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  • 1. WAYNE STATE UNIVERSITY FORUM ON CONTEMPORARY ISSUES IN SOCIETY MUNICIPAL BANKRUPTCY IS CHAPTER 9 BANKRUPTCY THE ULTIMATE REMEDY FOR FINANCIALLY DISTRESSED MUNICIPALITIES: ARE THERE BETTER RESOLUTION MECHANISMS? November 21, 2013 JAMES E. SPIOTTO PARTNER CHAPMAN AND CUTLER LLP Copyright © 2013 by James E. Spiotto. All rights reserved. This is part of a book entitled Municipalities in Distress? published by Chapman and Cutler LLP which is a 50-State Survey of State Laws Dealing with Financial Emergencies of Local Governments, Rights and Remedies Provided by States and State Authorization of Municipalities to File Chapter 9 Bankruptcy, which is available from Chapman and Cutler LLP or on Amazon.com., “The Role of the State in Supervising and Assisting Municipalities, Especially in Times of Financial Distress,” by James E. Spiotto in the MUNICIPAL FINANCE JOURNAL, Winter/Spring 2013 and “All Eyes on Detroit: What Happens to Unfunded Pension Liabilities When a Municipality Files for Bankruptcy?” MUNINET GUIDE (August 21, 2013), http:/www.muninetguide.com/print/php?id=604. jamesspiottopresentationreport-131120085353phpapp01.doc
  • 2. TABLE OF CONTENTS HEADING PAGE THE MUNICIPAL BANKRUPTCY EXPERIENCE............................................................. 1 THE LESSONS LEARNED FROM CONSTITUTIONAL CHALLENGES TO MUNICIPAL BANKRUPTCY PROVISIONS...................................................... 1 THE TRADITIONAL ROLE OF STATES IN ASSISTING FINANCIALLY TROUBLED MUNICIPALITIES...................................................................... 4 FINANCIAL CYCLES REQUIRE THAT STATE AND LOCAL GOVERNMENTS PREPARE FOR ECONOMIC DOWNTURNS..................................................4 HOW STATES HAVE ATTEMPTED TO SUPERVISE STATE AND LOCAL GOVERNMENT FINANCING AND VOLATILITY IN TIMES OF ECONOMIC DISTRESS................................................................................. 5 DEBT LIMITATIONS 5 REFUNDING BONDS 5 THE USE OF VARIOUS MECHANISMS BY STATES TO PROVIDE FINANCIAL OVERSIGHT AND ASSISTANCE TO MUNICIPALITIES IN DISTRESS................................................................................. 6 INTRODUCTION 6 STATES RECOGNIZING MUNICIPAL RECEIVERS: RHODE ISLAND AND TEXAS...........8 FINANCIAL CONTROL BOARDS AND THEIR PROGENY............................................... 8 DEVELOPMENT OF THE MUNICIPAL PROTECTION COMMISSION: A PROPOSAL.......11 THE STRUCTURE FOR OVERSIGHT AND EMERGENCY FINANCING...........................13 THE COMPETING FORCES IN A CHAPTER 9............................................................... 18 THE U.S. CONSTITUTION DOES NOT PRECLUDE THE CITIES THEMSELVES FROM SOLVING THEIR PENSION PROBLEMS....................................21
  • 3. THE TREATMENT OF PENSION AND RETIREE HEALTH BENEFITS IN OTHER RECENT CASES.................................................................................... 22 POSTURE OF PENSION ISSUES IN THE DETROIT CASE.............................................. 24 MUNICIPAL OPERATIONS AND CREDITOR PROTECTIONS......................................... 26 “SPECIAL REVENUES” PLEDGED TO BONDHOLDERS................................................27 STATUTORY LIENS PROTECT BONDHOLDERS.......................................................... 32 PAYMENTS TO BONDHOLDERS ARE NOT PREFERENCES..........................................34 LENGTHY LITIGATION ON THE COMPETING RIGHTS OF CREDITORS, INCLUDING PUBLIC EMPLOYEES AND RETIREES, MAY NOT BE IN THEIR BEST INTEREST......................................................................34 A SIMPLE ANSWER 36 LET’S DO IT 36 CONCLUSION 37
  • 4. As will be discus s e d in det ail below, the exp e ri e n c e of Detroit marks a bre ak from the pas t. Prior to Detroit, any econo mic ally- challen g e d major city of a Stat e worked with the Stat e to achiev e a solution to the econ o mic proble m s and to dev elo p a recov e r y plan to avoid the financial difficulties in the futur e. Part of the resolution of the Detroit econo mic crisis could be the rekindling of historical prec e d e n t . In oth er words, working with the Stat e, Detroit could dev elo p a recov e r y plan which would provid e nec e s s a r y funding for the recov er y. Long ter m, such an appro a c h is likely in the bes t inter e s t s of creditors, including employe e s and retire e s . It is only throu g h a robus t recov er y plan that creditors, including employe e s and retire e s , will be paid to the fullest exte n t possible. THE MUNICIPAL BANKRUPTCY EXPERIENCE As you may be aware, of the 651 municipal bankruptcies filed in the United States since the adoption of the authorizing legislation in 1937, few debtors have been major municipalities. Orange County, California in 1994, Bridgeport, Connecticut in 1991, Stockton, California and San Bernardino, California in 2012 and Detroit in 2013 are recent notable exceptions. See Appendix for the approximate population and debt for the largest cities and towns to have filed for Chapter 9 in the last 60 years. For the most part, the 651 Chapter 9 filings have been small municipalities or special tax districts or utilities. Further, in the recent municipal bankruptcy of Vallejo, California, which was filed in 2008, disputes with municipal unions over pensions and benefits bogged down the proceeding and delayed that City’s emergence from bankruptcy. It has been reported that the issue of the relative treatment of pension and debt payments likely will take center stage in the confirmation of a plan of adjustment in Stockton and San Bernardino and even lead to appellate review of the issue. The decision on the eligibility of Stockton took almost ten months. After more than a year in bankruptcy, the issue of the eligibility of San Bernardino has finally been determined, paving the way for a battle between the competing interests. It is safe to say that the availability of a bankruptcy option has not proven to be a “quick or easy fix” to municipalities.i This is particularly true where there has been contention between the major players in the case. Historically and practically, Chapter 9 debt adjustments should be the last resort after all other alternatives have been unsuccessful and shall seldom be deemed necessary. THE LESSONS LEARNED FROM CONSTITUTIONAL CHALLENGES TO MUNICIPAL BANKRUPTCY PROVISIONS The Tenth Amendment to the Constitution explicitly articulates the Constitution’s principle of Federalism by providing that powers not granted to the Federal Government nor prohibited to the States by the Constitution of the United States are reserved to the States respectively or to the people. Accordingly, while Article I, Section 8 of the Constitution gives Congress the power to “establish uniform laws on the subject of bankruptcies throughout the United States,” that power may not interfere with the power reserved to the States by the Tenth Amendment. While there may be precedent for the Federal preemption of bankruptcy law for
  • 5. corporations and individuals, there was, at our Nation’s founding, no precedent for a dual sovereign passing a law regulating the bankruptcy of the other. This remains the case today. The earliest iterations of statutes providing for municipal debt adjustment (Chapter IX) not unexpectedly resulted in a review of the constitutionality of municipal bankruptcy by the U.S. Supreme Court. As you know, the current version of Chapter 9 of the Bankruptcy Code attempts to embrace the concept of sovereignty of States and the limitations imposed by the Tenth Amendment. Section 903 of the Bankruptcy Code specifically reserves a State’s power to control municipalities.ii In addition, § 904 of the Bankruptcy Code specifically limits the jurisdiction and powers of the Court over the municipality. iii As a result, the power of a Bankruptcy Court presiding over a Chapter 9 case is limited and cannot interfere with the property, revenue, politics, government and affairs of the municipality. The jurisdiction of the Bankruptcy Court over the municipality flows from the specific authorization of the State in question to allow the municipality to file. Most States have chosen not to specifically authorize their municipalities to file. In fact, only twelve States have unconditionally authorized municipalities to file Chapter 9 petitions.iv Earlier versions of municipal bankruptcy legislation attempted to deal with these concepts as well. Prior to 1934, Federal bankruptcy legislation did not provide a mechanism for municipal bankruptcy, insolvency, or debt adjustment.v During the period 1929 through 1937, there were 4,700 defaults by governmental bodies in the payment of their obligations. vi In 1934, the House and Senate Judiciary Committees estimated that there were over 1,000 municipalities in default on their bonds.vii That was obviously a different stage of financial distress than presently exists today with no State in default of any its general obligation bonds. Until World War II, units of local government were very heavily dependent upon property tax. During the Depression, there was widespread nonpayment of such taxes. Bondholders brought suits for accountings, secured judgments and obtained writs of mandamus for levies of further taxes. The first municipal debt provisions of the Bankruptcy Act of 1898 as amended from time to time (hereinafter the “Bankruptcy Act”) were enacted as emergency legislation for the relief of such municipalities. The municipal provisions became effective on May 24, 1934.viii These provisions were to be operative for a two-year period from that date, but this period was later extended to January 1, 1940.ix The municipal debt adjustment provisions of the Bankruptcy Act enacted in 1934 reflected an attempt to protect municipalities from debilitating disputes with creditors. x The 1934 legislation provided a procedure whereby a local governmental unit, if it could obtain acceptances from two-thirds of its creditors, could have a plan of readjustment enforced by the Federal courts. The 1934 legislation contained language similar to the policy expressed in the current § 904: The Judge . . . shall not by any order or decree, in the proceeding or otherwise, interfere with (a) any of the political or governmental powers of the taxing district or (b) any of the property or revenues of the taxing district necessary in the opinion of the Judge for -2-
  • 6. essential governmental purposes or (c) any income producing property, unless the plan of adjustment so provides. Nevertheless, the Supreme Court determined that, under the 1934 legislation, the court, and to some extent, the creditors through the court, had certain control over the municipality’s revenues and governmental affairs. In 1936, the Supreme Court of the United States held, in the case of Ashton v. Cameron County Water Improvement Dist., No. 1,xi that the 1934 municipal bankruptcy legislation was unconstitutional because it infringed upon the sovereign powers of the States and potentially permitted too much control by a Federal court and by Federal legislation over municipalities, sub-sovereigns of the sovereign States. In 1937, new legislation was passed attempting to cure the defects outlined by the Court in Ashton and to protect municipalities from the injurious protracted litigation that some were enduring. The 1937 municipal bankruptcy legislation, enacted in response to the Ashton decision, required: (l) no interference with the fiscal or governmental affairs of political (2) a restriction on the protection of bankruptcy to the taxing agency itself; (3) no involuntary proceedings; subdivisions; (4) no judicial control or jurisdiction over property and those revenues of the petitioning agency necessary for essential governmental purposes; and (5) no impairment of contractual obligations by the States. This legislation was upheld by the Supreme Court in United States v. Bekins,xii where the Supreme Court noted that the statute was carefully drawn so as not to impinge upon the sovereignty of the States. Like the 1934 legislation, language similar to the § 904 concept was included, although references to “the opinion of the Judge” were deleted. Chapter IX then, while part of the Bankruptcy Act, provided a forum in which a municipality could voluntarily seek an adjustment of indebtedness if authorized by the State to file. A Chapter IX proceeding was not a proceeding to adjudge the city a bankrupt. The court’s jurisdiction did not extend to declaring the city bankrupt or to administering its affairs as a bankrupt. The court was limited to approving as a matter of law or carrying out a proposed plan for reorganization of a municipality’s debt.xiii The principles enumerated in Ashton and the 1937 legislation are important in understanding the role of a Bankruptcy Court in a Chapter 9 proceeding today. xiv The Court cannot constitutionally interfere with the revenue, politics, or day-to-day operations of the municipality. The Bankruptcy Court cannot replace, by its rulings or appointments, the City Council or any other elected or appointed official. The limited, but vital, role of the Bankruptcy Court is to supervise the effective and appropriate adjustment of municipal debt in accordance -3-
  • 7. with applicable law. (Obviously, the special limitations on the power of the bankruptcy court in a Chapter 9 case would not be applicable if the city consented to the stay or order of the court which affected its political or governmental powers.xv) Historically, Chapter IX and its successor Chapter 9 were intended to facilitate rather than mandate voluntary municipal debt adjustment, not municipal debt elimination. THE TRADITIONAL ROLE OF STATES IN ASSISTING FINANCIALLY TROUBLED MUNICIPALITIES States typically play an important role in assisting municipalities in times of financial distress. It is unusual that the largest city in the State of Michigan, Detroit, has chosen bankruptcy as its best option. States traditionally have enacted legislation designed to protect their cities from financial distress or to aid cities should financial distress befall them. Traditionally, States have attempted to supervise local government financing and limit volatility through the enactment of debt limitations and laws that permit the refunding of municipal obligations. Over time, States have developed more sophisticated mechanisms of assisting and providing oversight to their municipalities through the use of receivers, financial managers, and oversight and refinance authorities. Each state has its own, unique approach to these mechanisms. Various States have adopted different vehicles to provide supervision, oversight, and assistance to their municipalities on an ongoing basis and especially in times of financial distress. At their most basic, these methods, which may be found in legislation or constitutional provisions, include limitations on debt and taxes and on the authority to refinance outstanding debt. More hands-on involvement by the States arises in the event of financial distress. Procedures devised for such situations generally start with the requirement to balance the budget and progress to review, assistance and oversight by the States of municipal budgets and financial issues. In addition, States have developed unique approaches to the oversight, supervision, and assistance of local governments in times of emergency. These include advisory commissions that review the financials, the budgeting and financing done by municipalities, receiverships, financial managers, financial control boards, refinance authorities, oversight commissions, and others. These mechanisms will be briefly reviewed here and are discussed in more detail in Municipalities in Distress? referenced in endnote 1. FINANCIAL CYCLES REQUIRE THAT STATE AND LOCAL GOVERNMENTS PREPARE FOR ECONOMIC DOWNTURNS The impact of economic cycles has been demonstrated throughout the history of state and local government debt financing.xvi Unfortunately, we all recognize an adverse effect of downturns, namely, lower state and local government revenues. Nevertheless, economic downturns provide no holiday from the threat of higher state and local government expenses, which are highlighted by the ever-increasing need for improvement in infrastructure, education, health care, and public safety. Over time, various new mechanisms have been introduced to provide supervision and assistance to those local governments that are experiencing financial -4-
