Confronting the Challenges of Insolvencies

eBlog, 03/17/17

Good Morning! In this a.m.’s eBlog, we consider the suit filed by the Detroit Public Schools District seeking to prevent the closure of any additional schools in the city; then we snow shovel our way through the high drifts in Cambridge, Massachusetts to explore its creative issuance of mini municipal bonds, before racing to the warmth of Puerto Rico to observe the legal challenge between different kinds of municipal bondholders against Puerto Rico.

Schools of Hard Fiscal Knocks. In response to a threat by the Michigan School Reform Office (SRO) to target up to 16 Detroit public schools for closure in the newly created Detroit Public School District, created in the wake of the old system’s physical and fiscal insolvencies: to move as many as 7,700 students—permitting them to transfer to DPSCD schools, charter schools, or nearby districts; the Detroit Public Schools Community District is seeking to make a preemptive strike against said state plans to shutter some of its schools: the district board has voted to sue the state’s School Reform Office (SSRO) over the threat of school closures in the newly state-created district, suing to prevent the State of Michigan from closing any of its struggling schools, after the Board of Education, in the wake of a five-hour meeting, voted unanimously to file suit against the state School Reform Office, the State of Michigan, and Michigan School Reform Officer Natasha Baker. Detroit School Board Vice President Sonya Mays noted: “The action preserves the full range of our options.” The vote appeared to be in response to the state office’s identification last January of 38 schools statewide for potential closure, because they have ranked in the bottom 5% academically for three straight years: more than two-thirds of those public schools were in Detroit: 16 in the Detroit district, 8 in the Education Achievement Authority, and one charter school. However, a Moody’s report last month said that the student loss would have been somewhat offset by the school district’s absorption of 3,700 students who are currently educated by the Education Achievement Authority and nearly 500 students from one charter school closure

The suit was filed even though the Michigan Department of Education (MDE) had offered a proposal to school districts with schools on that closure list under which, if said districts reached agreement with the state agency on a plan to turn the schools around, then the school reform office would hold off on closure decisions. Detroit Public Schools Interim Superintendent Alycia Merriweather not only had said the district is interested in entering into such an agreement with the MDE, but also is planning to schedule a meeting soon—even as, notwithstanding, the board remains intent on moving forward with the lawsuit. It is unclear how much of the District’s resources will be siphoned out of the city’s ailing physically and educationally system’s budget to finance the litigation. Board President Iris Taylor stated: “We want to make it clear that filing suit is not a rejection of MDE’s offer to enter into a partnership agreement…It is simply the Board and the district ensuring that all options are available to us as we work through these challenges.” Ms. Taylor told the Detroit News that the board believes the school reform office actions were unlawful, because the board believes legislation approved last June which provided a financial rescue to the Detroit Public Schools—and which created the Detroit Public School District—provided the new district a clean slate: “Our district is entitled to operate schools for at least three years without even the threat of closure.” However, Michigan Attorney General Bill Scheutte last summer issued an opinion noting that if the Michigan Legislature had intended to give the district a three-year reprieve, the legislature would have clearly stated such an intent, noting that it had not.

In a city seeking to be a beacon to young families with children as critical towards re-growing its tax base, the suit seeks to bar the state from taking any additional steps to close any DPSDC schools until the court decides whether or not the SSRO has authority to close schools and whether the action taken to create the SSRO and the legislation itself is constitutional. That is, it is a suit regarding governance power and authority—and one in relation to which DPSCD Interim Superintendent Alycia Merriweather stated: “Closing schools creates a hardship for students in numerous areas including transportation, safety, and the provision of wrap around services…As a new district, we are virtually debt free, with a locally elected board, and we deserve the right to build on this foundation and work with our parents, educators, administrators, and the entire community to improve outcomes for all of our children.”

The lawsuit was filed, however, even as the Michigan Department of Education had offered the district and all others impacted by the threat of school closures a proposal under which duly elected school boards and district leadership would remain in full control of their schools, the curriculum, and their districts—an offer which Board President Taylor said the School Board was not necessarily rejecting, but rather in an effort to ensure “all options are available to us as we work through these challenges,” adding: “We appreciate Governor Snyder for hearing our concerns and taking action; however, we continue to believe that SSRO’s actions were unlawful. Among other things, we believe the legislation that created DPSCD in 2016 gave us a clean slate, which means, under the law, our district is entitled to operate schools for at least three years without even the threat of closure.” (Michigan’s legislation enacted in 2009 provides authority for the state to close schools ranked in the bottom 5% academically for three straight years.) This year, however, was the first time the SSRO has announced potential closures of schools under the state legislation—closures which carry a potential cost of foregone state aid from the $617 million state bailout of the fiscally and physically insolvent Detroit Public Schools district, under a state statute to overhaul the old Detroit Public Schools system. The newly created district operates schools and is scheduled to receive future state aid payments under the restructuring backed by Gov. Rick Snyder and state lawmakers. The SSRO threat has targeted up to 16 schools: the Detroit public school system would be at risk of the loss of not just 7,700 students, but also the state revenues that those students would have brought. Under the state proposal, students in the district could opt to transfer to DPSCD schools, charter schools, or nearby districts. Moody’s, last month, had reported that any such student loss would have been somewhat offset by DPSCD’s absorption of 3,700 students who are currently educated by the Education Achievement Authority and nearly 500 students from one charter school closure. The state-run Education Achievement Authority is scheduled to close in July.

