Municipal Bankruptcies Are Complicated Affairs. Really.

August 17, 2018

Good Morning! In this morning’s eBlog, we consider a rejection of an appeal challenging Jefferson County’s approved plan of debt adjustment from its chapter 9 municipal bankruptcy, and the recurring governance challenge in the U.S. territory of Puerto Rico whether the elected Governor and Legislature—or a federal Judge, or a Control Board ought to be making vital governing decisions.

Please note, there will be a temporary respite for eGnus and eBlog readers before publications resume the last week of this month.

A Fiscally Appealing Chapter 9 case? The U.S. Eleventh Court of Appeals has dismissed a challenge to Jefferson County’s chapter 9 municipal bankruptcy plan of debt adjustment, holding (please see Andrew Bennett et al v. Jefferson County, No. 15-11690, 11th U.S. Circuit Court of Appeals, August 16, 2018), holding that the U.S. District Court had erred when  it dismissed Jefferson County’s appeal, holding that the Chapter 9 case brought by a group of ratepayers of Jefferson County’s sewer system could be brought due to the concept of “equitable mootness,” a doctrine the court wrote which, until yesterday, “we have not been asked to apply in a chapter 9 municipal bankruptcy case,” with the court adding: “Municipal bankruptcy proceedings are usually complicated affairs, and the chapter 9 proceeding for Jefferson County, Alabama, involving about $3.2 billion in total sewer-related debt—has proved no different.”

Under the terms of the decision, the County would cut over $100 million in general fund expenditures, and the creditors will write off a significant amount of outstanding debt—over the course of the next four decades, the County is directed to implement a series of single-digit sewer rate increases—totaling about 365%–an amount which the court noted was “not far off of the national increase in inflation in the previous 40 years.” The court, in effect, with its decision, rejected the assertion by County ratepayers that their plan “validated corrupt government activity.”

The court also reviewed, de novo, the lower court’s conclusion that the doctrine of equitable mootness applied to this case—at that lower court, Jefferson County had argued the doctrine of equitable mootness applied and barred the ratepayers’ appeal from the U.S. bankruptcy court. The court here agreed, explaining why said doctrine could apply in a municipal bankruptcy case. (Essentially, the doctrine, the court explained, the courts may, under certain circumstances, reject bankruptcy appeals if the underlying rulings which would have gone into effect would have been “extremely burdensome.” The court went on to decide that some of the principles “will weigh more heavily in chapter 9 municipal bankruptcy cases “precisely because of how many people may be affected,” unlike in a chapter 11 bankruptcy, noting previous chapter 9 municipal bankruptcies we have written about in Stockton and Vallejo, where the district courts’ reasoning involved the implications that “municipalities and their bankruptcies implicate issues of sovereignty; whereas corporations or individuals and their bankruptcies do not—and that, accordingly, it is important for us to tread carefully where self-governance is concerned.” The court further noted: “In addition, it is not at all clear in which direction the ratepayers’ federalism arguments will cut from one chapter 9 bankruptcy to the next. Given the interests of the municipality and those of its residents (among others), there is a countervailing argument that a court ought to be more solicitous to the municipality that has obtained confirmation of its plan….”

Finally, the court recognized that “given the centrality of the constitutional rights to the fabric of the republic, there is a fair argument to be made that we should allow some leniency when a party which has allowed a bankruptcy plan to go into effect asserts,” adding, with regard to federalism concerns, “it will be appropriate to note them when deciding whether the doctrine should bar an appeal in a particular bankruptcy case,” which, is, as the court noted: “precisely what we did.”

 Jefferson County Commissioner David Carrington, a previous State & Local Leader of the Week, who led the county’s negotiations during its municipal bankruptcy case, said County leaders are pleased with the ruling, noting: “We were always confident in our Chapter 9 plan of adjustment,” but wincing that the years of litigation had come at great expense to county taxpayers running into “hundreds of thousands of dollars in frivolous litigation fees that could have been used for capital improvements to the sewer system.” (The County had filed its plan of debt adjustment in November of 2011—a plan subsequently approved by the court five years ago. Nevertheless, as the dean of chapter 9 municipal bankruptcy, Jim Spiotto, noted, the case had become one of the longest municipal bankruptcy cases in U.S. history.