  • 8. distress. There does not app e a r to be a reas o n any local gover n m e n t should hav e to endur e , without sup ervision or assist a n c e , the dev a s t a ti n g effects of a financial meltdow n and possibly to resort to the filing of municipal bankr u p t c y und er Chapt e r 9 of the U.S. Bankrup t c y Code. Tradition ally, Stat e s hav e worke d with their local gover n m e n t s to avoid financial meltd ow n s and bankr u p t c y, and ther e is no reas o n to believ e that tradition will not continu e. HOW STATES HAVE ATTEMPTED TO SUPERVISE STATE AND LOCAL GOVERNMENT FINANCING AND VOLATILITY IN TIMES OF ECONOMIC DISTRESS Historically, States have adopted various mechanisms to provide supervision, oversight, and assistance to their municipalities on an ongoing basis and especially in times of financial distress. In the past, these mechanisms primarily have started with basic limitations on debt and taxes and authorization to issue refunding bonds. At the front lines of protecting the financial status of local government are constitutional and statutory limitations on the debt municipalities may have outstanding at any time. In addition to debt limitations, all States include provisions in their statutory law for the issuance of refunding bonds. DEBT LIMITATIONS One of the mos t import a n t prot e c tion s for municip alities and their creditors is the limitation that the various Stat e s hav e impos e d on the amo u n t of debt a municipality ma y issue and hold at any one time —in fact, all Stat e s with the exc e p tio n s of Alaska, Florida, and Tenn e s s e e impos e som e sort of limit. xvii Municipalities in 28 Stat e s are restrict e d by limits impos e d by their resp e c tiv e cons titu tio n s . Twenty- one Stat e s that impos e debt limitation s on their municip alities do so via stat u t o r y provisions. Thes e municip al debt limits rang e from a perc e n t a g e of a valuation of ass e s s e d prop e r t y in the local unit of gover n m e n t to a set mon e t a r y amo u n t . xviii REFUNDING BONDS The mos t com m o n way that municip alities restruc t u r e their debt is throu g h the issua n c e of refundin g bonds . Refunding bond s, as the na m e implies, are bonds that are issu e d to red e e m the princip al of outs t a n di n g bond s. Every stat e provid e s som e sort of refundin g bond provision for its municip alities. By issuing refundin g bond s, a municip ality may be able to refina nc e its debt at a mor e favor a bl e inter e s t rate or restruc t u r e its outs t a n di n g obligation s to mat u r e at a time when the municip ality believ e s it will be mor e flush with mon e y. Refunding bond s also ma y help a municip ality to pus h off its debt trouble s for anot h e r day. In mos t cas e s , the -5-
  • 9. issua n c e of refundin g bond s does not res ult in an incre a s e in outs t a n di n g debt, bec a u s e the refund e d bond s no long er count towar d the legal limits. By settin g debt limits and taxing limits and allowing for the issua n c e of refundin g bonds , the Stat e s hav e att e m p t e d to curb the nu mb e r of municip al financial crises and defa ults . In addition to thes e provisions, som e step s hav e gon e a step furth er to help bele a g u e r e d municipalities resolv e their financial issu e s at the initial signs of a proble m . THE USE OF VARIOUS MECHANISMS BY STATES TO PROVIDE FINANCIAL OVERSIGHT AND ASSISTANCE TO MUNICIPALITIES IN DISTRESS The limitation on indeb t e d n e s s and auth oriza tio n to issue refundin g bond s are the basic tools in the Stat e s’ ars e n al to assist municip alities. Howev er, in time s of financial distr e s s , thes e basic appro a c h e s hav e bee n enh a n c e d by addition al mec h a ni s m s . Thes e met h o d s hav e start e d with reaffirmin g stat u t o r y require m e n t s to bala nc e budg e t s and progr e s s e d to gre a t e r stat e assist a n c e and oversig h t of municipal budg e t s and financ e s in time s of financial em e r g e n c y as well as the use of receiv er s and financial ma n a g e r s and oversig h t auth orities . Stat e s hav e appro a c h e d the task of sup e rvising and assisting their municip alities in a variety of ways. Althoug h thes e mec h a ni s m s vary by typ e and degr e e of sup ervision and assist a n c e , the wides pr e a d dev elop m e n t of thes e mec h a nis m s indicat e s the growing tren d of mor e active oversigh t and sup e rvision of municip alities by Stat e s in order to build bett e r credibility with citizens and creditors, including the municip al bond mark e t . INTRODUCTION Twenty- five Stat e s hav e imple m e n t e d municipal debt sup ervision or restruc t u rin g mec h a nis m s to aid municip alities. Thes e progr a m s , ma n y of which are identified in the Table below and which are describ e d in det ail in Municipalities in Distre s s ? , rang e from the California Debt and Inves t m e n t Advisory Commis sio n and the Florida Local Govern m e n t Financial Technic al Assista n c e Progr a m , which provide guida n c e for and kee p record s of the issua n c e of municip al bond s in thos e Stat e s , to the layer e d appro a c h of Rhod e Island to aid municip alities dep e n di n g on a municipality’s level of financial insta bility. Stat e s with thes e provisions hav e effectively used thes e mec h a nis m s to control the restruc t u rin g of their municip alities. Table: State Arizona California State-Implemented Programs to Aid Municipalities Intervention Provision School District Receivership Debt and Investment Advisory Commission -6-
  • 10. Table: State-Implemented Programs to Aid Municipalities State Intervention Provision Connecticut Ad hoc State Intervention District of Financial Responsibility and Columbia Management Assistance Authority Bond Financial Emergencies Act and Division of Bond Finance and Local Florida Government Financial Technical Assistance Program Georgia Government Monitoring Idaho Debt Readjustment Plans Financially Distressed City Law and Illinois Financial Planning and Supervision Distressed Political Subdivision Indiana Protections and Township Assistance and Emergency Manager Kentucky County Restructuring Provisions Board of Emergency Municipal Maine Finance Massachusetts Ad hoc State Intervention Emergency Financial Management and Local Government and School District Michigan Fiscal Accountability Act and Local Financial Stability and Choice Act Back-Up Payment Procedures for Minnesota Municipalities and School Districts Local Government Financial Nevada Assistance and Audit Enforcement Act New Hampshire Emergency Financial Assistance Local Government Supervision Act and Municipal Rehabilitation and New Jersey Economic Recovery Act of 2002 and Special Municipal Aid Act Emergency Financial Control Board; New York Municipal Assistance Corporation; New York Financial Control Board North Carolina Local Government Finance Act Fiscal Watch; Fiscal Emergency; and Ohio the Fiscal Emergencies and Financial Planning and Supervision Commission County Public Safety Emergency and Oregon Fiscal Control Board and Municipal Debt Advisory Commission Financially Distressed Municipalities Pennsylvania Act; Intergovernmental Cooperation Act -7-
  • 11. Table: State-Implemented Programs to Aid Municipalities State Intervention Provision Fiscal Overseer; Municipal Receiver; Rhode Island Budget Commission Emergency Financial Aid to Local Tennessee Government Financially Distressed Municipal Procedures Texas Municipal Receivership Deficiency Protection for Public Wisconsin Improvement Bonds STATES RECOGNIZING MUNICIPAL RECEIVERS: RHODE ISLAND AND TEXAS Som e Stat e s provid e for the appoint m e n t of a receiv er for trouble d municip alities. For exa m pl e , in June 2010, Rhod e Island en ac t e d a law providing a proc e s s of progr e s siv e stat e interv e n tio n for municipalities in financial distr e s s . The new law cre a t e d a thre e- ste p proc e s s for distre s s e d gover n m e n t , in what was possibly an att e m p t by Rhode Island to prev e n t ad hoc efforts by municipalities to restr uc t u r e with tactics that could be unfrien dly to the municip al mark e t s . xix In addition to the rece n t Rhod e Island law and a law in Texas allowing for a judicially appoint e d municip al receiv er, oth er Stat e s hav e chos e n to allow for a financial control board, em e r g e n c y ma n a g e r s , coordin a t o r s , overs e e r s , or a financial com mi s sion to aid trouble d municip alities. FINANCIAL CONTROL BOARDS AND THEIR PROGENY Today, the laws of Florida, Illinois, Indian a , Michigan, Neva d a , New Jersey, New York, North Carolina, Penns ylv a ni a, and Rhod e Island includ e a variation on a provision allowing for the appoint m e n t of a financial control board or com mi s sion, em e r g e n c y ma n a g e r s , receiver s , coordin a t o r s , or overs e e r s over a trouble d unit of local gover n m e n t . The inten t of ma n y of thes e provisions is to identify early signs of financial distre s s for a city or municip ality so that the stat e may interv e n e befor e the city or municip ality reach e s the level of a municip al crisis. Import a n tly, such provisions are not just a web of buried stat e laws nev er to be use d but, rath e r, are applied wher e situa tion s call for interv e n tio n. The Ne w York Exp eri e n c e . Perh a p s the mos t well -known appoint m e n t of a financial com mi s sion was the imple m e n t a ti o n of the New York City Financial Control Board in 1975. In the spring of 1975, New York -8-
  • 12. City was una bl e to mark e t its debt bec a u s e the bond mark e t had discov e r e d that, for more than ten year s, New York City had be e n using que s tion a bl e accou n tin g and borrowing practice s to elimin a t e its ann u al budg e t deficits. xx Banks refus e d to ren ew short -ter m loans that were ma t u rin g or to loan addition al cas h to the city, and only stat e cash adv a n c e s were kee ping the city afloat. The city’s spen din g for oper a tin g purpo s e s exce e d e d oper a tin g reve n u e s over sever al years , and the accu m ul a t e d fund deficit could be resolve d only by incre a sin g amo u n t s of short -ter m borrowing. New York City itself had no funds to me e t its short- ter m obligation s . New York City nearly default e d on the paym e n t of its not e s in Octob e r 1975, and it was predict e d that a defa ult was likely in Dece m b e r abs e n t feder al aid. xxi In respo n s e , the Stat e Municipal Assista n c e Corpor a tio n issu e d a series of securities on beh alf of the city and a financial control boar d was appoint e d . The New York City Financial Control Board was given the pow er and respo n sibility to review and provid e oversigh t with res p e c t to the financial ma n a g e m e n t of New York City’s gover n m e n t . Among other things, the act est a blis hing the boar d require d the city to prep a r e and sub mit a “rolling” four -year financial plan to the Financial Control Board prior to the beginnin g of each city fiscal year. The Pe n n s y l v a n i a Exp eri e n c e . Similar to the New York exp e ri e n c e , Penns ylv a ni a has imple m e n t e d a series of provisions to aid ailing cities. Penns ylv a ni a law cont ain s the Financially Distres s e d Municipalities Act, which applies to any count y, borou g h, incorpor a t e d town, towns hip, or hom e -rule municipality. xxii Under thes e provisions, if the stat e’s Depart m e n t of Comm u ni t y Affairs det er mi n e s that a municip ality is financially distre s s e d bas e d on cert ain trigg ering eve n t s , the dep a r t m e n t ma y appoint a coordin a t o r to guide the municip ality in gettin g its financial affairs in order. In addition to the Financially Distressed Municipalities Act, Pennsylvania law contains the Intergovernmental Cooperation Authority Act, which was created in 1991 to deal with insolvency issues faced by Philadelphia. The act created a five-member authority with authorization to enter into intergovernmental cooperation agreements with cities, and these agreements were preconditions to the issuance of any obligations by the authority. Among other things, the authority could issue bonds and the city and the authority were required to work together to develop a five-year recovery financial plan. The Michigan Experience. Likewise, the State of Michigan, under its former Local Government Fiscal Responsibility Act, has taken over the Detroit Public Schools, the City of Pontiac, the City of Escorse, the Village of Three Oaks, the City of Hamtramck, the City of Highland Park, and the City of Flint.xxiii These provisions were subsequently replaced by the Local Government and School District Fiscal Accountability Act. xxiv Under this act, if a school district or municipality was in a perilous financial situation, the governor of Michigan could declare a financial emergency. Should the municipality or school district enter into a financial emergency and an emergency manager be appointed, the emergency manager had broad powers -9-