Mr. Roger’s Neighborhood Municipal Bonds? Cambridge, Mass., a municipality of just over 107,000 across the Charles River from Boston, has succeeded in raising some $2 million through a sale of community-sourced general obligation minibonds, which the city’s underwriter, aptly named Neighborly, notes could reshape the municipal marketplace. The firm’s head of finance, James McIntyre, notes: “Our intention is to democratize access to municipal bonds.” Here the city will use the proceeds to fund capital projects such as school building renovations, and street and sidewalk improvements. The municipal bonds themselves were offered only to city residents, even though neither my daughter nor her husband, residents, seemed to be aware: individual orders are limited to $20,000, and lowered to a minimum investment amount to $1,000 from the customary $5,000. The opening for orders began selling at the close of business last month, closing last week: the Series A minibonds bonds pay a tax-exempt interest rate of 1.6% and will mature in five years. The firm notes that more than 240 individuals invested in the minibonds—municipal bonds to which Fitch Ratings, S&P Global Ratings, and Moody’s Investors Service assigned AAA ratings, with Cambridge City Manager Louie DePasquale noting: “This will not only engage residents, but we will make them a financial partner in our infrastructure investments.” Indeed, the city has helped via the distribution of “invest in Cambridge” mass-transit posters, a video, and a huge sign in front of City Hall. According to Neighborly founder Jase Wilson, “The most exciting thing about the Cambridge minibond issue is that it’s not a new idea at all…in fact the way our nation’s communities used to borrow money to build public projects.” Indeed, it was just 27 years ago that Denver issued its first minibonds; three years ago the Mile High City generated $12 million through a crowdfunding in $500 increments, as part of a $550 million transaction to finance city road improvements, leading Elizabeth FU of GFOA to note: “The minibonds definitely met Denver’s goal of helping residents invest in the community, so the project was well worth the additional resources and effort…Of course, this tool isn’t for everyone,” she added, noting some municipalities might experience trouble with the additional workload, the level of resources needed for administration, or the additional cost. Meanwhile, back in Cambridge, the municiplity also sold $56.5 million in general obligation municipal purpose loan of 2017 Series B bonds competitively on March 1. Morgan Stanley submitted the winning bid with a true interest cost of 2.303%. Proceeds from that sale will benefit sewer and stormwater, energy efficiency and street repair citywide, including Cambridge Common and Harvard Square. Neighborly’s director of business development, Pitichoke Chulapamornsri, said the firm structures municipal bond financings to connect a city’s capital plan with its residents—or, as he put it: “We are excited to help redefine the ‘public’ in public finance….Communities that are innovative and engaged are usually college towns: They are the ones with the most participation.”

Stay or Not? Puerto Rico Resident Commissioner Jennifer González Colón reports that an extension the stay on litigation of the PROMESA debt litigation stay is unlikely, notwithstanding Gov. Ricardo Rosselló’s proposed extension as incorporated in his proposed fiscal plan the Governor said he was seeking, with Del. González Colón (D-P.R.), Puerto Rico’s non-voting representative Congress noting there simply was insufficient time for Congress to act to amend PROMESA before the end of the stay. (PROMESA set the stay on debt-related suits against the Commonwealth on Feb. 15th, but allowed the PROMESA Oversight Board the option of moving it to May 1, which it did at the end of January.) Gov. Rosselló, in his plan, has argued that it was reasonable to ask for an extension, because his predecessor failed to use his time in office after PROMESA’s enactment to seek a negotiated debt restructuring: he said the extension would allow his administration time to release FY2015 and 2016 financial information, noting he would prefer reaching a negotiated agreement with creditors, rather than having a court impose restructuring terms. (Title VI of PROMESA allows the Oversight Board to reach negotiated solutions with municipal bondholders while the stay is in effect.) Indeed, in his plan he submitted at the end of last month, Gov. Rosselló said the Board probably will start PROMESA Title III’s court-supervised bankruptcy process before the stay elapses. Unsurprisingly, groups representing holders of both general obligation and Puerto Rico Sales Tax Financing Corp. (COFINA) senior bonds have said they are opposed to extending the litigation stay: José F. Rodríguez, an individual investor, as well as several investment firms, such as Decagon Holdings, GoldenTree Asset Management, and Whitebox Advisors—who are the main bondholders of the Puerto Rico Sales Tax Financing Corporation (COFINA)—will appeal U.S. District Court Judge Francisco A. Besosa’s ruling in favor of several general obligation bondholders, spearheaded by the Lex Claims and Jacana Holdings funds.  Mr. Rodríguez’s intentions—and those of several investments funds—to appeal the ruling at the First Circuit Court of Appeals was disclosed on Monday, making this the sole lawsuit against the U.S. territory which is currently active, after the approval of PROMESA last year, and in the midst of the automatic stay on litigations decreed by the federal statute. The plaintiffs are holding nearly $2 billion in COFINA senior notes.

According to the court’s notice, Mr. Rodríguez and the funds led by Decagon will go to the federal court to request revocation of Judge Besosa’s ruling: the Judge had agreed to hear Lex’s case, notwithstanding the request made by the main COFINA bondholders, Puerto Rico, and the PROMESA Oversight Board to apply the automatic stay on litigation. Last month, Judge Besosa—who had previously ordered Puerto Rico not to lose any time in commencing negotiations with its creditors—concluded that Lex’s lawsuit should be examined on its merits, with this judicial effort coming, even as the territory’s general obligation bond holders have asked Judge Besosa to declare the Emergency Moratorium Act unconstitutional, arguing that the enactment of the statute prompted Puerto Rico to default on its general obligation bonds other debt obligations. GO bondholders have also asked Judge Besosa to ban the government from paying COFINA bondholders—who are essentially the only ones who continue receiving payments for the amount they are owed, and to declare COFINA a null structure, since it served to divert the funds which it believes belong to the central Government. In his verdict, Judge Besosa denied the Government’s petition to halt the case and authorized the PROMESA Oversight Board to intervene in the lawsuit; however, he rejected the request made by COFINA’s primary bondholders to be part of the lawsuit to determine if the stay on litigations is applicable or not. In the wake of his decision, the Oversight Board filed a motion to appeal the decision—a request to which Puerto Rico has yet to intervene—notwithstanding apprehensions that the Lex Claims litigation could result in certain of the territory’s assets being frozen, something which would be likely were Judge Besosa to determine that the Moratorium Act is unconstitutional. According to the case file at the Court of Appeals, the Oversight Board has until March 24th to act.  