Another Appeal. Meanwhile, south of Jefferson County, Puerto Rico Governor Ricardo Rosselló confirmed yesterday that the executive branch will also appeal the decision of Judge Laura Taylor Swain, the judge assigned by the federal court to deal with the quasi chapter 9 municipal bankruptcy of Puerto Rico—a decision in which it was determined that the PROMESA Oversight Board has the authority to impose its certified fiscal plan and budget, with the Governor stating: “It has become very clear what is the unworthy colonial situation in Puerto Rico, where some courts have decided that in some aspects of the budget the hands are tied to the Legislative Assembly and somewhat to the executive to make determinations, so of course we are going to appeal,” with his comments coming in the wake of Judge Swain’s dismissal, earlier this month, of nine of the allegations presented in the suit of the Financial Advisory Authority and Fiscal Agency (Aafaf), as well as all the allegations of the lawsuit filed by the Puerto Rico Legislature—and the legislative leadership, where the respective leaders, Thomas Rivera Schatz and Carlos “Johnny” Méndez, already filed an information motion before the court notifying it they would attend the First Circuit of Appeals of Boston—albeit, Governor Rosselló, noted, he would not provide them with the power to “make executive decisions with the vehicle of the executive order.”

Colocar el Interruptor. Nearly a year after Hurricane Maria plunged Puerto Rico into physical and fiscal darkness, NPR’s Adrian Florida reports: “Now nearly 11 months after Hurricane Maria plunged Puerto Rico into darkness, officials there say they are done restoring the island’s power: no more lanterns, and no more “candles.” PREPA has announced its work restoring power to the island is done: it took almost a year, tens of thousands of new poles, thousands of miles of wire, and help from two federal agencies. She described it as a “restoration plagued by scandal and delays. It cost some $3 billion. And now that it’s done, experts agree the power grid is just as fragile as before the hurricane. This morning, Jose Ortiz, the fifth CEO to head the power utility since the storm, was offering a reality check on local radio station WKAQ. Some homes still don’t have power because they’re damaged

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Planning Municipal Debt Adjustment

May 21, 2018

Good Morning! In this morning’s eBlog, we take a fiscal perspective on post-chapter 9 Vallejo, before exploring the seeming good gnus of lower unemployment data from Puerto Rico.

Fiscal Reinvention.  After Vallejo, a waterfront city in Solano County of about 115,000 in California’s Bay Area, filed for chapter 9 municipal bankruptcy, just over a decade ago, on May 17, 2008, claiming it could no longer afford to pay wages and benefits promised to its employees; it appears its chapter 9 plan of debt adjustment has worked. The municipality, which served twice as California’s capital, was the nation’s largest city to file for municipal bankruptcy when it did—a period during which, in the wake of cuts of as much as 40 percent in its police force, and closure of its fire stations, leading to sharp increases in crime—there were, consequently, serious declines in assessed property values.  The municipality’s cash reserves disappeared; it was unable to pay its bills amid falling property tax revenue, soaring costs of employee compensation and pension liabilities, and a consequent surge in foreclosures. Thus, with its official exit, the city will be able to resume its governance—albeit, as Moody’s moodily explained last month, the city’s plan of debt adjustment will bequeath “significant unfunded and rapidly rising pension obligations,” adding that in addition to higher taxes, the city will be confronted by “challenges associated with deferred maintenance and potential service shortfalls.” Further, the credit rating agency noted, the “probability of continued financial distress and possibly even a return to bankruptcy.” Today, median household income in the city is under $40,000, while average municipal employee compensation is over $114,000. The city currently has 17 police sergeants receiving compensation packages which range from $220,000-$469,000—in addition to generous promised retirement pensions.  