  • 13. to operate and restructure the municipality, including the ability to reject, modify, or renegotiate contractual obligations.xxv As a last resort, this emergency manager could file a Chapter 9 municipal bankruptcy petition on behalf of the municipality. xxvi This Public Act 4 of 2011 provided for a Michigan emergency manager with extraordinary power. The act was very controversial, especially to local government bodies and elected officials. A referendum placed on the November 6, 2012, ballot defeated Public Act 4 of 2011, the Michigan Emergency Manager Law. On December 27, 2012, the governor of Michigan signed into law the Local Financial Stability and Choice Act,xxvii which replaced the defeated Public Act 4. Also, in 2012, Indiana passed legislation allowing its Distressed Political Subdivisions Appeal Board to appoint an emergency manager for its distressed subdivisions on grounds and with powers similar to the Michigan emergency manager.xxviii The Mas s a c h u s e t t s Ad Hoc Exp eri e n c e . Similar to the laws of Stat e s est a blis hin g specific auth ority for financial control board s or similar com mis sio n s , Mass ac h u s e t t s has typically employe d a syst e m of imple m e n ti n g legislation on an ad hoc basis to crea t e a financial control board or overs e e r s for municipalities in sever e financial distr e s s . The Calif or ni a Exp eri e n c e : Ne u tr a l Evalu a t o r . California also has exp eri m e n t e d with the conc e p t of introdu cing a third party to assist in the resolution of municip al financial difficulties. California rece n tly enac t e d a provision restricting the ability of its municip alities to file petitions to institut e Chapt e r 9 proc e e di n g s . xxix The thrus t of the legislation is to provide a period of objective and dedic a t e d negoti a tion and resolution of issue s affecting major creditors or financial proble m s . The legislation provid e s for a neutr al evalu a tio n proce s s , otherwis e known as me dia tion, for major creditors and partie s to the financial proble m s . The neutr al evalu a t o r proce s s provide s a profes sio n al, inde p e n d e n t , neutr al advisor to serv e as the sup ervising adult, which is the ess e n c e of a neutr al evalu a t o r. The neutr al evalu a t o r can foster nego ti a tio n s amo n g the municip ality and repr e s e n t a t iv e s of major creditor cons titu e n ci e s , including workers and union repr e s e n t a t iv e s , vend or s, contr a c t suppliers, holders of major claims including bond h old e r s , judg m e n t creditors, or other s whos e inter e s t s could affect the financial fate of the municipality. The neutr al evalu a t o r proce s s may not last more tha n 60 days from the dat e the evalu a t o r is chos e n unles s the municipality or a majority of participa tin g inter e s t e d parties elect to ext e n d the proce s s up to an addition al 30 days. The neutr al evalu a t o r proce d u r e is inten d e d to be an exp e dit e d proc e s s and canno t last more than 90 days from the dat e of the selection of the neutr al evalu a t o r. - 10 -
  • 14. DEVELOPMENT OF THE MUNICIPAL PROTECTION COMMISSION: A PROPOSAL The exp erie n c e of the New York Financial Control Board, the Rhod e Island receiver appro a c h , and the me dia t o r of the California stat u t o r y sche m e hav e coale s c e d in the conce p t of a municip al prot ec tion com mis sio n. (See Appen dix for chart s illustr a tin g how such a com mis sio n would function.) Under consid e r a tio n by som e Stat e s is the use of a municip al prot e c tio n com mi s sion utilizing som e of the bes t asp e c t s from the me dia tion proce s s of the neutr al evalu a t o r and the oversig h t and sup e rvision of financial control boar d s and a receiver. Under this municip al debt resolution mec h a ni s m , the stat e would est a blis h an entity that would hav e a quasi- judicial function and pow er similar to a com mi s sion or special mas t e r appoint e d by a stat e supr e m e court or other objectiv e nonpolitical proce s s . The me m b e r s of the com mi s sion would be indep e n d e n t , exp erie n c e d exp e r t s in gover n m e n t a l oper a tio n or financ e as well as me dia tion and debt resolution tech niq u e s , including bankru p t c y. The com mis sio n would start with thos e municip alities that petition for help or thos e municipalities that hav e trigg e r e d cert ain est a blis h e d criteria wher e the jurisdiction of the com mi s sion is ma n d a t e d by stat e law. The first phas e is me di a tion and cons e n s u a l agr e e m e n t by the municipality and the affect e d creditor cons titu e n ci e s similar to the neutr al evalu a t o r proce s s . Howev e r, particip a tion by the com mis sion may be require d, and nego tia tion and discus sio n of positions are strictly confide n ti al. The stat e law est a blis hing the com mis sio n would hav e an exce p tio n to its ope n me e tin g s law and its free d o m of inform a tio n law to allow for ope n discus sio n of the s e sensitive and confide n ti al topics. If addition al tax reve n u e s or loans or grant s from the stat e are ne e d e d , reco m m e n d a t i o n s to the stat e by the com mis sio n would take effect unles s blocke d by the stat e legislatur e within a specified period of time. The com mi s sion can likewis e call for a refer e n d u m on a local basis for incre a s e d taxe s or oth er actions . Specified time periods for resolution will be set forth and, if the volunt a r y proc e s s is not succe s sf ul, the secon d phas e is ma n d a t o r y if the com mi s sion so require s . In the secon d phas e , the com mis sio n and its design a t e d me m b e r s turn into a quasi -judicial pan el, and the municip ality is requir e d to set forth the step s to be take n to addr e s s its specific financial proble m (recov e r y plan). Creditors, workers, and taxp a y e r s will hav e the ability to com m e n t and to att e m p t , throu g h nego tia tion, to modify the recov er y plan within a set period of time. Then, the recov e r y plan is pres e n t e d to the pan el me m b e r s of the com mi s sion for det er mi n a tio n of the plan’s feasibility and whet h e r it is reas o n a bl y fair to creditors’ inter e s t s in relation to the requir e m e n t that, und er all circu m s t a n c e s , ess e n ti al gover n m e n t a l service s, at leas t at an est a blis h e d nec e s s a r y level, mus t be maint ain e d for the reas o n a bl e futur e. One of the trigg er s for the com mis sio n’s jurisdiction is the petition by the municip ality, its workers, or taxp a y e r s that a gover n m e n t a l function - 11 -
  • 15. em e r g e n c y exists. The municip ality or petition mus t stat e that ess e n ti al service s as to the he alth, safet y, and welfare of its resid e n t s are being thre a t e n e d and that the forced reduc tio n in service s, given the municip ality’s financial condition and its reve n u e s , impairs the healt h, safet y, and gen e r al welfare of its resid e n t s . The com mis sion, after hearin g all sides (municip ality, workers , taxp a y e r s , affect e d creditors), will det er mi n e : • What is sust ain a bl e and afford a bl e; • What the municip ality can afford; • What adjus t m e n t s mus t be ma d e to the recov er y plan to allow the municip ality to continu e to provid e ess e n ti al gover n m e n t a l service s to its reside n t s at est a blis h e d ma n d a t e d levels to pres e r v e the health, safet y, and welfare of its resid e n t s and to pay what is feasible to its creditors, including workers’ wag e s and pen sion s . The com mi s sion will act as an “hon e s t broker” to ma n d a t e incre a s e s in taxe s , wher e nec e s s a r y; incre a s e s in contribu tio n s by the municipality or workers for pension or oth er ben efits, if nec e s s a r y; or reduction, delay, or stre tc hin g out of paym e n t s to creditors. Furth er, if nec e s s a r y to pres e r v e the public he alth, safet y, and welfar e of the municipality’s reside n t s , the com mis sio n will hav e the pow er to reduc e workers’ wag e s , pension s , or other ben efits. A municipality that und er e s ti m a t e s in its recov e r y plan its ability to pay creditors and workers will hav e nec e s s a r y incre a s e s in the paym e n t s impos e d with the ben efits going to the workers and the creditors. A municip ality that over e s ti m a t e s its ability to pay or mak e s pro mis e s that are not sust ain a bl e and afford a bl e will suffer reduc e d paym e n t s to workers and creditors and possibly incre a s e d taxe s . The findings of the com mis sio n will specify if they are final and enforc e a bl e by the partie s or if furth e r nego ti a tio n s or proce e di n g s are nece s s a r y. The com mi s sion will be charg e d to mak e sure that the municip ality and the stat e maint ain acce s s to the financial mark e t s , and the ability to borrow will be prot ec t e d if possible. This com mis sio n proc e s s should help prot ec t all parties , workers, vendor s , and creditors and the taxp a y e r s and the municip ality so they will hav e nee d e d me a n s of continu e d financing credibility that can be acco m plis h e d on the local level bas e d upon maint aining mark e t credibility. The com mis sio n can auth orize the municipality to enforc e its findings. The findings, det e r mi n a tio n s , and rulings of the com mis sio n can hav e the force of law by providing that, if the legislat ur e does not act within a short, specified period and overtur n the act of the com mis sio n, it is the law. This may provide conflicte d or fractur e d legislat ur e s with a grac ef ul resolution - 12 -
  • 16. with political denia bility. Such me a n s of enforc e m e n t can includ e having the recov er y plan approv e d or revis e d by the com mis sio n as the basis for a prenego ti a t e d or “pre- pack a g e d ” Chapt e r 9 plan. The com mis sio n can auth orize the municipality to file a Chapt e r 9 proce e di n g bas e d on the recov er y plan as a pre -pack a g e d Chapt e r 9 plan. Such a pre- packa g e d Chapt e r 9 plan can significantly reduc e costs, exp e n s e s , uncert ai n t y, and financial mark e t risk of a free -fall Chapt e r 9 proc e e di n g. In the corpor a t e world, for insta n c e , pre -pack a g e d Chapt e r 11 plans (corpor a t e plans of reorg a niz a tion) hav e bee n confirm e d in weeks rath e r tha n mont h s or year s with reduc e d costs, risks, and uncer t ain ti e s . This municipal prot e c tion com mis sio n conc e p t is still in its form a tiv e stag e s and is being discus s e d in various Stat e s . It could be the me a n s of providing stat e and local gover n m e n t coop er a tio n and oversig h t while allowing the municipality, its elect e d officials, workers and unions, creditors and bond h old e r s to hav e a me a n s of particip a tion with a definitive end result. Furth er, the resolution for affect e d workers and creditors can be hard- wired for a paym e n t sourc e of dedica t e d tax e s for ass ur e d paym e n t of wag e s , ben efits, and creditor claims rath e r than the specula tiv e hop e of futur e paym e n t at the willingn e s s of future legislative actions. xxx THE STRUCTURE FOR OVERSIGHT AND EMERGENCY FINANCING Local gover n m e n t s that hav e encou n t e r e d financial distre s s hav e resort e d to financing and oversig h t auth oritie s (such as New York City and Philad elp hia). This appro a c h can involve various degr e e s of formal oversig h t and control. In the beginning, it can be as simple and benign as a “com mi s sion” that review s the city budg e t and mak e s reco m m e n d a t i o n s bas e d on new reve n u e sourc e s . If nece s s a r y, the com mis sio n can dev elo p into a refina ncin g aut h ority with full pow er to refina n c e existing debt of the local gover n m e n t and to auth orize collection of new reve n u e sourc e s or withdr a w us e of new reve n u e sourc e s if budg e t reco m m e n d a t i o n s are not followe d or me t. There are two basic adv a n t a g e s to this appro a c h : • The new indep e n d e n t issuer can hav e ther efor e , acce s s to borrowing in the has an ass ur e d sourc e of reve n u e to isolat e d from the bankru p t c y and other financial credibility and, capital mark e t pl a c e if it pay debt service that is legal risks; and • An indep e n d e n t aut hority can use various tools to enforc e fiscal discipline on the local gover n m e n t bec a u s e it can be remov e d from political pres s u r e s . The basic idea is that the auth ority is given a reve n u e sourc e. It then borrows and assign s the reve n u e sourc e to pay debt service on the bonds , paym e n t s to creditors and to provid e funds for nec e s s a r y infras tr uc t u r e - 13 -
  • 17. enh a n c e m e n t to foster improv e d econ o mic growt h. The auth ority mak e s the bond proce e d s availabl e to the local gover n m e n t to pay its exp e n s e s and retire the deficit. A basic legislativ e choice is whet h e r the local gover n m e n t levies the new tax e s and pledg e s the proc e e d s to the auth ority or the aut hority is the taxing body auth orize d to levy tax e s . In addition, the sub -sover eig n’s ability to levy new tax e s ma y be condition e d on a balanc e d budg e t or approv al of the aut h ority. The New York Tim e s rece n tly has favor a bly report e d on this conce p t of an Authority as a struct u r e to assis t trouble d cities deal with their proble m s , including ballooning pension and debt obligation s . See Walsh, Mary Williams. “Step pin g Up with a Plan to Save America n Cities.” New York Tim e s 12 Nov. 2013, NY ed: F16. Financing throu g h the auth ority can be used both for a long -ter m amor tiza tio n of the cumul a tiv e deficit and, if nec e s s a r y, for an interi m period, to acco m plis h the annu al reve n u e anticip a tion not e borrowings that are nec e s s a r y for the sub -sover eig n to oper a t e . Differen t reve n u e sourc e s might be use d for each typ e of borrowing. The disciplinary tools are import a n t and a wide rang e of tools can be cons tr uc t e d , including the following: Grants from the Federal, State or Regional Governmental Bodies. Obviously, a source of funds has to exist from which to make grants. The grant becomes a tool if the federal, state, or regional governmental bodyxxxi imposes performance conditions as a precondition to any grant. The federal, state, or regional governmental body can make the process more politically palatable by freely making a grant to the authority while requiring either in the legislation or in the grant documents that the authority impose performance requirements. Loan s fro m th e Fed e r a l , Sta t e or Re gi o n a l Gov er n m e n t a l Bodi e s . Inste a d of a gran t, the feder al, stat e, or local gover n m e n t a l body can mak e loans that require ultima t e rep a y m e n t . The rep a y m e n t ter m s can be varied dep e n di n g upon the local gover n m e n t’ s complia nc e with an approv e d financial plan and the achiev e m e n t of goals over time. That is, inter e s t rat e s can be incre a s e d or decr e a s e d as ne e d e d ; in a worst -cas e scen a rio, princip al paym e n t can be accel er a t e d for a defa ult. There can also be in cert ain Stat e s the ass u m p tio n of the obligation s by the stat e . Int er c e p t s . Part of the discus sion in struct uring grant s and loans should consid e r “interc e p ti n g ” the paym e n t s to the local gover n m e n t . Legislation can be writte n that per mit s the stat e or region al gover n m e n t a l body to withhold thes e paym e n t s if the local gover n m e n t acts inappr o p ri a t el y or fails to act, or that per mits thos e reve n u e s to be pledg e d (e.g ., paid directly) to lend er s or bond h old e r s . In the imple m e n t a t i o n stag e , ther e is an issu e of whet h e r special inter e s t group s , such as unions, local financial institution s , or pension funds might hav e the ability and willingn e s s - 14 -