COFINA Under Attack. Likewise, the appeal made by the group of COFINA’s primary bondholders in the Lex Claims case arrives at a time when the GO bondholders have launched a media campaign asking for the elimination of the public corporation that issues debt payable with the Puerto Rico Sales and Use Tax (IVU, by its Spanish acronym). Last week, Senate President Thomas Rivera Schatz and House Speaker Carlos “Johnny” Méndez backed COFINA and pointed out that the entity was lawfully created with the endorsement of both main political parties. However, in the fiscal plan prepared by Ricardo Rosselló Nevares’s administration and certified by the OB on Monday, the IVU funds that are sent every year to COFINA appear as part of the revenues the Government would use to pay for public services. In that sense, Rosselló Nevares’s plan is an echo of what former Governor Alejandro García Padilla did, which was to combine all revenues that, according to the bond contracts, should have been reserved for the repayment of the debt. According to Gov. Rosselló Nevares’s plan, one of the revenues would be what is allocated to the General Fund—10.5% of the IVU—, but the plan also adds an allocation identified as “Additional IVU”. In this allocation, which is referred to COFINA, the IVU allotments to foster the film industry and for the Municipality Financing Corporation add up to $850 million this fiscal year. The amount increases to $906 million in FY 2019, and continues to increase until it reaches $9.936 billion in 10 years.

 

The Promise of PROMESA

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eBlog, 6/30/16

In this morning’s eBlog, we applaud Sen. Majority Leader Mitch McConnell’s leadership in securing swift passage of the House-passed PROMESA legislation yesterday in the full Senate, clearing the way for the President to sign the bill into law and for the appointment of a financial control board.

Puerto Rico: Ensuring Essential Public Services. With Senate Majority Leader Mitch McConnell (R-Ky.) advising his colleagues: “The U.S. territory of Puerto Rico is in crisis, it owes billions of dollars in debt, and it could be forced to leave residents without essential services like hospitals and public safety resources without prompt congressional action…this bill [PROMESA] won’t cost the taxpayers a dime…What it will do is help Puerto Rico restructure its financial obligations and provide much-needed oversight to put into place reforms,” the Senate voted 68-30 to pass and sent the legislation for President Obama’s signature—avoiding default on a $2 billion debt payment due tomorrow. As enacted, the new law will create a process to guide what looms as the largest municipal-debt workout in U.S. history; it comes as Puerto Rico’s government has already commenced defaulting on $70 billion in debts. As enacted, the new neither authorizes nor prevents a default; rather it provides the U.S. territory with a stay against creditor litigation. In the wake of passage, President Obama called the bill “critical first step toward economic recovery and restored hope for millions of Americans who call Puerto Rico home,” adding “I look forward to signing the bill into law, and remain committed to working with Congress and the people of Puerto Rico to return to lasting economic growth and opportunity. U.S. Treasury Secretary Jacob Lew noted: “In a world where people have given up on Washington to deal with technical, complicated, controversial things, it ought to be a moment of some encouragement.” The Congressional action came against a background of increasing fiscal pressure: U.S. hedge funds, which own Puerto Rico’s most senior municipal bonds, had strongly opposed the Congressional legislation, and had even sued to block a local debt moratorium measure, had argued that their bonds were “required to be paid first in times of scarcity, ahead of even what government deems ‘essential services.’” Some municipal bond investors and outside political groups spent millions of dollars on a lobbying effort to kill the debt-relief bill, which could force them to accept larger upfront losses on their investments. U.S. Treasury officials had warned the lawsuit hinted at the likelihood that investors would seek an injunction in the event of a default that would force Puerto Rico to cut essential public services to pay its constitutionally prioritized debts. In an odd pairing, labor unions also opposed the legislation.

Some bondholders say the island’s government, with the blessing of the Treasury Department, has made Puerto Rico’s difficulties worse by threatening to default on debt. They say the territory has exaggerated its financial difficulties.

Pedro Pierluisi, Puerto Rico’s nonvoting member of Congress, applauded PROMESA’s passage and said he is “firmly convinced that it is the best legislative solution to a terrible problem” that his constituents have been forced to confront: “Once the President signs the bill into law, the next step will be to select the seven members of the oversight board,” he added: “I intend to play a role in this process, because it is critical that the board members be intelligent, hard-working, fair, and familiar with Puerto Rico. It is my hope and expectation that at least several of the board members, in addition to being highly qualified, will be of Puerto Rican birth or descent or have strong ties to Puerto Rico.” The legislation authorizes a seven-member oversight board, appointed by the President with input from Congress, with one of the board members required to either have a permanent residence or place of business in the commonwealth. The oversight board will be tasked with overseeing Puerto Rico’s finances and approving any court-supervised debt restructuring. The oversight board PROMESA would create would have the power to require balanced budgets and fiscal plans, as well as to file debt restructuring petitions on behalf of the Commonwealth and its entities in a federal district court as a last resort if voluntary negotiations do not succeed. It would also have the power to require Puerto Rico to follow recommendations it makes, even if the commonwealth’s government disagrees.

Republicans have been wary of the bill’s restructuring process for its similarity to municipal bankruptcy and the possibility it could create a precedent for fiscally troubled states, such as Illinois to come to Congress asking for similar treatment—members, that is, apparently unfamiliar with the nation’s dual sovereignty. Democrats have been concerned with, among other things, the way the oversight board would be structured and its unilateral decision-making power. They also have condemned a separate provision that would allow the governor of Puerto Rico to authorize employers to temporarily pay employees under the age of 25 a $4.25 per hour minimum wage instead of the federal minimum wage of $7.25.

The Pressure of Looming Deadlines in Municipa Finance

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eBlog, 6/22/16

In this morning’s eBlog, we explore the difficult transition challenge in Detroit of the state’s public school system after 7 years of state control back to the city; we observe the deteriorating fiscal collapse of the small municipality of Opa-locka, Florida; and we observe the increasingly frantic negotiations, threats, and litigation in Puerto Rico as its big deadline approaches the week after next.

