s projected economic pressures. For this reason, we downgraded to C from Ca not only the senior notes issued by the now defunct Government Development Bank, but also bonds issued by the Puerto Rico Infrastructure Financing Authority and backed by federal rum tax transfer payments, the Convention Center District Authority’s hotel occupancy tax-backed bonds, the Employees Retirement System’s bonds backed by government pension contributions, and the 1998 Resolution bonds of the Puerto Rico Highways and Transportation Authority.”

Puerto Rico Governor Rossello late Wednesday said that the U.S. territory’s fiscal plan, approved by the PROMESA Board, does not contemplate any double taxation, adding that, between the increase in the property tax and the reduction of expenses in the municipalities, he favored the latter as a measure to compensate for the absence of the state subsidy of $350 million. He reiterated that, as a substitute for these funds, the properties which are not currently paying taxes to the Centro de Recaution de Ingresos Municipales (CRIM: the Municipal Revenue Collection Center) should be identified, because they are not included in their registry. The Governor also stressed that the economic outcome of these two fiscal initiatives is still being evaluated, albeit he estimated that they could generate about $100 million, noting: “Whatever the differential after that for the municipalities, there are two mechanisms that can be worked: One, a mechanism to seek an additional source of income, or, two, to avail cuts…The central government has taken the cutting position. We are already establishing a protocol to cut in the agencies, to consolidate, to eliminate the expenses that are not necessary, to go from 131 to between 35 to 40 agencies. That has been our action. The municipalities—now we will have a conversation with our technical team—will have several options: ‘either cut as did the central government or seek mechanisms to raise more funds or impose taxes.’” Currently, mayors evaluate to increase the arbitrage of the real property to 11.83% or to 12.83% in all the municipalities; the concept is for members of the Executive to offer assistance to do the modeling. Thus, the president of the board of CRIM, Cidra Mayor Javier Carrasquillo, said CRIM will be “sensitive to the reality of the pockets of Puerto Ricans: We have to be cautious and responsible in the recommendation that we are going to make…There is nothing definitive yet. There are recommendations.” The Governor noted that the PROMESA Board approved fiscal plan approved last month does not contemplate an increase in property taxation, asserting it was “false to imply that our fiscal plan entails an increase in the rate or a double rate on properties,” albeit recalling that the disappearance of $350 million in transfers to municipalities begins on July 1, when the fiscal year begins, promising it will be done progressively, so that in the next budget (2017-2018) $175 million disappear, and the remaining $175 million, the next fiscal year, describing it as a “two-year fade out.” Unsurprisingly, he did not specify when or how the plan would fiscally benefit this island’s municipalities, stating: “We have already been able to have pilot efforts to identify different municipalities where 60% of their properties are not being assessed…We are going to commit ourselves so that all these properties are in the system.”

The End of a Chapter 9 Era? Municipal bankruptcy is a rarity: even notwithstanding the Great Recession which produced a significant number of corporate bankruptcies—and federal bailouts to large for-profit corporations and quasi-federal corporations, such as Fannie Mae; the federal government offered no bailouts to cities or counties. Yet from one of the nation’s smallest cities, Central Falls, to major, iconic cities such as Detroit and Jefferson County, the nation experienced a just-ended spate, before—with San Bernardino’s exit last month, the likely closure of an era—even as we await some resolution of the request by East Cleveland to file for chapter 9 municipal bankruptcy. The lessons learned, compiled by the nation’s leading light of municipal bankruptcy, therefore bear consideration. Jim Spiotto, with whom I had the honor and good fortune over nearly a decade of effort leading to former President Reagan’s signing into law of the municipal bankruptcy amendments of 1988, offers us a critical guide of ten lessons learned:

  1. Do not defer funding of essential services and infrastructure: Detroit is a wake- up call for others that there is never a good reason to defer funding of essential services and infrastructure at an acceptable level. If you do, Detroit’s fate will be yours.
  2. Labor and pension contracts under state constitutional and statutory provisions should not be interpreted as a mutual suicide pact: It appears one of the reasons why resolution of pension and labor costs was not achieved in Detroit prior to filing Chapter 9 was the belief of the workers and retirees that, under the Michigan constitution, those contractual rights could not be impaired or diminished to any degree. This position failed to take into consideration that the municipality can only pay that which it has revenues to pay and, in an eroding declining financial situation, there will never be sufficient funds to pay all obligations, especially those that may be unaffordable and unsustainable.
  3. Don’t question that which should be beyond questioning and is needed for the long-term financial survival of the municipality: A dedicated source of payment, statutory lien or special revenues established under state law must be honored and should not be contested. Capital markets work effectively when credibility and predictability of outcome are clear and unquestioned. Current effort to pass new legislation (California SB222 and Michigan HB5650) to grant statutory first lien on dedicated revenues. Further, as noted in the Senate Report for the 1988 Amendments to the Bankruptcy Code and Chapter 9 “Section 904 [of Chapter 9 limiting the jurisdiction and power of the Bankruptcy Court] and the tenth amendment prohibits the interpretation that pledges of revenues granted pursuant to state statutory or constitutional provisions to bondholders can be terminated by filing a Chapter 9 proceeding”. This follows the precedent from the 1975 financial distress of New York City and the State of New York’s highest court ruling the state imposed moratorium was unconstitutional given the constitutional mandate to pay available revenues to the general obligation bondholders. See Flushing Nat. Bank et. al. v. Mun. Assistance Corp. of New York, 40 N.Y.S.2nd 731, 737-738 (N.Y. 1976). Just as statutory liens and special revenues, there is a strong argument that state statutory and constitutional mandated payments (mandated set asides, priorities, appropriations and dedicated tax revenue payments) should not and cannot be impaired, limited, modified or delayed by a Chapter 9 proceeding given the rulings of the Supreme Court in the Ashton and Bekins cases and the prohibitions of Sections 903 and 904 of Chapter 9 of the Bankruptcy Code.
  4. Debt adjustment is a process, but a recovery plan is a solution: As noted above, while Detroit has proceeded with debt adjustment which provides some additional runway so it can take takeoff in a recovery, such plan is not the cure for the systemic problem. Rather, the plan provides additional breathing room so that the municipality, through its Mayor and its elected officials, may proceed with a recovery plan, reinvest in Detroit, stimulate the economy, create new jobs, clear and develop blighted areas and raise the level of services and infrastructure to that which is acceptable and attract new business and new citizens.
  5. Successful plans of debt adjustment have one common feature: virtually all significant issues have been settled and resolved with major creditors: While the Detroit Plan started with sound and fury between the emergency manager and creditors and what they would receive, in the end, similar to what occurred in Vallejo, Jefferson County and even in Stockton (with one exception), major creditors ultimately reached agreement and supported the Plan of Debt Adjustment that allowed the municipality to move forward, confirm the Plan and begin its journey to recovery.
  6. One size does not fit all: There are many ways to draft a plan of debt adjustment and sometimes the more creative, the better. As noted above, traditionally major cities of size with significant debt did not file Chapter 9. They refinanced their debt with the backing of the state which reduced their future borrowing costs and allowed them to recover by having the liquidity and the reduced costs necessary to deal with their financial difficulties. Detroit chose a different path.
  7. A recovery plan must provide for essential services and infrastructure: “Best interest of creditors” and “feasibility” can only mean an appropriate reinvestment in the municipality through a recovery plan where there is funding of essential services and infrastructure at an acceptable level to stimulate the municipality’s economy to attract new employers and taxpayers thereby increasing tax revenues and addressing the systemic problem. While no plan of debt adjustment is perfect or assured, there should be, as the Bankruptcy Court in Detroit throughout the case pointed out, a plan to show the survivability and future success of the City.
  8. Confirmation of a plan of debt adjustment is only the beginning of the journey to financial recovery, not the end: It is important to recognize, as noted above, that Chapter 9 is a process, not a solution. The recovery plan, which will take dedication and effort by the elected officials of the City along with residents, public workers and other creditors is the only way to achieve success. It is measured not by months, but by years, and by the constant vigilance to ensure that the systemic problem is addressed effectively in a permanent fix.