Vallejo Assistant City Manager Craig Whittom last week noted that the city had been left to determine its Chapter 9 bankruptcy end date in the wake of U.S. Bankruptcy Judge Michael McManus’ approval of the city’s plan of debt adjustment last August—a key component of that plan being the codification of municipal bond repayment obligations to the city’s largest creditor, Union Bank, a plan approved by the Vallejo City Council three weeks ago, with Mr. Whittom noting that Vallejo’s formal chapter 9 exit is important in tangible ways for the city. For instance, he noted the elimination of real estate agents’ requirement to disclose that the city is in bankruptcy when selling properties, albeit conceding that municipal bankruptcy-deferred lawsuits against the city will now be free to go forward.

Nevertheless, leaving municipal bankruptcy is a fiscal challenge of its own—especially in instances where a municipality’s plan of debt adjustment does not take into account public pension obligations. As Ed Mendel of Calpensions explained: “Vallejo received court approval to exit from bankruptcy last week with a plan that includes a sharp increase in pension payments to CalPERS—the opposite of what many expected when the city declared bankruptcy in May 2008,” a resolution which, left the municipality with a proverbial ball and chain around its ankle because, by 2014, the city was confronted by ballooning public pension liabilities, with CNN reporting that Vallejo’s recent public-safety retirees have annual pension benefits which top $100,000 a year, leading Wallet-Hub to describe Vallejo as the “second least recovered city.”  That is, absent the ability to trim benefits for current employees, there are few options to keep pensions from consuming ever-increasing parts of a municipality’s budget.

Nevertheless, the city’s leaders have demonstrated innovative fiscal grit and determination: it has begun reinventing itself, using technology to fill personnel gaps, rallying residents to volunteer to provide public services, and even offering its voters the chance to decide how their taxes will be used—in return for an increase in the sales tax. Now, for the first time in five years, the city expects to have enough money to address potholes, weeds in public rights of way, etc.  

Lessons Learned. Prior to its chapter 9 filing, Vallejo’s salaries for city employees had ballooned: a number of top officials were making $200,000 or $300,000—enough so that some 80 percent of the city’s budget went toward compensation, even as the city’s credit rating was downgraded to junk status—meaning that, as part of the city’s plan of debt adjustment, the municipality paid only five cents for every dollar it owed to its bondholders, while the city also reduced employees’ pay, health care and other benefits—making it harder to attract key employees.  

That meant, as former Councilmember Marti Brown noted, that for Vallejo to fiscally survive, the city needed to study best practices from around the world and bring some of them to California—an effort which, in retrospect, she said turned “out to be a really positive experience for the city.” Together with former Councilmember Stephanie Gomes, the two elected leaders focused on public safety: they went the neighborhood to neighborhood setting up e-mail groups and social media accounts so residents could, for instance, share pictures of suspicious vehicles and other information: the number of neighborhood watch groups jumped nearly 300% from 15 to 350. Moreover, the City Council worked out an unusual compact with residents: in return for agreeing to a one-penny sales tax increase, projected to generate an additional $9.5 million in revenue, the resident gained the right to vote on how the funds would be used: citizen participatory budgeting—the first in a North American city.

This fiscal and governing innovation—or “ground-up restructuring,” as Karol Denniston, a partner with Squire Patton Boggs LLP notes, has meant that, today, Vallejo is “now routinely one of the top 10 cities where people want to live, which is a huge turn-around from when they entered bankruptcy.” The median listing price in Vallejo had soared to $420,000 by last month from $290,000 in May of 2015, according to realtor.com, crediting city leaders for turning around the relationships with its police and fire employees: “It looks like someone was able to improve those relationships: You have to bring the employees and the taxpayers along at the same time to reach a good consensus on financial goals.” Thus, unsurprisingly, last week, Finance Director Ron Millard presented a structurally balanced $105 million budget to the City Council for the fifth consecutive year—proposing reserves of 17.3%, after a strict fiscal diet of austerity measures in the intervening years composed of cutting police and fire services to the bone, tax increases, and economic development measures.