Public Schooling on Municipal Bankruptcy. Detroit Public Schools Emergency Manager and retired U.S. Bankruptcy Judge Steven Rhodes plans to meet with both Michigan officials and Detroit families this week to explain and discuss the implementation of the state’s $167 million “rescue” plan for the Detroit Public Schools (DPS) which Gov. Rick Snyder signed into law yesterday—which includes $467 million in debt relief and $150 million in start-up costs for creation of a new debt-free school district—at a meeting today at which key players from Gov. Rick Snyder’s office, the state Treasury, and the Michigan Department of Education are expected. Under the new laws, the school district will be divided on July 1 into two corporations as part of this plan enacted to prevent the system from filing for municipal bankruptcy: The existing DPS district will stay intact for tax-collection purposes to retire $617 million in debt over 8½ years, including $150 million for transitional startup costs to launch a new district and to ensure it has enough cash flow to operate. The new district, which will receive the $617 million infusion of state funds to cover the lost tax revenue, will educate students. A new school board will be elected in November, and a commission of state appointees that oversees city budgets will also review the schools’ finances. The new law splits the old DPS in two, leaving the old entity to pay off debt through existing millage, while a new debt-free district will receive its full state funding allowance to focus on education. Judge Rhodes is expected to serve as an official “transition manager” for the newly created school district. Under the legislation, the transition manager would run Detroit schools until new school board members take office next January after November’s elections. Judge Rhodes wants to ensure everyone “is on the same page as it relates to knowledge” of the legislation, so that participants can begin working together on a project management plan to implementing the state assistance package and launch of a new Detroit Public Schools Community District.

The learning curve will be challenging: the state assistance plan was adopted on a partisan vote without a single vote of any Detroit legislator: the greatest challenge is likely to be with regard to charter school proliferation in the city and the growing percentage of special education students who attend the traditional public school district. Because the new state law omits a proposed commission which would have had governing authority with regard to the placement of traditional and charter schools in the city, there are expected to be significant challenges for the new DPS. Indeed, Michigan Education Superintendent Brian Whiston yesterday noted: “The conversation isn’t going away,” adding that charter school proliferation is also causing challenges for other urban school districts in Saginaw, Benton Harbor, and Pontiac—or, as Mr. Whiston described it: work creatively to get more funding (for DPS) if we have to…and also to look at how we manage the opening and closing of schools — to do it in a way that provides parents’ choices, which is important, but also in a way that we manage those choices.” (One of the newly enacted state DPS provisions directs the state to develop an “A-to-F” grading system, so Detroit parents can better decide which schools, whether traditional or charter, are the best.

Will There Be a State Bailout? Opa-locka, Florida leaders have met in an effort to address critical financial crises which threaten to plunge the small municipality into municipal bankruptcy—with Commissioners voting earlier this week to dip into resources in the city’s wastewater reserve fund to make payroll this week—even as the small municipality has stopped payments to mechanics who work to keep the municipality’s old police cars working: Opa-locka is over $1 million in debt. But even that debt seems to pale compared to the growing, day-to-day challenge of operating, a challenge so severe the city commission had felt compelled to dip into the municipality’s sewer fund reserves. Florida’s Gov. Rick Scott has already declared a state of emergency for the city—and now recognizes it might have to act to bail the city out. Even the city’s governance has been challenged, with the commission appointing former mayor John Riley to fill an open commission seat after former commissioner Terence Pinder killed himself—as he was confronting bribery charges. The new Commissioner Riley told his colleagues: “First of all, I want to really find out the status of the city and what’s been done and what’s not been done.”

Tropical Fiscal Storm. Hedge funds Jacana Holdings, Lex Claims, MPR Investors, and RRW I yesterday filed suit in federal court in New York, seeking to have the federal court bar Puerto Rico from using its April-adopted Puerto Rico Emergency Moratorium and Financial Rehabilitation Act for its general obligation bonds—and to seek the court’s intervention to mandate that Puerto Rico prioritize the payment of the it general obligation (GO) bonds.  (The plaintiffs filing currently hold bonds from Puerto Rico’s $3.5 billion 2014 GO bond sale—municipal bonds for which the bond’s indentures specify the underlying bonds are to be governed by New York law and use New York’s courts to resolve disputes.) The suit charges that “Governor Alejandro García Padilla has willfully violated the first priority guaranteed to general obligation bonds by Puerto Rico’s constitution and has flouted centuries-old federal constitutional protections for contract and property rights…,” adding that the “Moratorium Act is transparently unlawful.” Unsurprisingly—and even as the U.S. Senate could act by as early as next week to take up and consider the House-passed PROMESA legislation—the U.S. territory of Puerto Rico decried the resort to litigation as a failure to “continue good faith negotiations…” much less to “acknowledge the reality of the commonwealth’s fiscal crisis: This attempt by hedge funds to disrupt the commonwealth’s ability to keep the lights on and provide essential services for the 3.5 million Americans on the island makes clear that the Senate must act and pass PROMESA before July 1.”

In filing suit—rather than awaiting Congressional action or working for good faith resolution, the plaintiffs, in their filing, charged that the “Puerto Rico legislature lacks the legislative authority to modify New York’s law of contracts…,” adding that “In case the available revenues including surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid,” but also adding that Puerto Rico’s Moratorium Act breaks the contract and due process clauses of the U.S. constitution. The filing occurs in the midst not only of Congressional action, but also confidential creditor debt negotiations, including with some of the litigants and other holders and insurers of Puerto Rico GO and Sales Tax Finance Corp. (COFINA) debt—negotiations which the Puerto Rico Government Development Bank yesterday reported had broken down.