  • 18. to inves t in such financing. New York City had suppor t from unions in purch a si n g significant positions of its refinan cing debt. Bud g e t Proc e s s Involv e m e n t . Having a financial plan to work out of the deficit, following that plan, and chan gin g the plan as exp erie n c e dicta t e s are the keys to a succ e s sful workout. The first step is to identify the proble m s and to stop the financial blee din g to the degr e e possible. Req u ir e d Fina n c i a l Perf or m a n c e . The aut hority can legislativ ely be given pow er s to participa t e in and monitor the local gover n m e n t’ s budg e t proce s s acros s a broa d spectr u m . Ultima t ely, the tee t h in the progr a m are that bond proc e e d s or new tax reve n u e sourc e s are not ma d e available to the local gover n m e n t until it complies with the plan, and that continu e d complianc e is requir e d for a continuin g reve n u e flow. The legislation itself can cont ain the requir e m e n t s , or it can auth oriz e the aut h ority to dev elo p and est a blish the requir e m e n t s . Legi s l a t i v e As si s t a n c e . A financially distr e s s e d local gover n m e n t come s as a som e w h a t recalcitra n t beg g a r to the legislat ur e . An auth ority that is monitoring (and actively particip a tin g in) the local gover n m e n t’ s recov er y can give it credibility with the legislatur e or, alter n a tiv ely, if the local gover n m e n t fails to mak e progr e s s , can assis t the legislat ur e in dev elo ping new criteria and progr a m s . Moral Oblig a t i o n s of th e Sta t e . Some Stat e s may be cons titu tion ally able to ass u m e debt of a local gover n m e n t . In such Stat e s an “extr a- legal” stat e guar a n t y called a “mor al obligation” is som e ti m e s use d to credit enh a n c e bond s. App oi n t m e n t of Auth ori t y Mem b e r s . The mak e u p of the gover nin g body of the auth ority is critical to its succ e s s . Paym e n t of its staff is import a n t . It is conc eiv a bl e that som e com m u ni t y lead e r s ma y be willing to serv e withou t comp e n s a ti o n if they believ e the aut h ority and its tools are cap a bl e of succ e s s . Wheth e r or not the local gover n m e n t is able to appoint or be repr e s e n t e d on the auth ority is a que s tion for the draft er s of the legislation. Acc el e r a t i o n of Loan s . If the auth ority mak e s loans to the local gover n m e n t , the loan could includ e the right to acceler a t e rep a y m e n t of the obligation s if the local gover n m e n t fails to comply with the recov er y plan. Publici t y . By participa tin g in the local gover n m e n t recov e r y proc e s s , the auth ority can beco m e a mec h a ni s m for diss e mi n a ti n g both good and bad inform a tio n abou t the progr e s s of the local gover n m e n t’ s recov e r y efforts. Such inform a tio n flow and disclos ur e will be helpful in building credibility with the inves t m e n t com m u nit y. The exp e ri e n c e s of - 15 -
  • 19. New York City, Clevela n d , and Philad elp hi a stres s the import a n c e accur a t e and clear com m u nic a tio n with the financial mark e t. of Po w e r s . The auth ority can hav e as ma n y or as few pow er s as the legislat ur e may requir e, including but not limited to: Authorizing filing of a judicial action for municipal debt adjus t m e n t by the local gover n m e n t ; 1. Granting, after hearin g and notice, a stay ag ains t litigation and debt enforc e m e n t ; 2. Approving or withdr a win g futur e us e of incre a s e d tax reve n u e s ; 3. Rejecting or financing; 4. Deter mi nin g financial em e r g e n c y or recov e r y; 5. Approving, exp e diting, or withholding stat e aid and entitle m e n t to taxe s distribu t e d to the local gover n m e n t ; 6. Approving or issuing bond s for refina ncin g or paying gover n m e n t deficit or extr a o r din a r y oper a tin g exp e n s e s ; 7. Reporting to the stat e reg ar din g the nee d for furth er legislative or disciplinary tools; and 8. Transf errin g cert ain gover n m e n t a l service s to other gover n m e n t a l bodies or cons olida tin g gover n m e n t a l services on a region al basis or with other municipalities. approving budg e t , financial plans, and future local Con s o li d a t i o n of Re gi o n a l Ess e n t i a l Gov e r n m e n t a l S er vi c e s . One inter e s tin g propo sition for Stat e s is whet h e r cert ain ess e n ti al gover n m e n t a l service s such as public safet y (police and fire) or public he alth or educ a tio n should be consolida t e d and combin e d on a region al basis to gain the ben efits of the efficiencies and elimina tio n of duplicativ e and overlap pin g service s and ad minis tr a tio n. Legislation can be writte n so that som e or all of the abov e- describ e d tools are available to the auth ority. Thes e tools can be design e d and enac t e d so that they are ma n d a t o r y or discretion a r y. The choices and variations can be furth er deline a t e d . A variation of the interc e p t and periodic financial reporting has bee n used in conn e c tion with trouble d debt securitie s issue d by local gover n m e n t as a mec h a nis m to ens ur e the flow of paym e n t s from taxe s or fees to the bond h old e r s . - 16 -
  • 20. Any sufficient distre s s e d refer e n c e stat e municipal refina ncin g or restruc t u rin g board should hav e pow er and auth ority und e r stat e law to effectively sup e rvis e a local gover n m e n t . Accordingly, any such municip al oversig h t and auth ority should be auth orize d to be able to: 1. Require balanc e d budg e t s and provid e econo mic discipline and reportin g; 2. Issue debt in the stat e’s na m e or as a sep a r a t e entity to obt ain mark e t credibility and acce s s ; 3. Have the pow er to nego tia t e judicial jurisdiction; 4. Review service s or costs gover n m e n t a l bodies; 5. Have the right to interc e p t tax reve n u e and ens ur e paym e n t for ess e n ti al service s and nec e s s a r y oper a tin g costs; 6. Have the pow er to auth oriz e a Chapt e r 9 filing if ne e d e d ; 7. Obtain bridg e financing of, or refinan c e , trouble d debt; 8. Transf er cert ain service s reduc e exp e n dit u r e s ; 9. Grant funds to the municipality to bridg e the financial crisis; 10. Provide funds to the municip ality by me a n s of a loan with ter m s that are realistic or paya bl e from out- of-stat e tax sourc e s that can be offset; 11. Use an interc e p t of stat e tax paya bl e to the municipality to ens ur e ess e n ti al municip al service; 12. Creat e privat e- public partn e r s hi p s to leas e and sell municipal prop e r ti e s to provid e bridg e financing and cash- flow relief; 13. Develop a vend or assis t a n c e progr a m to provid e vend or paym e n t s throu g h financing by purch a s e of vendor claims at a discou n t (fixed discou n t) and secur e d by paym e n t from dedica t e d tax reve n u e s over time or provid e curre n t cas h flow relief from curre n t or futur e vendor paym e n t s ; that debt can restruc t u rin g be tran sf e rr e d to other gover n m e n t a l - 17 - and qua si- to other ag e n ci e s to
  • 21. 14. Explore the consolida tio n gover n m e n t a l service s; and on a region al 15. Monitor complia nc e with any restr uc t u rin g complia nc e and prev e n t financial erosion. basis of cert ain plan to ens ur e THE COMPETING FORCES IN A CHAPTER 9 Chapter 9 is generally viewed as the remedy of last resort for troubled municipalities. If permitted by its state law, a municipality typically does not seek Chapter 9 relief unless it is in extreme financial distress with no obvious solution. Among the factors that can lead to such serious financial distress include the decline of urban areas, the decline of industry and related shrinking of the tax base, unaffordable and unsustainable personnel costs and large debt obligations in excess of the ability to pay. Chapter 9, however, is a vehicle not for elimination of debt, but for debt adjustment. (See Appendix for Charts regarding the differences between Chapter 9 and Chapter 11 of the Bankruptcy Code.) The primary purpose of Chapter 9 is to allow the municipal unit to continue operating while it adjusts or refinances creditor claims. Faced with the necessity to adjust debt, cities who recently have filed for Chapter 9 have been faced with heated battles between public employees and representatives of public debt with respect to the conduct of the case and the plan of adjustment to be confirmed. Accordingly, a brief discussion of the provisions in Chapter 9 governing the rights of employees and public debtholders is instructive. The following chart su m m a riz e s the priorities of creditor paym e n t s in Chapt e r 9. SUMMARY OF CHAPTER 9 PRIORITIES TYPE OF CLAIM EXPLANATION 1. Obligations secured by a statutory lienDebt (bonds, tax anticipation notes, revenue to the extent of the value of the anticipation notes) issued pursuant to statute that itself ab collateral. imposes a pledge. (There may be delay in payments due to automatic stay – unless stay is lifted – but ultimately will be paid.) One may expect the bondholders secured by a state statutory lien to argue that the municipality must pay on time the pledged revenues since to do otherwise is contrary to state law and §§ 903 and 904 of the Bankruptcy Code. 2. Obligations secured by special Special revenue bonds secured by any of the revenues (subject to necessary following: operating expenses of such project or (A) receipts derived from the ownership, operation, or system) to the extent of the value of the disposition of projects or systems of the debtor that are - 18 -
  • 22. TYPE OF CLAIM EXPLANATION collateral.ab used primarily or intended to be used primarily to provide transportation, utility or other services, These obligations are often nonrecourse and, in the event of default, including the proceeds of borrowings to finance the the bondholders have no claim againstprojects or systems; (B) special excise taxes imposed on particular activities or transactions; (C) incremental non-pledged assets. tax receipts from the benefited area in the case of tax increment financing; (D) other revenues or receipts derived from particular functions of the debtor, whether or not the debtor has other functions; or (E) taxes specially levied to finance one or more projects or systems, excluding receipts from general property, sales or income taxes (other than tax increment financing) levied to finance the general purposes of the debtor.c There should be no delay in payment since automatic stay is lifted under § 922(d). 3. Secured lien based on bond resolutionUnder the language of §§ 522 and 928, liens on such or contractual provisions that does notcollateral would not continue postpetition. After giving meet test of statutory lien or special value to the prepetition lien on property or proceeds, revenues to the extent perfected there is an unsecured claim to the extent there is prepetition, subject to the value of recourse to the municipality or debtor. One may expect prepetition property or proceeds the creditor to argue that pursuant to §§ 903 and 904, c thereof. the court cannot interfere with the power of a State to control a municipality in exercise of political or governmental powers with the property or revenues of the debtor, and that includes the grant of security to such secured creditor. 4. Obligations secured by a municipal facility lease financing. Under § 929 of the Bankruptcy Code, even if the transaction is styled as a municipal lease, a financing lease will be treated as long-term debt and secured to the extent of the value of the facility. 5. Administrative expenses (which would Pursuant to § 943, all amounts must be disclosed and include expenses incurred in be reasonable for a Plan of Adjustment to be connection with the Chapter 9 case confirmed. itself).d Chapter 9 incorporates § 507(a) (2) which, by its terms, provides a priority for administrative expenses allowed under § 503(b). These would include the expenses of a committee or - 19 -
  • 23. TYPE OF CLAIM EXPLANATION indenture trustee making a substantial contribution in a Chapter 9 case. 6. Unsecured debt includes: A. Senior unsecured claims with benefit of subordination paid to the extent of available funds (without any obligation to raise taxes) which include any of B, C, D or E below. B. General obligation bonds. Secured by the “full faith and credit” of the issuing municipality. Postpetition, a court may treat general obligation bonds without a statutory lien or special revenues pledge as unsecured debt and order a restructuring of the bonds. Payment on the bonds during the bankruptcy proceeding likely will cease. C. Trade. Vendors, suppliers, contracting parties for goods or services. Payment will likely cease for prepetition goods or services.e D. Obligations for accrued but unpaidThese do not enjoy any priority, unlike in a Chapter prepetition wages and pensions and f 11. other employee benefits. E. Unsecured portion of secured indebtedness. F. Subordinated unsecured claims. Any debt subordinated by statute or by contract to other debt would be appropriately subordinated and paid only to the extent senior claims are paid in full. Senior debt would receive pro rata distribution (taking unsecured claim and subordinated claim in aggregate) attributable to subordinated debt until paid. a Chapter 9 incorporates § 506(c) of the Bankruptcy Code which imposes a surcharge for preserving or disposing of collateral. Since the municipality cannot mortgage city hall or the police headquarters, municipal securities tend to be secured by a pledge of a revenue stream. Hence, it is seldom a surcharge will be imposed. But see numbers 3 and 4. b Chapter 9 incorporates § 364(d) of the Bankruptcy Code, which permits a debtor to obtain post-petition credit secured by a senior or equal lien on property of the estate that is subject to a lien if the prior lien holder is adequately protected. - 20 -
  • 24. c A pledge of revenues that is not a Statutory Lien or Special Revenue Pledge may be attached as not being a valid continuing Post-Petition Lien under § 552 of the Bankruptcy Code. d These expenses strictly relate to the costs of the bankruptcy. Because the bankruptcy court cannot interfere with the government and affairs of the municipality, general operating expenses of the municipality are not within the control of the court, are not discharged and will remain liabilities of the municipality after the confirmation of a plan or dismissal of the case. e Section 503(b)(9) provides for a priority claim to be paid on confirmation of a plan for the value of goods provided prepetition within 20 days of the petition date. f Chapter 9 does not incorporate § 1113 of the Bankruptcy Code, which imposes special provisions for the rejection of collative bargaining agreements (making the standard less restrictive, i.e., “impairs ability to rehabilitate”) or §§ 507(a)(4) and (5), which give a priority (before payment of unsecured claims) to wages, salaries, commissions, vacation, severance, sick leave or contribution to pension plans of currently $12,475 per employee. THE U.S. CONSTITUTION DOES NOT PRECLUDE THE CITIES THEMSELVES FROM SOLVING THEIR PENSION PROBLEMS Cities may purs u e chan g e s to pension contr a c t s that are not sust ain a bl e and afford a bl e and impair the Stat e’s ability to provide ess e n ti al gover n m e n t a l service s . In fact, the U.S. Supr e m e Court has held that an impair m e n t to a contr a c t may be uph eld wher e reas o n a bl e and nec e s s a r y to serv e an import a n t public purpo s e . xxxii In U.S. Trust Com p a n y v. New Jersey, the impaire d obligation was a stat u t o r y cove n a n t betw e e n New York and New Jersey addr e s sin g reve n u e s and res erv e s pledg e d as security for bond s relat e d to the Port Authority. xxxiii A New Jersey stat u t e rep e al e d the xxxiv cove n a n t . The Court conclud e d that New Jersey’s action was a contr a c t u al impair m e n t and violat e d the Contra c t Claus e of the U.S. Constitu tio n in the abs e n c e of showing that the impair m e n t was nec e s s a r y and rea s o n a bl e to serv e an import a n t public purpos e . xxxv Courts employ a four- part inquiry und er the Contr ac t Claus e. xxxvi First, a contr a c t u al obligation mus t be involved. Secon dly, the legislation mus t impair that obligation. Next, the impair m e n t mus t be subs t a n ti al. Finally, in order to be valid, the impair m e n t mus t be “rea s o n a bl e and nec e s s a r y to serv e an import a n t public purpo s e .” xxxvii “An impair m e n t rises to the level of subs t a n ti al when it abridg e s a right which fund a m e n t a lly induc e d the partie s to contr a c t initially or when it abridg e s legitim a t e exp e c t a ti o n s which the partie s rea s o n a bl y and heavily relied upon in contr a c tin g.” xxxviii Deter mi nin g that ther e is an impair m e n t does not end the inquiry. As the Supre m e Court in U.S. Trust not e d: The Contract Clause is not an absolute bar to subsequent modification of a state’s own financial obligations. As with laws impairing the obligations of private contracts, an impairment may - 21 -