The Challenging Road to Recovery. Puerto Rico’s unemployment rate slipped below 10% last month for the first time in nearly two decades—albeit the change is more a reflection of emigration than economic improvement. According to the Bureau of Labor Statistics, nonetheless, Puerto Rico’s unemployment rate was 9.9%, its lowest level since it was 9.8% in November of 2000—a rate nearly 50% lower than the Spring of 2009. The BLS reported that the number of residents with jobs declined 1% last month from April of 2017 according to the Bureau’s Current Employment Statistics, and this showed total non-farm employment declining last month by 3.6% from a year earlier, with private sector non-farm employment down 3.3% from a year earlier—denoting a further sign of the fiscal challenges ahead as the U.S. territory restructures its debt. Of concern is who is leaving, as Advantage Business Consulting President Vicente Feliciano noted that the “unemployment rate is down mainly due to emigration: Thus, there are fewer people employed, but as a result of emigration, fewer people are looking for a job; meanwhile, the Puerto Rico economy is being impacted by the start of [hurricane-related] insurance and federal transfers.” Nevertheless, he reported that the Economic Activity Index in March 2018 was up with respect to February 2018: “Cement sales are up over 20% in March 2018 compared to March 2017. While these transfers are only beginning, they are non-recurrent and therefore should not be the basis for debt renegotiation.” However, Inteligencia Económica Chairman Gustavo Vélez noted: “The [labor force] participation rate remains very low…The information that I have is that the labor market is not normalized yet. Nevertheless, key industries like construction and retail are doing well because of the federal recovery funds already deployed into the local economy ($10 billion since October 2017).” According to the most recent economic activity index release (March), the index was down 2.6% from a year earlier; however, this was a rebound from the 19.7% decline in November 2017 from November 2016.

Who’s on First? Confidential conversations between the PROMESA Board and Gov. Ricardo Rosselló Nevares’s administration continued over the past few days without the certainty to reach a balance between the revenues and expenses the Government will have during the upcoming fiscal year—a year commencing in little over a month, on July 1st. Yet, even with the adjustments made by Governor Rosselló, following some of the Board’s mandates, government expenses are proposed for some $8.73 billion, a level some $200 million higher than the revenue certified by the Board. Nevertheless, neither the Board, nor the Fiscal Agency and Financial Advisory Authority (FAFAA) have been willing to discuss the preparation of the new budget or the differences, which have been publicly outlined between the parties. For his part, the Governor has refused to accept the revenue scheme certified by the Board to prepare the budget, instead opting to use the numbers contained in the new Fiscal Plan—while the PROMESA Board has objected that pensions adjustments contained in the Fiscal Plan have not been implemented, nor have their proposed labor reforms been listed.

Some parties have indicated that, as part of the process between the parties, Puerto Rico has promised, as required by the PROMESA Board, to eliminate Law 80, a Puerto Rican law which protects workers from unjust dismissals, in exchange for the allocation of some $100 million to municipalities, as well as an increase in funds for the Legislature, the Governor’s Office, and the Federal Affairs Administration. The see-saw issue at a time of steep cuts in Puerto Rican government services and school closures, including limitations in the Government’s Health Plan, has led Gov. Rosselló Nevares’ administration to criticize the seemingly contradictory fiscal situation in which the PROMESA Board has requested nearly a 33% increase from $60 million to $80 million in the amount it receives to finance its operation and bankruptcy lawsuits of the central government and several public agencies, at the same time, as Rafael Hernández Montañez, spokesman of the Popular Democratic Party minority in the House, expressed the Board does not appear to “think the same about the elimination of workers’ rights,” and at the same time the Governor is looking to increase government investment in Puerto Rico’s future.