Yesterday’s hedge fund suit followed in the wake of a growing pile of suits against Puerto Rico: last month hedge funds holding more than $750 million of the debt of the GDB revived a lawsuit, accusing the U.S. territory’s government of “changing the rules of the game” by amending the Moratorium Act, seeking in the revived litigation to overturn the Moratorium Act and Law 40, which Puerto Rico amended last month. Last week, municipal bond insurer National Public Finance Guarantee sued Puerto Rico in the U.S. District Court for the District of Puerto Rico, seeking to overturn the Moratorium Act. The resort to federal court likely emerges from both the faltering confidential talks with some of Puerto Rico’s municipal bondholders, as well as perceptions that litigation might produce a richer outcome for hedge funds than the pending PROMESA legislation likely headed to the signature of President Obama. All this comes as the proverbial clock is running down to next week’s deadline for Puerto Rico to pay $2 billion it does not have in interest and principal due on a variety of securities, which Governor Alejandro Garcia Padilla has made clear Puerto Rico cannot pay in full. Bloomberg reported that Puerto Rico’s benchmark general-obligation bonds traded yesterday at about 66 cents on the dollar to yield 12.8 percent.

The Governing Challenge in Averting Insolvency

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eBlog, 6/10/16
In this morning’s eBlog, we consider the bipartisan legislation overwhelming passed by the U.S. House of Representatives last night to address Puerto Rico’s looming insolvency—and a related U.S. Supreme Court decision; then we look at the almost Detroit Public Schools filing for chapter 9 municipal bankruptcy. It almost seems as if these events and actions were staged just for my fine graduate class on public policy process.

 

Oye! The House last evening passed and forwarded to the Senate legislation to address Puerto Rico’s looming insolvency on a bipartisan 297-127 vote: Speaker Paul Ryan (R-Wi.) and Minority Leader Nancy Pelosi (D-Ca.) took to the House floor to urge support for the legislation, with Speaker Ryan noting: “The Puerto Rican people are our fellow Americans. They pay our taxes. They fight in our wars…We cannot allow this to happen.” The bill now heads to the Senate, where there is little evidence Senators are eager to remake the bill wholesale, particularly as conditions on the island continue to worsen. The only amendment to fail was one offered by Democrats that would have struck a provision of the bill permitting Puerto Rican employers to pay workers under 25 years old less than the minimum wage. The legislation is critical as Puerto Rico—being neither a municipality, nor a state, falls into a Twilight Zone in terms of authority to address an insolvency. Puerto Rico has defaulted on three classes of municipal bonds, including last month when it missed most of a $422 million payment, and faces $2 billion in payments on July 1 that the island’s governor said cannot be paid. That final vote on the amendment was 196 in favor to 225 against. Puerto Rico’s government has begun defaulting on $70 billion in debts, and has warned it could run out of cash this summer.

In pressing for the vote, the Speaker warned that pressure would mount on Congress to spend money rescuing the territory if it could not arrest its economic decline, telling his colleagues: “This bill prevents a bailout. That’s the entire point…if we do not pass this bill…there will be no other choice.” Anne Krueger, a former IMF economist who led a detailed review of Puerto Rico’s economy, has warned: “Come July 1, if nothing is done, Puerto Rico will technically be bankrupt…Assets will be tied up in courts. It is very likely that essential services will have to be suspended.”

As drafted, the House-passed legislation does not commit a single federal dollar to Puerto Rico. The legislation creates a federal oversight board—whose members will be appointed by Congress and President Obama, and not the governor—to determine whether and when to initiate court-supervised debt restructuring: it charges the board with the responsibility to determine the hierarchy of municipal debt obligations and encourages it to respect the existing legal framework, which places constitutionally backed general obligation debt above pension liabilities. The board terminates after Puerto Rico regains the ability to borrow at reasonable interest rates and balances its budget for four consecutive years. Congressional leaders and the Treasury hope the bill will avert a long, expensive courtroom battle between hedge funds and the federal government—a battle that could harm investment in the U.S. territory’s economic future and undercut its ability to provide essential public services (servicing Puerto Rico’s current debt burden today absorbs approximately 30 percent of the Commonwealth’s revenues)—especially as Puerto Rico is now at the forefront of the Zika virus. While critics have falsely warned the bill could set a precedent for distressed states to seek similar relief, the dual sovereignty created by the founding fathers—or statesmen—in the U.S. Constitution clearly undercuts such claims: Congress granted U.S. citizenship in 1917 under the Jones-Shafroth Act to residents of Puerto Rico, which was seized in the Spanish-American War of 1898. The U.S. gave the territory the right to elect its own governor in 1947.

 Republicans have been concerned that the language would allow the to-be appointed oversight board to elevate pensions above the island’s full faith and credit general obligation municipal bond debt: Rep. John Fleming (R-La.) submitted an unsuccessful amendment to require compliance with the legal hierarchy, calling the statutory use of the word “respect” a “weasel word.”

Hear Ye! By coincidence, the U.S. Supreme Court chimed in almost simultaneously in a 6-2 decision (Commonwealth of Puerto Rico v. Sanchez Valle et al., (2016), No. 15-108, involving a simple criminal prosecution for firearms sales, but also the related governance issue of the Commonwealth’s autonomy—a case in which attorneys for Puerto Rico argued that it should be able to try two men who already had pleaded guilty in federal court. Justice Elena Kagan, writing for the majority, said that would amount to double jeopardy, writing: “There is no getting away from the past…Because the ultimate source of Puerto Rico’s prosecutorial power is the federal government…the Commonwealth and the United States are not separate sovereigns.” Reasoning that even though Congress, in 1950, gave Puerto Rico the authority to establish its own government under its own constitution, that did not, in and of itself, break the chain of command that originates with Congress. As a result, the majority determined, the Commonwealth should be treated the same as other U.S. territories. While the 50 states and even Indian tribes enjoy sovereign powers that preceded the union or were enshrined in the U.S. Constitution, Justice Kagan wrote, Puerto Rico in 1952 “became a new kind of political entity, still closely associated with the United States, but governed in accordance with, and exercising self-rule through, a popularly ratified constitution,” adding that Puerto Rico’s Constitution, significant though it is, does not break the chain.” Justice Ruth Bader Ginsburg went further in her concurrence, suggesting that the high court should hear a case that tests whether states and the federal government should remain able to try defendants for the same crime.