  • 25. be constitutional if it is reasonable and necessary to serve an important public purpose. xxxix In Faitout e Iron & Ste el Co. v. City of Asbury Park , the court sust ain e d the alter a tio n of a municip al bond contr a c t. In Faitout e , the New Jersey Municipal Financ e Act provide d that a stat e ag e n c y could plac e a bankru p t local gover n m e n t into receiver s hip. Under the law, similar to a Plan of Adjust m e n t for a Chapt e r 9 municipal bankru p t c y action, the inter e s t e d partie s could devis e a plan that would be binding on noncon s e n ti n g creditors if a stat e court decid e d that the municip ality could not oth erwis e pay its creditors and the plan was in the bes t inter e s t of all creditors. xl After cert ain bond h old e r s diss e n t e d , the court det e r mi n e d that the plan help e d the city me e t its obligation s more effectively. “The nec e s sity comp elle d by unex p e c t e d financial condition s to modify an original arra n g e m e n t for disch ar gin g a city’s debt is implied in every such obligation for the very reas o n that ther e b y the obligation is disch ar g e d , not impaire d.” xli The court the n found that the plan prot e c t e d creditors and was not in violation of the Contr ac t Claus e. There is a differe n c e betw e e n inability to pay and an unwillingn e s s to pay. Any modification of pension ben efits mus t be tied to being fair to the workers. Benefits can be adjus t e d to the ext e n t the labor costs or pen sion obligation s prev e n t the providing of ess e n ti al gover n m e n t a l service s wher e no furth e r tax incre a s e is possible. It is ess e n ti al that sufficient funds are available to fund a recov e r y plan to crea t e the new jobs that will lead to new taxp a y e r s and new reve n u e s for a succe s sf ul recov er y. In other words, to effectu a t e a recov er y plan, it is nece s s a r y to stimula t e incre a s e d busin e s s activity so that new jobs will be crea t e d , esp e ci ally for the youn g e r workforce. Accordingly, und er the right set of facts, wher e the record de m o n s t r a t e s that the City cann o t in good faith mar s h al any addition al reve n u e s or cut any require d services without impairing the public welfar e, the Contr ac t Claus e should not bar the action. Paying what is sust ain a bl e and afford a bl e per mit s the municipality to recov e r and grow. This recov e r y and growth is requir e d in order to hav e sufficient funds to employ curre n t workers and to pay ben efits to retired employe e s . THE TREATMENT OF PENSION AND RETIREE HEALTH BENEFITS IN OTHER RECENT CASES Vallejo face d a dra m a tic decline in reve n u e s couple d with rising public safet y costs and overw h el mi n g obligation s to its employe e s . In that cas e, Vallejo was able to modify its collective barg aining agr e e m e n t s and save d subs t a n ti al su ms otherwis e owed to curre n t employe e s . It also reduc e d retire e he alth care obligation s . The pension obligation s to existing retire e s were not modified. - 22 -
  • 26. In Stockto n and San Bern ar dino, both filed in 2012, the tension betw e e n public employe e s and repr e s e n t a t iv e s of public debt initially playe d out in disput e s over the eligibility of the debtor s to file for Chapt e r 9. Both cas e s ultima t el y result e d in decisions affirming the validity of the petitions . As a result, the next battle looming in thos e cas e s is whet h e r the cities can propo s e and confirm a plan that would impair the rights of the California Public Employe e s Retire m e n t Syst e m (“ C ALPERS ”). The two cities app e a r to be taking differe n t appro a c h e s with Stockto n keepin g curre n t on all paym e n t s to the pen sion fund and San Bernar dino, which previously had halte d bi-weekly paym e n t s to C ALPERS app a r e n tl y rece p tiv e to a modification of the existing position of C ALPERS . The court in the Stockto n cas e has exa min e d the issu e of the impair m e n t of retire e s’ contr a c t on a prelimin a r y basis. xlii There, the court not e d that, while the “Contr a c t s Claus e is a key navig a tion al star in the firma m e n t of our cons titu tion and econo mic univers e , it is subject to being eclips e d by the Bankru p t c y Claus e: ‘The Congr e s s shall hav e pow er to . . . est a blis h . . . uniform Laws on the subject of Bankru p t cie s throu g h o u t the United Stat e s .’ U.S. C ONST ., article 1, § 8, claus e 4.” xliii Significan tly, the court not e s , the Contr ac t Claus e ban s a stat e from making a law impairing the obligation s of contr a c t. It does not ban Congr e s s from making a law impairing the obligation of a contr a c t. Accordingly to the Stockto n judg e, “this asym m e t r y is no accide n t. The Bankru p t c y Claus e nec e s s a rily aut h orize s Congr e s s to mak e laws that would impair contr a c t s . Sturg e s v. Crownins hi eld , 17 U.S. (4WHEAT.) 122, 191 (181 9).” xliv In its 1938 decision validatin g the secon d municip al insolve nc y stat u t e , the Stockto n court note d the Supre m e Court explain e d that “ ‘natur al and rea s o n a bl e rem e d y throu g h comp o sition’ is not available und e r stat e law ‘by rea s o n of the restriction impos e d by the Feder al Constitu tion upon the impair m e n t of contr a c t s by stat e legislation’ but the ‘bankru p t c y pow er is comp e t e n t to give relief.’ Henc e, a stat e by auth orizing a municipality to file a cas e legitim a t el y ‘invites the interv e n tio n of the bankru p t c y pow er to sav e its age n c y which the Stat e itself is pow erle s s to rescu e .’ United Stat e s v. Bekins , 304 U.S. 27, 54 (193 8).” xlv In the Stockto n cas e, Judge Klein conclud e d that “while a stat e canno t mak e a law impairing the obligation s of contr a c t, Congr e s s can do so and the goal of the Bankrup t c y Code is adjus tin g the debt or/cr e dit or relations hip. “It follows the n,” accordin g to Judge Klein, “tha t contr a c t s may be impair e d in this Chapt e r 9 cas e withou t offendin g the Constitu tio n.” xlvi According to the Stockto n court, that includ e d eve n retired city employe e s ’ healt h ben efits. The Judge ruled that the feder al bankru p t c y pow er, by oper a tio n of the Supr e m a c y Claus e, tru m p s the contr a c t s claus e in the California stat e constitu tio n. Inter e s tin gly, the Puerto Rican Constitu tio n cont ains langu a g e similar to that in California explicitly statin g, “No laws impairing the obligation s of contr a c t shall be en ac t e d .” When the Puerto Rican gover n m e n t pas s e d - 23 -
  • 27. legislation refor min g the Com m o n w e a l t h’s pension syst e m , the new legislation was challen g e d on the basis of the Puerto Rican constitu tio n al provision. Rece n tly, the Supr e m e Court of Puerto Rico in In the Matter of Trinidad Hernan d e z v. Com m o n w e a l t h , 2013 WL 3586 6 1 6 (June 24, 2013), uph eld the retire m e n t syst e m refor m as cons titu tio n al. The Puerto Rican Supr e m e Court relied upon the cas e of U.S. Trust Co. v. New Jersey , 431 US 1 (1977), in which the United Stat e s Supre m e Court held that a gover n m e n t can impair its contr a c t obligation s if that impair m e n t is reas o n a bl e and nec e s s a r y to serv e a high er import a n t purpo s e . Relying upon this ration al basis sta n d a r d , the Puerto Rican Supre m e Court uph eld the retire m e n t syst e m refor m as cons titu tion al, holding that the me a s u r e was take n to prev e n t the retire m e n t syst e m collaps e and Puerto Rico’s credit being downgr a d e d to junk. The Court rea s o n e d that such purpo s e s were nec e s s a r y and reas o n a bl e to ade q u a t e l y addr e s s the financial crisis that thre a t e n e d the actu a ri al solve nc y of the syst e m . Addition ally, the Puerto Rican Supr e m e Court stat e d that “The prot e c tion of contr a c t u al obligation s is not absolut e, as it should be har m o niz e d with the regula t o r y role of the stat e in the public inter e s t ” and that it is “for this reas o n, it is stan d a r d law that not [every compr o mi s e would cons titu t e ] an uncon s tit u tio n al impair m e n t of contr a c t.” The Court not e d the pension adjus t m e n t s were nec e s s a r y to maint ain credibility in the financial mark e t s and the solvenc y of the Retire m e n t Syst e m . POSTURE OF PENSION ISSUES IN THE DETROIT CASE The first major briefing in the Detroit bankru p t c y involve d the eligibility of Detroit to be a debt or und er Chapt e r 9. In the proc e s s , the ability of the bankru p t c y court to diminish or impair pen sion s has alre a d y bee n raise d. In the court’s order of August 26, 2013 reg ar din g eligibility objections , notices of hearin g s and certification s purs u a n t to 28 U.S.C. § 2403( a)&(b), the court indicat e d it would not be addr e s sin g the legal ability of the court to impac t the rights of City employe e s and retire e s at the pres e n t time statin g: The Court fully recognizes and appreciates the extraordinary importance of the pension rights of the City employees and retirees in this case and how the City will ultimately propose to treat those rights. It is an important question not only to the City’s employees, retirees and unions, but also to all of the parties in this case. However, the requirement of eligibility that the City desires “to effect a plan to adjust such debts” under 11 U.S.C. § 109(c)(4) does not obligate the City to prove that any particular plan that it might later propose is confirmable. Accordingly, the Court will not consider the issue of the treatment of pension rights when - 24 -
  • 28. considering the eligibility objection . . . The court fully preserves the opportunity of all parties to present their positions relating to the City’s treatment of pension rights when the debtor requests confirmation of plan, or, perhaps in some other appropriate context.xlvii In a sep a r a t e filing in the cas e, the Attorn e y Gen er al of the Stat e of Michiga n has note d that Article IX, § 24 of the Michiga n Constitution is an expr e s s and una m bi g u o u s stat e m e n t of the will of the people of the Stat e of Michiga n that the accru e d financial ben efits of each pension plan and retire m e n t syst e m of the Stat e and its political subdivisions “shall not be diminish e d or unimp air e d .” xlviii While conce din g that it canno t reas o n a bl y be disput e d that the City of Detroit is eligible to file for Chapt e r 9 bankru p t c y, xlix the Attorn e y Gen er al stat e d that, in moving forward and propo sin g the plan, the City and its ma n a g e r s are boun d by the strictur e s of Michiga n law, including Article IX, § 24 of Michigan’s Constitu tion. l The Attorn e y Gen er al distinguis h e d the situa tion from that facing the court in Stockto n bec a u s e the California Constitution cont ains no specific prot e c tio n for pension s , only a gen e ric Contra c t Claus e. li The position of the Michiga n Attorn e y Gener al is not absolut e: “Import a n tly, Article IX, § 24 is not an absolut e bar on the City’s ability to adjus t its debt in a Chapt e r 9 proce e di n g . The City ma y nego ti a t e to adjus t contr a c t u al ter m s und e r pension plans and retire m e n t syst e m s . . . . Similarly, the City is not prev e n t e d from taking eve n unilat e r al action with res p e c t to unaccr u e d financial ben efits . . . and § 24 does not implicat e the City’s obligation s with resp e c t to pro mis e d health ben efits . . . (‘The ratifiers of our Constitutio n would hav e com m o nl y und e r s t o o d financial to includ e only thos e ben efits that cons titu t e of mon e t a r y paym e n t s and not ben efits of a non- mon e t a r y natur e such as healt h care ben efits.’) lii The Attorn e y Gener al conclud e d that ther e are cons titu tion ally acce p t a bl e ways for the City of Detroit to reduc e its liabilities for its pension plans withou t violating the cons titu tion al rights of existing retire e s . “But to the exte n t the City or its ma n a g e r desire to diminish or impair vest e d pension ben efits, Michiga n law prohibits the m from eve n proposin g such a plan.” liii Various other parties , including the unions, hav e expr e s s e d the sa m e view as part of their objection s to the eligibility of Detroit to file a Chapt e r 9 cas e. The City previou sly has argu e d that the crushin g burd e n of the City’s debt service, pension and retire e ben efit obligation s , abs e n t a restr uc t u rin g, will lead to furth e r reduction s to the City’s oper a tin g exp e n s e s at the incre a s e d risk to citizens’ he alth, safet y and quality of life. In respo n s e to the eligibility objection s , it is likely the City will argu e that public workers and unions want prior paym e n t bas e d on the Constitution al provision that pension s are not to be impaire d or diminish e d , but they fail to consid e r that such Constitu tion al provisions only insur e that pension e r s hav e a contr a c t u al right to be paid rath e r tha n having pension s being a gratuity. In the seco n d half of the 1900 s , ther e was a de m a n d that pen sion s no long er - 25 -