During oral argument last January, a majority of Justices appeared to side with the Obama administration, which argued that, as a territory of the United States, Puerto Rico cannot try the gun dealers after federal courts have acted, with Asst. Solicitor General Nicole Saharsky arguing: “Congress is the one who makes the rules.” The majority appeared to agree: Justice Kagan, writing for the majority, noted: “If you go back, the ultimate source of authority is Congress.” Nevertheless, in their dissent, Justices Stephen Breyer and Sonia Sotomayor stood by Puerto Rico — with Justice Breyer writing that if the court ruled against it, “that has enormous implications” for setting back the U.S. territory’s legal status: “Longstanding customs, actions and attitudes, both in Puerto Rico and on the mainland, uniformly favor Puerto Rico’s position — that it is sovereign, and has been since 1952, for purposes of the double jeopardy clause.” Justice Sotomayor, whose parents were born in Puerto Rico, said during oral argument that the island is an “estado libre asociado” Ironically the case was the first of two involving Puerto Rico to come before the high court this term. The Court is also re weighing the Commonwealth’s effort to restructure part of its $70 billion public debt, an issue addressed last evening by the House: a federal appeals court blocked the restructuring because of conflicts with U.S. bankruptcy laws.

Schooling for What If & Municipal Bankruptcy. With uncertainty whether the Michigan legislature would be able to pass and send legislation to him before the Detroit Public Schools exhausted all its cash—and before the legislature completed its session, Gov. Rick Snyder’s administration had commenced discussion with regard to drafting a chapter 9 municipal bankruptcy filing for DPS—in some apprehension of a wave of vendors’ and employees’ suits against DPS—the city’s public school system foundering in more than $515 million in outstanding operating debt: key staff worked with attorneys on a possible DPS chapter 9 bankruptcy, and Gov. Snyder had exchanged text messages with his former law school colleague and appointee as Detroit’s Emergency Manager, Kevyn Orr, who had, as we have catalogued, served as Emergency Manager in charge of both taking Detroit into municipal bankruptcy, and then piloting it through its successful emergence and approval of its plan of debt adjustment. Michigan State Treasurer Nick Khouri recently estimated the DPS would need $65 million for capital costs, including deferred maintenance and upgraded security equipment; $125 million for cash flow needs due to the timing of school aid payments and other startup expenses; and $10 million for academic programming. Now, in the wake of partisan action on which we reported yesterday, DPS will be able to make payroll, pay vendors, and purchase supplies this summer to prepare for school this fall. Logistically, the new school district will be created by July 1: retired U.S. Judge Steven Rhodes, DPS’s emergency manager appointed by Gov. Snyder and now serving as DPS’ transition manager, is working with state administrators to implement the new agreement.

Scooping & Tossing in Puerto Rico & Actions that Could Shape a City’s Future in Michigan

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eBlog, 6/03/16

In this morning’s eBlog, we consider a critical audit commission report released yesterday in Puerto Rico: a report which could have significant implications for Congress when it takes up HR 4900, the Committee on Natural Resources Puerto Rico Oversight, Management, and Economic Stability Act or PROMESA, as early as next week, as well as passage last night in the Michigan House of legislation to address the Detroit Public Schools’ looming insolvency: ironically both DPS and Puerto Rico confront July 1 deadlines. 

Scooping & Tossing. The Puerto Rico Public Credit Comprehensive Audit Commission, a government-appointed commission made up of 17 members, including elected officials, representatives of the financial institutions, credit unions, academics and organized labor, in an audit published yesterday, suggests that much of the territory’s debt may have been sold illegally—and that Puerto Rico may be able to void some of its borrowing repayment obligations because politicians exceeded constitutional debt limits and their own authority: that is, potentially the finding would permit the government to declare the tax-exempt bonds invalid and courts to then decide that creditors’ claims are unenforceable. The scope of the audit report covers the two most recent full-faith-and-credit debt issues of the Commonwealth: Puerto Rico’s 2014 $3.5 billion general-obligation bond offering and a $900 million issuance in 2015 of Tax Refund Anticipation Notes to a syndicate of banks led by J.P Morgan. The report’s conclusions may allow the Commonwealth to pursue a strategy with even more dire consequences for the island’s municipal bondholders: the report says that Puerto Rico may have violated its constitution by borrowing to finance deficits, borrowing beyond its debt ceiling and using a refinancing technique called the “scoop and toss” to effectively exceed bond-duration limits.

Funds to meet these debt obligations are not in the Commonwealth’s proposed budget: this Tuesday, Gov. Alejandro García Padilla, sent a proposed FY2017 budget to the island’s legislature that provides for only $209 million of the $ 1.4 billion of current debt-service cost. As Gov. Padilla told reporters at a news conference: “This is simple: either we pay Wall Street or we pay Puerto Ricans. If the legislature decides we pay Wall Street more, well, each has his responsibility. I will continue defending Puerto Ricans. Money I send to Wall Street, I do not have to provide services here.”

Puerto Rico defaulted May 1 on a portion of its $72 billion in outstanding debt, but the commission’s audit covers two debt issues expected to default on July 1. 

The Puerto Rican constitution contains a balanced-budget clause that explicitly prohibits borrowing to finance operating deficits, but its politicians borrowed to cover deficit financing in its 2014 General Obligation Bond Offering, according to the commission’s initial review. The March 2014 General Obligation Bond states that the proceeds would be used in part to cover deficits that had accumulated and that were expected to occur in the year of the offering. The documents include a chart showing deficits financed with borrowing during the past and that were expected to recur. In addition, Puerto Rico did not inform its bondholders that its constitution forbids it from using debt to finance deficits. That, the Commission’s report suggests would constitute “substantive” noncompliance with the letter of the Constitution.

The U.S. Supreme Court has said in the Litchfield v. Ballou case and, more recently, in litigation related to Detroit’s bankruptcy that borrowing above a debt ceiling may allow the issuer to declare debt invalid and, therefore, unpayable. Detroit, in its plan of debt adjustment, sought to invalidate $1.45 billion in COPs (certificates of participation), debt issued by two shell companies called “service corporations.” The parties settled before the case went to trial, but, while refusing two initial proposed settlements, U.S. (now retired) Bankruptcy Judge Steven Rhodes determined that Detroit’s argument had “substantial merit” and that the suit would have had a “reasonable likelihood of success.” According to Melissa B. Jacoby, a professor of law at the University of North Carolina who specializes in distressed debt, negotiations have been complicated by claims that certain tax-exempt bonds are special and have priority over debt held by other creditors. She states: “But if some debt was issued illegally, then, at the very least, those creditors’ claims of priority are dramatically weakened: Indeed, they would be lucky to get anything at all.”

The commission itself is a creature set up two years ago, with yesterday’s report its first step in the commission’s work output: it includes many of the most powerful members of the Puerto Rico legislature; it also included Melba Acosta Febo, president of the Government Development Bank for Puerto Rico, several prominent Puerto Rican economists, accountants, business leaders, and one union official. In its report, the commission suggests that Puerto Rico’s selling of bonds going back to 1979 may have illegally broken the Puerto Rican constitution’s requirement for a balanced budget. The consequence of this may be that a court may bar it from borrowing in the future to finance operating deficits: the Commonwealth may be forced to raise taxes, or “declare the debt unpayable for lack of authorization.” (Puerto Rico’s constitution states that it cannot spend more than 15% of “internal revenues” in its Treasury on GO debt. Depending on definitions, it may be exceeding this level, according to the commission.) The report also finds that the constitution’s prohibition against issuing debt with more than 30 year maturities may have been broken through the sale of refunding bonds, and it questions whether the commonwealth and its advisors and underwriters complied with SEC Rule 15c(2)-12, which bars the sale of debt when an issuer is not disclosing financial information in a reasonable and timely manner.

Howard Cure, Director of municipal research at Evercore Wealth Management yesterday noted: “It seems as if this commission is trying to re-write history by questioning the commonwealth’s ability and authorization to have entered into many of their recent debt agreements…The idea of requiring a balanced budget is somewhat spurious since most states, as well as the commonwealth, don’t distinguish between a balanced budget on a cash or an accrual basis. Since most states look at their budget on a cash basis, there have been various gimmicks to balance operations such as deferring salaries or leasing back facilities. States such as California and Connecticut have also deficit financed their operations at various points in time…Questioning the actual authority to have entered into these debt issuances seems dubious.”

Focusing on Not Leaving a City’s Children Behind. Michigan House Speaker Kevin Cotter (R-Mount Pleasant) yesterday, in the wake of House passage of a legislative package by which Michigan would help pay off Detroit Public Schools’ (DPS) crippling debt and provide more transition aid under a $617 million rescue plan, described the marathon outcome as a “a plan put forward to save education in Detroit, not just an entity…and at the same time avoid what would be a disastrous [municipal] bankruptcy.” What’s not included in the adopted House plan is a Detroit Education Commission that would have authority over some charter and public schools, especially where the schools are located in the city.

In this set of bills, an advisory council will produce non-binding reports on where schools and transportation are needed in the city. Of the $150 million in transition costs, only $25 million can be used for maintenance and improvements in the district’s deteriorating school buildings. The rest of the money can be used for items such as teachers, vendors, financial services, human resources, cash flow needs, and improvements to technology in the new school district. The legislation also includes anti-strike language with substantial fines for teachers, administrators and school board members in response to sick-outs staged by Detroit teachers earlier this year to bring attention to the horrible conditions in the schools and the prospect of payless paydays. 

Final legislative action and the Governor’s signature on some plan is key before DPS runs out of cash on June 30th. Earlier yesterday, Michigan Governor Rick Snyder, speaking at the Mackinac Policy Conference, had warned that a lack of financial stability in DPS this summer could cause more students to leave the school system, which has seen its enrollment plunge from 150,000 students a decade ago to about 46,000 this spring.

The key House action came on a 55-53 vote in the wake of intense talks between legislative leaders and Gov. Snyder: that bill would call for school board elections in November, but does not include a Senate-approved education commission, backed by Gov. Snyder and described as a critical priority by Detroit Mayor Mike Duggan—because of its vital role in determining where traditional and charter schools could locate in the city. Now the six-bill package heads to the Republican-controlled Senate, where it faces its own tests and final exam as early as next week. During House debate, Speaker Cotter said the compromise plan achieves the twin goals of returning the district to local control and relieving district debt, which would free up more money for classrooms, while key sponsor Rep. Daniela Garcia (R-Holland) added the bills will free up money that can go back into Detroit classrooms and provide oversight to taxpayers in other parts of the state.

For his part, Gov. Snyder embraced the House package despite its omission of the commission, calling it “a good step toward a compromise that sets in motion positive progress for the families of Detroit to have a sustainable and successful educational system.” As adopted, the amended House package includes $150 million in transition aid to restore academic programs and fix school buildings. Instead of the commission, vehemently opposed by the charter school lobby, the legislation would provide for an advisory council to produce reports highlighting where schools are needed and study a potential city-wide transportation system to serve all students. The six-member council would include district officials and charter representatives. Poor-performing traditional public or charter schools could be closed under the legislation, which would require the School Reform Office to develop an A-F letter grade system to evaluate schools. Three years with a failing grades would prompt closure. A state-appointed transition manager would run the new debt-free Detroit district until the elected school board took over in January. The manager could appoint an interim superintendent and adopt an initial budget. As passed by the House, the bill would effectively end the governor’s Education Achievement Authority, requiring the new district to withdraw from the inter-local agreement that facilitated its creation. The school board would appoint a new superintendent, but would need approval from Detroit’s Financial Review Commission to hire a CFO, fire a superintendent, or fund out-of-state travel for board members or district officials. The final legislative package includes several reforms previously approved by the House, including: increased penalties for teacher “sickouts,” merit pay, and the option for the school board to hire non-certified teachers to fill vacancies. The House plan differs from a plan passed by the Senate in March that included the DEC, which would be appointed by the Detroit Mayor and have authority over some of the charter and public schools.