  • 29. be tre a t e d as grat uitie s. Pay as you go obligation s are only paid if ther e are funds available and the gover n m e n t is so inclined to mak e paym e n t . In order to mak e sure that ther e would be sufficient funds, ther e was push to tre a t such pension s as enforc e a bl e , contr a c t u al obligation s . Six Stat e s , including Michiga n, hav e cons titu tio n al provisions that stat e pension obligation s canno t be impaire d or diminis h e d bas e d upon the Contra c t Claus e. The legislative history of such cons titu tion al provisions does not supp ort a sup er priority for such pension obligation s to crowd out funds for ess e n ti al gover n m e n t a l service s nec e s s a r y for the survival, growt h and econ o mic futur e of the municip ality. The City can be exp e c t e d to argu e that, view e d in the cont e x t of the Contra c t Claus e, such obligation s can be adjus t e d , including in a bankru p t c y proc e e di n g. Pension obligation s as contr a c t u al obligation s may be impair e d for a higher public purpo s e such as the he alth, safet y and welfar e or in bankru p t c y. Pension ben efits that crowd out ess e n ti al gover n m e n t a l service s and infras tr uc t u r e at the level nee d e d for a turn a r o u n d or recov e r y of the municipality are count e r p r o d u c tiv e and only impair the future of the municip ality and the ability in the futur e to pay workers and mak e pension paym e n t s . The City likely will ass e r t that paying all that can be paid realistically is not an impair m e n t or diminish m e n t but reality. MUNICIPAL OPERATIONS AND CREDITOR PROTECTIONS While in a Chapt e r 9 proc e e di n g, the municipality will still hav e to function as a municip ality. Dep e n di n g upon the stat u t o r y mission of the municip ality, ther e are cert ain nec e s s a r y and basic municipal services that mus t be provid e d , such as public safet y (police and fire), public healt h and welfare (educ a tio n and healt h, trans p o r t a tio n, building and zoning and, und er cert ain insta n c e s , sew er, water and electrical service s ). Also, in order to effectu a t e a recov e r y plan, which is nec e s s a r y for a turn a r o u n d , and to prev e n t futur e financial distr e s s , ther e mus t be funding of ess e n ti al gover n m e n t service s. This will produc e a stimul a tion of the econo m y and encour a g e growth of the municipality which will attr a c t new busin e s s e s and new citizens . This econo mic growt h will cre a t e ne e d e d jobs, esp e ci ally for youn g e r workers who will in turn beco m e taxp a y e r s and which will res ult in incre a s e d tax reve n u e s . In order to acco m plis h the recov er y plan, improv e d infras tr uc t u r e is requir e d in order to ens ur e the require d mov e m e n t of good s, service s and workers. In addition, enh a n c e d educ a tio n progr a m s are import a n t to train youn g workers for the specific jobs cre a t e d . Furth e r, improv e d public safet y and welfar e progr a m s that will lead to a constru c tiv e environ m e n t fostering econ o mic growt h and recov er y. Defining what the s e nec e s s a r y municip al service s are is a que s tion of stat e law and local choice and ma y by itself be a compl ex issu e. A bankr u p t c y court and creditors will not be able to succ e s sfully interfer e with such service. Section 904 of the Bankrup t c y Code recog niz e s this reality. - 26 -
  • 30. Accordingly, cert ain be the caus e of the or modified withou t “special reve n u e s , ” Bankrup t c y Code, exp e n s e s . reve n u e s and activities of the municip al body that may “insolve nc y” may not be able to be restr ain e d , curtaile d a comp elling reas o n . Even municipal debt secur e d by which pledg e is pres e r v e d by reas o n of § 928 of the is subject to the paym e n t of nec e s s a r y oper a tin g “SPECIAL REVENUES” PLEDGED TO BONDHOLDERS Many municipal bond s are reve n u e bonds secur e d by a pledg e of reve n u e s derive d from a specific project or a special tax levy. In fact, all Stat e s recog niz e som e form of a reve n u e bond. As backgro u n d , in a corpor a t e bankru p t c y cont e x t, § 552 of the Bankru p t c y Code provid e s that prop e r t y acquire d by the est a t e or the debt or after com m e n c e m e n t of a cas e is not subject to any lien resulting from a security agr e e m e n t ent e r e d into by the debt or before the com m e n c e m e n t of the cas e. Thus, in a corpor a t e bankru p t c y, if a reve n u e pledg e were to exist, such as a lien on invent o r y or accou n t s receiv a bl e, the pledg e likely would not survive the filing of a bankru p t c y petition (na m el y any prop er t y or reve n u e cre a t e d post -petition, such as inven t or y ma n uf a c t u r e d or accou n t s receiva bl e receive d from sales of invent o r y after the filing of the cas e). In a municipal bankr u p t c y, how ev e r, this is not the cas e. Specifically, § 928 of the Bankrup t c y Code provid e s that in the cas e of “special reve n u e s , ” the security inter e s t in “special reve n u e s ” rem ain s valid and enforc e a bl e eve n thoug h such reve n u e s are receive d after a Chapt e r 9 filing. Subs e c tio n (b) of § 928 provid e s that in the cas e of project or syst e m financing, the bond h old e r s’ lien on “special reve n u e s ” is subject to nec e s s a r y oper a tin g exp e n s e s of the project or syst e m . Thus, subject to the paym e n t of oper a tin g exp e n s e s , holder s of special reve n u e bonds would continu e to receive paym e n t on thos e bond s, reg ar dl e s s of the bankru p t c y filing. liv Section 928 was incorpor a t e d into the Bankrup t c y Code by the Municipal Bankru p t c y Amend m e n t s , which were adop t e d in 1988, as part of an Act to Amen d the Bankru p t c y Law to Provide for Special Reve n u e Bonds, and for Other Purpos e s , Pub. L. No. 100- 597 (198 8) ( “1988 Am e n d m e n t s ” ). As note d by the Bankrup t c y Court in the Jefferso n Count y, Alaba m a Chapt e r 9 bankru p t c y proc e e di n g, the 1988 Amend m e n t s bec a m e nec e s s a r y bec a u s e at the time the 1988 Amend m e n t s were adop t e d , ther e was gre a t conc er n in the municipal bond mark e t that the application of gen e r al com m e r ci al financ e conc e p t s rend e r e d the ext e n sio n of credit to a trouble d municip ality fraug h t with risk. lv In fact, “[a] major purpos e was to chan g e from using corpor a t e debt principles in the municip al financing cont e x t when their application would be at odds with how municipal financing has evolve d. This was and rem ai n s esp e ci ally lvi apt for reve n u e bas e d municipal financing tran s a c tio n s .” lvii As is clearly set forth not only in the specific provisions add e d to Chapt e r 9 by the 1988 Amen d m e n t s but - 27 -
  • 31. also in the legislativ e history for the 1988 Amend m e n t s , Congr e s s conclud e d that, without the 1988 Amend m e n t s , the uncert ai n t y of the effect of Chapt e r 9 as it then exist e d on municip al debt could hav e dire effects . This was esp e ci ally true with resp e c t to concer n s reg ar din g the continu a tio n of a lien on reve n u e s in a Chapt e r 9 proc e e di n g. lviii The Sen a t e Report for the 1988 Amen d m e n t s , Sena t e Report No. 100- 506, 100t h Cong., 2d Session (1988) (the “Senat e Report” ), ma d e it clear that the inten tio n of the 1988 Amen d m e n t s was to addr e s s the real worry in the mark e t pl a c e that reve n u e s dedica t e d to the rep a y m e n t of municip al reve n u e obligation s would be divert e d to oth er purpo s e s once a local gover n m e n t ent er e d bankr u p t c y; that this worry rend e r e d clarification of the law a nec e s sity; and that reve n u e debt could not be impaire d in a Chapt e r 9. lix The sa m e concer n was reflect e d in the Hous e Report for the 1988 Amen d m e n t s , which not e d that the bill “re m e di e s the inconsist e n ci e s betw e e n bankru p t c y law and principles of municipal financ e to remov e the pot e n ti al for proble m s that now exist.” lx As not e d by the Jefferso n Count y Bankru p t c y Court, “[i]f nothing mor e is evide n t from . . . the legislativ e history, it is that Congr e s s inten d e d that cert ain of the corpor a t e financ e principles be modified including chan gin g how the auto m a t ic stay applies to reve n u e bas e d financing for municipalities.” lxi In fact, the Bankru p t c y Court in Jefferson Count y found that it was clear from the legislative history acco m p a n yi n g the 1988 Amend m e n t s that the elimina tio n of the pote n ti al loss of a municip al creditor’s lien on special reve n u e s was critical to Congr e s s . lxii Inde e d , the 1988 Amen d m e n t s were enac t e d , in part, to prot ec t the municip al bond mark e t from the uncer t ain t y com m o n in other com m e r ci al credit mark e t s , provide for rea dily available inexp e n s iv e financing for municipalities and municipal project and ens ur e that municip al reve n u e bond h old e r s receiv e the ben efit of their barg ain withou t the unc er t ain t y typical in non- gover n m e n t financing. In en ac tin g the 1988 Amen d m e n t s , Congr e s s specifically recog niz e d that “the propo s e d am e n d m e n t s reflect e d the principles that hav e long be e n the pre mis e for municip al financ e but hav e not be e n expr e s sly stat e d in the Bankrup t c y Code.” lxiii The Sen a t e Report stat e d : The problems created by the incorporation of general commercial finance concepts into municipal bankruptcy provisions first came to light as a result of the financial crisis confronting the City of Cleveland, Ohio in 1979. Cleveland needed additional financing but lenders were unwilling to lend for a variety of reasons, including the incorporation into Chapter 9 of the general bankruptcy concepts of Section 552 of the Code. … Thus lenders who contemplated providing financing during financial troubles of the City were discouraged given the concern that their security interest might terminate upon a Chapter 9 filing of the city. … Such uncertainty may have dire effects in the future …. - 28 -
  • 32. Thus, § 928 provide s that special reve n u e s acquire d by the debt or after the com m e n c e m e n t of a bankr u p t c y cas e are subject to any lien gran t e d on special reve n u e s prior to the bankru p t c y filing. Section 928 is inten d e d to ens ur e that reve n u e bonds do not beco m e tran sfor m e d into gen e r al obligation bond s with a call ag ain s t all the ass e t s of the municip ality upon the filing of bankru p t c y petition. lxiv The Bankrup t c y Court in Jefferson Count y explains: The bigger picture of what was to be accomplished by the 1988 Amendments comes from knowing that the post-bankruptcy loss of a security interest in pledged special revenues via § 552(a) or the § 547 avoidance of a payment to a bond or warrant holder pursuant to a special revenue financing could have made the obligation or avoided transfer unsecured. As an unsecured indebtedness, it was then potentially repayable from the general revenues of the municipal entity. Under this scenario, it might have been changed by the pre-1988 version of the Bankruptcy Code from an obligation repayable solely from the revenues of the system or project or a specified tax into one repayable from the general revenues of the municipality. Essentially, it may have been turned from a nonrecourse into a recourse obligation of the municipal government.lxv As backgro u n d , prior to the addition of § 928 to the Bankru p t c y Code, § 552( a) of the Bankrup t c y Code was applicable to reve n u e debt in a Chapt e r 9. That section provide s that prop e r t y acquire d by a debt or after the com m e n c e m e n t of the bankr u p t c y cas e is not subject to a lien cre a t e d prior to the bankru p t c y filing unles s the acquire d prop e r t y constitu t e d proce e d s of the prop er t y pledg e d prior to the bankru p t c y filing. The result of the application of § 552(a) in the municip al cont e x t gen e r ally was to strip the lien of reve n u e bond h old e r s . Therefor e, the reve n u e bond h old e r s would beco m e uns e c u r e d creditors with a claim agains t the post p e tition reve n u e s that had previou sly secur e d the reve n u e bonds and their claims would beco m e part of the gen e r al obligation s of the municipality. The gen e r al funds would then be use d to pay all creditors including the reve n u e bond h old e r s . As a result, rath e r tha n taking the risk that a specific reve n u e stre a m would be sufficient to pay debt service on their bond s, reve n u e bond h old e r s were, in fact, taking the risk that the gen e r al fund of the municip ality would not be sufficient to rep a y all debt s of the municipality. Section 928 resolve d this proble m by providing that reve n u e bond h old e r s continu e to hav e a lien on special reve n u e s gen e r a t e d after the bankr u p t c y cas e. As the legislativ e history mak e s clear, the addition of § 928 was motiv a t e d by the desire to mak e it easier for municipalities to obtain nee d e d financing for public project s. - 29 -
  • 33. In addition to providing that the lien on special reve n u e s continu e s after a Chapt e r 9 filing, the 1988 Amend m e n t s also de alt with the proble m of timely paym e n t . In order to avoid the delay in paym e n t caus e d by the auto m a t ic stay of § 362, the 1988 Amen d m e n t s add e d a new subs e c tio n to § 922 of the Bankrup t c y Code that mak e s the auto m a tic stay provision inapplica bl e to the paym e n t of pledg e d special reve n u e s to the holder s of municip al inde b t e d n e s s . lxvi The Sen a t e Report obs erv e d that the paym e n t of the net reve n u e s , after paym e n t of oper a tio n and exp e n s e s of the inco m e producing prop er t y, should be paid to the holders of secur e d bond s without the application of the auto m a tic stay, which is the deriva tio n of § 922(d) in the Code, as the Sen a t e Report stat e s : This provision [362] is overly broad in Chapter 9, requiring the delay and expense arising from a request for relief from automatic stay to accomplish what many state statutes mandate: the application of pledged revenues after the payment of operating expenses to the payment of secured bonds. The automatic stay should specifically be inapplicable to application of such revenues.lxvii In fact, as the Senate Report noted at page 21, Reasonable assurance of timely payment is essential to the orderly marketing of municipal bonds and notes and continued municipal finance. The clear inten t of Congr e s s in enac tin g the 1988 Amend m e n t s was to provid e ass ur a n c e s to the capit al mark e t s that special reve n u e s ess e n ti al to municip al financing rem ai n unimp air e d in the eve n t of a Chapt e r 9 filing. “[T]he am e n d m e n t s insur e that reve n u e bond h old e r s receive the ben efit of their barg ain with the municip al issu er, na m el y, they will hav e unim p air e d rights to the project rev e n u e pledg e d to the m .” lxviii New Section 927 [928] along with the definition of Special Reve n u e s in Section 902(3) prot e c t the lien on reve n u e s . lxix In sum, Congr e s s ma d e clear that reve n u e bond h old e r s are entitled to receive the reve n u e s pledg e d to the m withou t any interfer e n c e and on a timely basis. Particular att e n tio n should be direct e d to the definition of “special reve n u e s , ” the pledg e of which survives bankru p t c y. lxx “Special reve n u e s ” are define d as: - 30 -