The Importance of Bipartisan Leadership in Averting Severe Human & Fiscal Distress

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eBlog, 5/26/16

In this morning’s eBlog, we applaud House Speaker Paul Ryan (R-Wisc.), House Natural Resources Committee Chair Rob Bishop’s (R-Utah), U.S. Treasury Secretary Jacob Lew, and House Minority Leader Nancy Pelosi (D-Ca.) for their leadership roles in contributing to the remarkably swift, bipartisan markup of legislation (PROMESA) to address Puerto Rico’s looming insolvency; and, we continue to follow the seemingly unrelenting challenge in Wayne County to emerge from its fiscal emergency consent agreement.

House Panel Forwards Puerto Rico Legislation. The House Natural Resources Committee yesterday voted 29-10 to send to the full House legislation, HR 5278, to address Puerto Rico’s debt crisis with solid bipartisan support, a strong sign the bill could move quickly through Congress ahead of a potential default by the territory on July 1. As reported, the bill would create a debt-restructuring process and name a seven-member financial control board, not the government elected by Puerto Rico, to determine whether and when to initiate court-supervised debt restructuring, and it would have the power to approve or reject budgets. The board would terminate after Puerto Rico regains the ability to borrow at reasonable interest rates and balances its budget for four consecutive years.to oversee the U.S. territory—not unlike previous control boards in New York City and Washington, D.C.—and similar to the oversight fiscal control board created as part of Detroit’s exit from the largest municipal bankruptcy in American history. The bipartisan vote came despite the strong opposition from some municipal bondholders, hedge funds, and unions: millions of dollars on television advertisements had been expended to defeat it. Chair Rob Bishop (R.- Utah) said he expects majorities of both parties to back the bill when it comes to the House floor when Congress returns the week after next, while in the Senate, Majority Leader Mitch McConnell (R.- Ky.) said Senators were “anxious to take up” whatever the House could pass. The White House supports the measure. The measure was opposed by both labor unions and Puerto Rican elected officials, as well as some House members, who claimed the bill would threaten creditors’ rights and create a potential precedent for distressed states—claims not only inconsistent with the dual sovereignty of the United States, but also because the legislation was done through the territories clause of the U.S. Constitution—or, as David Hammer, co-head of municipal bond portfolio management at Pacific Investment Management Co. put it: “This creates a clear firewall and ring-fences Puerto Rico from the broader muni market,” adding hat, moreover, the debt-restructuring mechanism would require Puerto Rico to cede more power to the federal government, noting: “That’s not something a state or local government would ever seek to do.”

The Committee rejected proposed amendments to delete language limiting Puerto Rico’s minimum wage, ease economic aid to the island, and ban the Federal Reserve from purchasing Puerto Rican bonds or paying down the commonwealth’s debt—as well as amendments focused on Puerto Rico’s constitutionally guaranteed debt. (Roughly $18 billion of the more than $70 billion in Puerto Rican municipal debt is backed by its constitution.) The committee also rejected an amendment from Rep. John Fleming (R-La.) that critics said would not give the board enough flexibility to properly sort out debt repayment priorities according to the Puerto Rican Constitution. The bill cleared committee with one significant change. The adopted amendment from Rep. Garret Graves (R-La.) mandates that no federal money can go to paying down or buying Puerto Rican debt or liability, which could help tamp down Republican fears of a potential bailout.

Pensionary Solvency. Wayne County, Michigan Executive Warren Evans has taken another step in pressing his commitment to take the county surrounding Detroit out of its emergency consent agreement by the end of this year by, yesterday, announcing the County will make an additional $14 million contribution toward its underfunded pension system—a contribution which will be in addition to the $63 million which the County is currently obligated to pay annually into its retirement fund, but falls short of the $19 million county officials originally anticipated they would be able to afford. In FY2014, Wayne’s pension audit revealed some $840.5 million of unfunded pension liabilities. According to Wayne County spokesman James Canning, last December officials determined the County could make a $10 million contribution into the pension fund from funds declared as surplus from its Delinquent Tax Revolving Fund and Property Forfeiture funds; in addition Wayne anticipated it could funnel another $9 million from fund balances—albeit, in the wake of a third-party administered study on its pension system conducted earlier this year, the County determined it would only be able to contribute an additional $4 million from the fund balances. When the County entered into the consent agreement, it faced an accumulated deficit of $82 million, a yearly structural deficit of $52 million, $1.3 billion in unfunded health care liabilities, and a pension fund that was underfunded by nearly $900 million. By last month, according to its CAFR, its FY15 year-ending accumulated deficit of more than $82 million had been eliminated and the books were closed with a $35.7 million unassigned surplus—albeit some $30 million of that was earmarked for specific uses, leaving Wayne County with a surplus of only $5.7 million.

Other key steps involved reductions in other post-employment benefits, where the County achieved reductions of about $850 million in unfunded liabilities—reducing its OPEB liability by 65%, and bringing the county’s pay-as-you-go contribution this year down more than 50 percent from $40.4 million to $17.6 million—savings achieved by switching some retirees to what the county deems more “cost-effective health plans and providing others with need-based stipends to purchase their own insurance.” Absent such changes, Wayne County had warned that the actuarial accrued liability was on track to rise to $1.8 billion.

The Route out of Municipal Bankruptcy

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

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

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

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

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

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

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

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

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