  • 34. (A) receipts derived from the ownership, operation, or disposition of projects or systems of the debtor that are primarily used or intended to be used primarily to provide transportation, utility, or other services, including the proceeds of borrowings to finance the projects or systems; (B) special excise taxes imposed on particular activities or transactions; (C) incremental tax receipts from the benefited area in the case of tax-increment financing; (D) other revenues or receipts derived from particular functions of the debtor, whether or not the debtor has other functions; or (E) taxes specifically levied to finance one or more projects or systems, excluding receipts from general property, sales, or income taxes (other than tax-increment financing) levied to finance the general purpose of the debtor…lxxi Exa mpl e s of the “special reve n u e s ” me n tion e d in claus e (A) includ e receipt s derive d from or receiv e d in conn e c tion with the owner s hip, financing, oper a tio n or disposition of a municipal wat er, electric or trans p o r t a ti o n syst e m . An excis e tax on hotel and mot el roo ms or the sale of alcoholic bev er a g e s would be a special excis e tax und er claus e (B). “Special excis e taxe s ” are taxe s specifically identified and pledg e d in the bond financing docu m e n t s and are not gen e r ally available to all creditors und er stat e law. Gen er al stat e sales, gen e r al incom e or gen e r al prop e r t y taxe s would not be special excis e tax e s withou t specific langu a g e dee m e d levied to financ e a specific project or syst e m . In a typical tax incre m e n t financing referr e d to in claus e (C), public improv e m e n t s are financ e d by bond s paya bl e solely from and secur e d by a lien on incre m e n t a l tax receipt s resulting from incre a s e d valua tion s in the ben efit e d are a . Althoug h thes e receipt s ma y be part of the gen e r al tax levy, they are consid er e d to be attribu t a bl e to the improv e m e n t s so financ e d and are not part of the pre e xis tin g tax bas e of the com m u ni t y. Exam pl e s of reve n u e s from particular functions und er claus e (D) would includ e regula t o r y fees and sta m p tax e s impos e d for the recording of de e d s or any identified function and relat e d reve n u e s identified in the municip ality’s financing docu m e n t s , such as tolls or fees relat e d to a particular service or ben efit. Under claus e (E), an incre m e n t a l sales or prop e r t y tax specifically levied to pay indeb t e d n e s s incurr e d for a capital improv e m e n t and not for the oper a tin g exp e n s e s or gen e r al purpo s e s of the debtor would be consid e r e d “special reve n u e s . ” Likewis e, any special tax or portion of a gen e r al tax specifically levied to pay for a municip al financing should be tre a t e d as “special reve n u e s . ” lxxii - 31 -
  • 35. STATUTORY LIENS PROTECT BONDHOLDERS In cert ain situa tion s , eve n if holding gen e r al obligation bonds for which the contr a c t u al pledg e of a municip ality’s tax e s or reve n u e s gen e r ally would ter min a t e on the filing of a municip al bankru p t c y petition, a bond h old e r ma y continu e to receive paym e n t in the wake of a Chapt e r 9 filing if the und erlying stat u t e auth orizing the issua n c e cont ains a stat u t o r y lien, which lien come s into exist e n c e by virtue of the stat u t e and arise s by force of the stat u t e on specific circu m s t a n c e s or conditions and not requiring furth e r action by the municipality. lxxiii A stat u t o r y lien canno t be canc el e d on the filing of a bankru p t c y petition or by the bankru p t c y court. This appro a c h was recog niz e d by the district court on app e al in the Orang e County bankr u p t c y. There, the court found that the lien securing tax and reve n u e anticip a tion not e s purs u a n t to a California stat u t e auth orizing the county to pledg e ass e t s to secur e not e s was a stat u t o r y lien. Since the stat u t e impos e d the pledg e , not a security agr e e m e n t , it survive d the filing of a Chapt e r 9 petition. lxxiv At leas t thirty- two Stat e s recog niz e som e form of a stat u t o r y lien in relation to their bond obligation s . lxxv The significanc e of special reve n u e s and stat u t o r y liens was illustr a t e d rece n tly by the cas e of Sierra Kings Health Care District, in which a court order reaffirm e d the fact that a Chapt e r 9 proce e di n g and any order or Plan of Debt Adjust m e n t cann o t interfer e with note s , bond s or municip al obligation s that are paid from the pledg e of taxe s or reve n u e s that are special reve n u e s or subject to a stat u t o r y lien. lxxvi Of special significanc e is the fact that the Sierra Kings court confirm e d , for the first time, the post -petition effectiv e n e s s of a municipality’s pledg e of ad valore m taxe s which qualified as both a special reve n u e pledg e and a stat u t o r y lien. The Chapt e r 9 proc e e di n g, order s and plan would not affect the timely paym e n t on thes e bond s according to their ter m s . The following chart sum m a riz e s the inten d e d tre a t m e n t of bonds and not e s , dep e n di n g on how they are secur e d , in a Chapt e r 9 proce e di n g . - 32 -
  • 36. SUMMARY OF BASIC TREATMENT OF BONDS AND NOTES IN CHAPTER 9 TYPE OF BONDS/NOTES BANKRUPTCY EFFECTS General Obligation Bonds Post-petition, a court may treat general obligation bonds as unsecured debt absent a statutory lien or a pledge of revenues that classifies as special revenues and order a restructuring of the bonds. Payment on the bonds during the bankruptcy proceeding likely will cease. Pre-petition, general obligation bonds are backed by the unlimited taxing power of the municipality (its “full faith and credit”) and are historically subject to conditions such as voter authorization, limitations on particular purposes, or debt limitation to a percentage of assessed valuation on the power of municipal entities to incur such debts. General Obligation Bonds plus Pledged Revenues Assuming that the general obligation pledge is an actual pledge of revenue and to the extent that it may be classified as a statutory lien or special revenues, this secured issuance will be respected to the degree it is consistent and authorized under state law. A pledge of revenues that is not a statutory lien or special revenues may be attacked as not being a valid continuing Post-Petition Lien under § 552 of the Bankruptcy Code. This position may be questioned under §§ 903 and 904 of the Bankruptcy Code given the prohibition that the court not interfere with the power of a State to control a municipality in exercise of political or governmental powers the government affairs or revenues of the municipality. Special Revenue A pledge on special revenue bonds will survive a bankruptcy filing. PreBonds petition, a special revenue bond is an obligation to repay solely and only from revenues of a municipal enterprise (net of operations and maintenance costs) that are pledged to bondholders. The contemplated remedy for default often focuses on a covenant to charge rates sufficient to amortize the debt. Defaulted bondholders are expected to seek mandamus in court to require the municipal borrower to raise its rates. Revenues Subject to Statutory Lien Assuming the pledge is authorized under state law through a statutory lien, the bankruptcy court should respect that statutory lien. Thus, as long as the revenues are subject to a statutory lien, payments to the bondholders should be protected post-petition. Gener al obligation bond s without any pledg e of reve n u e or special cons titu tion al priority can be tre a t e d like any oth er uns e c u r e d claim of vendor s , workers or pen sion; how ev e r, in Medley, Florida, in 1968, ther e was a distinction ma d e to pay bond indeb t e d n e s s on sche d ul e and stretc h out - 33 -
  • 37. the paym e n t s to oth er uns ec u r e d creditors over a 10- year period since failure to mak e paym e n t on the bonds might caus e the municip ality to lose acce s s to the mark e t or to pay a significan tly higher price for acce s s that would justify a bett e r tre a t m e n t for bond inde b t e d n e s s for the ben efit of all. As note d in Faitout e Iron & Ste el Co. et al. v. City of Asbur y Park, N.J., 316 U.S. 502 (1942), discretion mus t be exercis e d in de aling with secur e d claims. While the court recog niz e d that New Jersey’s Depr e s sion- era Municipal Financ e Com mis sion Act of 1931 could impair municip al debt, ther e was recog nition that secur e d claims and tax anticip a tion and reve n u e not e s stan d on an entirely differe n t footing from other municipal obligation s and, in relation to the m, no claim is affect e d by the Municipal Financ e Com mis sion Act of New Jersey. The plan adop t e d by Asbury Park paid gen e r al obligation bond h old e r s a compr o mi s e paym e n t (less in amo u n t and a delay in paym e n t ). PAYMENTS TO BONDHOLDERS ARE NOT PREFERENCES The Bankru p t c y Code also provid e s ass ur a n c e to holder s of all municip al bond or note obligation s that paym e n t s receive d within 90 days of the com m e n c e m e n t of a municipal bankru p t c y petition are not prefer e n c e s that ma y be clawe d back. lxxvii Specifically, § 926(b) of the Bankru p t c y Code provid e s that a transf er of prop er t y of the debt or to or for the ben efit of any holder of a bond or note on accou n t of such bond or note may not be avoid e d und er § 547. While this section refers to “bond s or not e s ,” ther e is nothing in the legislativ e history to supp ort the view that this provision is limite d only to instru m e n t s be aring such titles. The inten t app e a r s to be that § 926(b) should be applicable to all forms of municipal debt and allow such holders to keep such paym e n t s wher e the Bankrup t c y Code would otherwis e requir e any paym e n t s ma d e within 90 days of a bankru p t c y filing to be retur n e d to the est a t e . Special reve n u e s and stat u t o r y liens are design e d to provide a municip ality exp erie n cin g financial distr e s s with addition al available sourc e s of financing throu g h various options of refina ncin g or refundin g old debt or obt aining addition al liquidity with the use of special reve n u e s or stat u t o r y liens that are inten d e d to continu e to pay and hav e a continuin g lien on taxe s collect e d eve n if the municipality should auth orize filing a Chapt e r 9 proce e di n g . LENGTHY LITIGATION ON THE COMPETING RIGHTS OF CREDITORS, INCLUDING PUBLIC EMPLOYEES AND RETIREES, MAY NOT BE IN THEIR BEST INTEREST Detroit is the largest United States city to file for bankruptcy and, unlike the examples referenced above, was also the first instance in which the largest city in any state has been unable to work with the state to come up with a solution to the city’s financial struggles. Pensions are - 34 -
  • 38. long-term obligations. As we are seeing the Detroit case, the failure to fund them today can lead to insurmountable problems tomorrow. A municipality’s ability to adequately fund pensions is extricably intertwined with its ability both to have funds to pay the pensions and also to meet the necessary costs to govern effectively and survive.lxxviii Municipalities cannot pay that which they have no revenues to fund. Further, when obligations become so overwhelming to a municipality as to crowd out necessary expenses for essential governmental services and infrastructure, the consequences can be devastating and can lead to the meltdown of the bankruptcy. Participants in the Detroit bankruptcy are presently engaged in the legal and metaphysical question of whether specific state constitutional provisions can mandate that, unlike other contracts, unfunded pension obligations must be paid in a municipal bankruptcy without any impairment or reduction. This appears to be the first instance in which the type of specific constitutional provision protecting public employees’ pension rights as exist in Michigan has been tested in a Chapter 9. If the issue is litigated in the bankruptcy court and appealed to the higher courts, including possible review by the United States Supreme Court, it could take years to decide the matter. In the meantime, what should be the principal goal of the case may be ignored. That is, developing a successful recovery plan that is sustainable and affordable. Without a successful recovery plan, there will not be enough funds to employ workers, provide essential services or pay pensions, impaired or unimpaired. In reality, the future of pension funding, workers continued employment and a recovery plan for Detroit is dependent upon determining what costs and expenses are sustainable and affordable. This would include determining what amount of pension obligations can be paid that is reasonable, prudent and feasible. Such determination must take into account the necessity of sufficient funding for a recovery plan whereby essential governmental services can be raised to an acceptable level and infrastructure provided to encourage, stimulate and insure business growth and expansion with its accompanying creature of good new jobs, especially for the young citizens of Detroit. This will insure not only Detroit’s short-term recovery, but its long-term success. If we were hon e s t with ours elv e s , we would all ad mit that ther e is a simple answ e r to this controv e r s y. Workers (curre n t and retired) who hav e labor e d hard and esp e ci ally thos e who are nece s s a r y for the recov e r y and succe s s of a municip ality des e rv e to be paid for pas t efforts, and as much as can be paid should be paid to me e t the s e obligation s as pro mis e d . Likewis e, workers and retire e s rely on the continu e d succ e s s and growth of the municip ality for continu e d employm e n t and pen sion paym e n t s . Howev e r, if the municipality continu e s to erod e and does not succe e d with its recov e r y plan, ther e will be less not mor e to fund pension s and to keep workers employe d . It is truly unfortu n a t e that som e pro mis e s ma d e to public employe e s ma y not hav e be e n att ain a bl e, ma y not hav e be e n realistic, and may not hav e bee n found e d on any prud e n t notion of gover n a n c e . Insiste n c e on full paym e n t of thos e obligation s would lead to the very res ult all parties fear: the failure of the efforts to restor e Detroit to a soun d financial footing. - 35 -
  • 39. A SIMPLE ANSWER Fortun a t el y, the answ e r to all of this is simple. Rath e r than positioning and fighting as to what can be paid, what cann o t be paid and what mus t be paid, it is in the bes t inter e s t s of all partie s striving for the recov er y and succ e s s of the municipality to recog niz e and det e r mi n e what is sust ain a bl e and afford a bl e acknowle d gin g the resulting adjus t m e n t s are simply a recog nition of reality. In the long ter m, this will pay mor e than the bes t litigation stra t e g y. Pension obligation s can be appro pria t ely adjus t e d to what is sust ain a bl e and afford a bl e, allowing the municip ality to inves t in that which will help it recov e r and grow. There would be the det er mi n e d afford a bl e fixed paym e n t s and conting e n t paym e n t s that would only be paid if ther e are incre a s e d reve n u e s from the succe s s of the recov e r y. If the municip ality does bett e r, ther e will be mor e funding. Pension s are not impaire d or diminish e d bec a u s e realistically all that can be paid is being paid. Pension plan ben eficiaries hav e improv e d exp e c t a tio n s that the municipality oper a tin g und er a realistic recov er y plan will mak e futur e paym e n t s to fund their pension s bas e d on anticip a t e d recov er y and succ e s s of the municip ality. Also, ther e could be periodic adjus t m e n t s to the fixed and conting e n t paym e n t s bas e d on actu al results of the recov er y and what is afford a bl e. There should be a periodic review of the progr e s s in the recov er y plan. If ther e is a nee d to adjus t paym e n t s on pen sion obligation s so that what is paid is sust ain a bl e and afford a bl e, thos e adjus t m e n t s should be ma d e . Furth er, if the recov er y plan is a succ e s s and stimula t e s econo mic growt h and new jobs, ther e should be an incre a s e in reve n u e s to pay unfun d e d pension obligation s . In addition, Stat e s or the Feder al gover n m e n t should consid er cre a tin g a Pe n s i o n Saf e t y Net so that, in the eve n t of a shortfall in municipal pension funds, public workers who did not or could not pay into social security could obt ain at leas t the maxi m u m ben efit paya bl e und e r social security guar a n t e e d by a gover n m e n t a l or privat e insur a n c e progr a m . LET’S DO IT The reason why this approach has not been followed to date in Detroit or in other situations is because we are presently playing the game of blink. Everyone believes that the other side should give in and blink. From the standpoint of the workers and the retirees, they can achieve a resolution that is better than what can be obtained in the best fought litigation or any other mechanism by working with the municipality and recognizing that, together, they must (1) determine what is sustainable and affordable to allow recovery and growth for the municipality and (2) develop how the municipality can stimulate and attract business and new jobs to the community. In that way, workers and retirees hopefully can participate in a share of the new tax revenues as the fulfillment of their future pension funding needs. In doing so, the solution to - 36 -
  • 40. underfunding can be obtained. Namely, the price for the adjustment to what is sustainable and affordable is the hardwiring of pension funding going forward. The municipality must identify and dedicate a sustainable and sufficient revenue source for the funding of pension obligations so that we will never again repeat the unfortunate scenario that to balance budgets we forego pension contributions and promise future pension benefits that are not sustainable and affordable. CONCLUSION As discussed above, Chapter 9 is not a solution to the problems of a financially-troubled municipality. Rather, Chapter 9 is a process. As a result, debt adjustment without a recovery plan does not create an economic turnaround and raises the question of the futility of the process. Essential governmental services must be funded. A recovery plan that stimulates the economy while providing adequate funds for the payment of essential governmental services will lead to economic opportunities and resulting job opportunities for the citizens of Detroit, especially for the young workers. This recovery plan can only be accomplished by assuring participants that essential governmental services will be provided, including improved infrastructure and essential services so the blighted areas are transformed into areas where businesses and citizens will desire to reside and flourish and good jobs are available for all. Such a process will lead to new and expanded business and job opportunities, which result is in the best interest of all creditors. The recovery plan necessarily must be based upon the payment of what is sustainable and affordable. The increased revenues that flow from the creation of new jobs and new taxpayers under the recovery plan should permit the additional funds to ensure payment of these obligations that should be paid, including continued employment of public workers and appropriate funding of pensions. Without a successful recovery plan, the repayment of obligations will not only be difficult but practically impossible. However, restructuring of the obligations in a manner that pays what is feasible is in the best interest of all. - 37 -
  • 41. ENDNOTES - 38 -
  • 42. i In fact, not all fifty States permit their municipalities to file for Chapter 9. Only twelve States specifically authorize municipal bankruptcies. ALA. CODE 1975 § 11-81-3 ARIZ. REV. STAT. ANN. § 35-603 ARK. CODE ANN. § 14-74-103 IDAHO CODE ANN. § 67-3903 MINN. STAT. ANN. § 471.831 MO. ANN. STAT. § 427.100 MONT. CODE ANN. §§ 7-7-132 and 85-7-2041 NEB. REV. ST. § 13-402 OKLA. STAT. ANN. TIT. 62 §§ 281, 283 S.C. CODE ANN. § 6-1-10 TEX. LOC. GOV’T CODE § 140.001 WASH. REV. CODE § 39.64.040 Twelve States specifically authorize municipal bankruptcies. Twelve States conditionally authorize municipal bankruptcies. Three States grant municipalities limited authorization, two States prohibit filing but one has an exception and twenty-one remaining States are either unclear or do not have specific authorization to file. For more detail, see the book entitled Municipalities in Distress? published by Chapman and Cutler LLP, which is a 50 state survey of State laws dealing with financial emergencies of local governments, rights and remedies provided by States and State authorization of municipalities to file for Chapter 9 bankruptcy. ii “This Chapter does not limit or impair the power of a State to control, by legislation or otherwise, a municipality of or in such State in the exercise of the political or governmental powers of such municipality, including expenditures for such exercise . . .” 11 U.S.C. § 903. iii “Notwithstanding any power of the court, unless the debtor consents or the plan so provides, the court may not, by any stay, order, or decree, in the case or otherwise, interfere with - (1) any of the political or governmental powers of the debtor; (2) any of the property or revenues of the debtor; or (3) the debtor’s use or enjoyment of any income producing property.” 11 U.S.C. § 904. iv See States listed in Note 1. v See The Bankruptcy Act of 1800, 2 Stat. 19 (1800); The Bankruptcy Act of 1841, 5 Stat. 440 (1841); The Bankruptcy Act of 1867, 14 Stat. 517 (1867); The Bankruptcy Act of 1898, 30 Stat. 544 (1898). That is not to say that there were no defaults in government obligations in the nineteenth century. Indeed, the 1842 default by the State of Pennsylvania on its bonded debt inspired William Wordsworth to pen the sonnet “To the Pennsylvanians” in which he spoke of “won confidence, now ruthlessly betrayed.” It was the defaults of local utility districts and municipalities in the 1800s that tarnished the integrity of the “new frontier’s” obligations. George Peabody, an eminent financier, sought to be admitted to polite English Society only to be rebuffed, not due to his lack of social grace, but because his countrymen did not pay their debts. It was the defaults by State governments in the early nineteenth century and municipalities in the late nineteenth century that brought about the procedures which are now taken for granted, including debt limitations on municipal issues, bond counsel, and clearly defined bondholders’ rights and State statutory provisions relating thereto.
  • 43. vi See A Commission Report, City Financial Emergencies: The Intergovernmental Dimension (Advisory Commission on Intergovernmental Relations, Washington, D.C., July 1973) (“ACIR Report”). vii S. Rep. No. 407, 73rd Cong., 2d Sess. (1934). viii 48 Stat. 798 (1934). ix 49 Stat. 1198 (1936). x See generally H.R. Rep. No. 207, 73rd Cong., 1st Sess. 103 (1933); H.R. Rep No. 517, 75th Cong., 1st Sess. 3-4 (1937); H.R. Rep. No. 686, 94th Cong., 1st Sess. 541, 542 (1975); H.R. Rep. No. 595, 95th Cong., 1st Sess. 397-398 (1977); S. Rep. No. 95-989, 95th Cong., 2nd Sess. 110 (1978), reprinted in 1978 U.S.C.C.A.N. 5787. xi Ashton v. Cameron County Water Improvement Dist. No. 1, 298 U.S. 513, 80 L. Ed. 1309, 56 S. Ct. 892 (1936), reh’g denied 299 U.S. 619, 81 L. Ed. 457, 57 S. Ct. 5 (1936). xii United States v. Bekins, 304 U.S. 27, 82 L. Ed. 1137, 58 S. Ct. 811 (1938), reh’g denied 304 U.S. 589, 82 L. Ed. 1549, 8 S. Ct. 1043 (1938). xiii Leco Properties, Inc. v. R.E. Crummer & Co., 128 F.2d 110 (5th Cir. 1942). Further, the court had no jurisdiction to determine the existence the city or boundary disputes in the nature of quo warranto. Green v. City of Stuart, 135 F.2d 33 (5th Cir. 1943), cert. denied 320 U.S. 769, reh’g denied 320 U.S. 813, 88 L. Ed. 491, 64 S. Ct. 157 (1943). xiv Upon the adoption of the Bankruptcy Reform Act of 1978, the roman numerals which had previously been used to identify chapters of the Bankruptcy Act were abandoned in favor of arabic numbers. Hence, since the effective date of the Bankruptcy Code, “Chapter IX” has become Chapter 9. xv See, In re Richmond Unified School District, 133 B.R. 221 (Bankr. N.D.Cal. 1991), (a chapter 9 debtor may voluntarily divest itself by consent of its autonomy rights under § 904 of the Bankruptcy Code. xvi Since 1949, there have been 11 economic downturns in the United States, and the states and their local governments not only have weathered those financial storms but have provided substantial support to the eventual economic recovery by expenditures for infrastructure and other purposes that have increased employment and GDP growth. In each of these economic downturns, increased government debt financing for needed essential infrastructure and improvements was what helped provide the stimulus for recovery. These bond-funded projects have stimulated the economy by providing increased employment for construction, purchase of goods, and the ripple effect that such increases in salaries and purchases have on tax revenues, employment, and GDP. See “The Role of the State in Supervising and Assisting Municipalities, Especially in Times of Financial Distress,” by James E. Spiotto in the MUNICIPAL FINANCE JOURNAL, Winter/Spring 2013. xvii Even Alaska and Florida have some indirect control on debt. Alaska has a limitation on taxes and a municipality may not levy ad valorem taxes for any purpose in excess of 3% assessed value of the property in the municipality. However, these limitations do not apply to taxes levied for payment of
  • 44. principal and interest on bonds. Alaska Stat. §§ 29.45.090, 29.45.100 and 29.47.200 (2012). Florida has a limitation on ad valorem taxes to finance or refund capital projects only if approved by the voters. xviii Compare Alabama—Ala. Const. Art. XII, § 225 and Ark. Const. § 342 (2012) (debt may not exceed a particular percentage of valuation) with Washington, DC—D.C. Code § 47-102 (setting debt limit at 1878 levels). Alabama is somewhat unique in providing that any tax to be levied must be levied by the state legislature and does not grant the local government the power to levy taxes on its own. xix See “Assembly and Governor OK Measure to Prevent Municipal Receivership”; Available at http://www.rilin.state.ri.us/news/pr1.asp?prid=6591. xx For a detailed study of the New York City fiscal crisis see Donna Shalala and Carol Bellamy, “A State Saves a City: The New York Case,” Duke Law Journal, 1976(6) (January 1977); United States Congress, House of Representatives Committee on Banking, Finance and Urban Affairs, Subcommittee on Economic Stabilization, Securities and Exchange Commission Staff Report on Transactions in Securities of the City of New York (95th Cong. 1st Sess., August 1977). xxi New York Times, October 19, 1975, Section 4 at 1. xxii 53 Pa. Stat. §§ 11701.101-11701.501. xxiii Former Mich. Comp. Laws. § 141.2802 (this provision has been replaced by the Local Government and School District Fiscal Accountability Act). See also Eric Scorsone, Local Government Financial Emergencies and Municipal Bankruptcy, Michigan Senate Fiscal Agency Issue Paper; Available at http://www.senate.michigan.gov/sfa/publications/issues/localgovfin/localgovfin.pdf. xxiv Mich. Comp. Laws §§ 141.1501-141.1531 (2011). xxv Mich. Comp. Laws. § 141.1519 (2011). xxvi Mich. Comp. Laws. § 141.1523 (2011). xxvii Local Financial Stability and Choice Act, Mich. Pub. Act 436 of 2012, Mich. Comp. Laws, § 141.1541 et seq. The new act contains 19 different possibilities that would allow for the state financial authority to conduct a preliminary review of a local government’s finances to determine the existence of probable stress. The state financing board is required to complete a final report and then to submit that report to the local emergency financial assistance loan board to determine if probable financial stress exists for the local government. If probable stress is found, the governor is then required to appoint a review team for that local government, and that review team, after investigating the circumstances and meeting with the local government, must submit a written report to the governor within 60 days following its appointment, although it may be granted one extension of 30 days to conduct its analysis. In its report, the review team must conclude either that a financial emergency exists or that one does not exist, and within 10 days of receiving the report, the governor must also make a determination as to the existence or not of a financial emergency. The decision is appealable to the Michigan Court of Claims within 10 business days by a resolution approved by two-thirds of the members of the local government’s governing body.
  • 45. Should a financial emergency be found, the local government must either (1) enter into a consent decree with the state, (2) agree to the appointment of an emergency manager, (3) enter into a neutral evaluation process or (4) file a Chapter 9 bankruptcy petition if so approved by the governor. If it does not choose an option, the local government must proceed under a neutral evaluation process. Each of the options provides a process for resolving the causes of financial distress. If the neutral evaluation process or other options do not result in a resolution, the governing body of the local government must adopt a resolution recommending that it proceed under Chapter 9 and submit that resolution to the governor and state treasurer for consideration and approval by the governor. xxviii Ind. Code § 6.1.1-20.3 et seq. (2012). xxix Cal. Gov’t Code §§ 53760; 53760.1; 53760.3; 53760.5; and 53760.7 (as amended and added by Cal. A.B. 506; signed into law on October 9, 2011). This provision was first put to the test by the City of Stockton, California, which filed a Chapter 9 petition in June 2011 after going through a neutral evaluator process. San Bernardino in August 2012 avoided the neutral evaluator process by declaring a fiscal emergency, as discussed below. xxx Chapman and Cutler LLP has been working with the Civic Federation of Chicago and its pension committee with regard to the development of the municipal protection authority or commission as an alternative to the rush to Chapter 9 or the continued inability to effectively address financial distress by municipalities. xxxi “Regional Governmental Bodies” could include counties, municipalities, or regional governmental bodies for special purposes such as transportation, public safety, or health services. xxxii U.S. Trust Company v. New Jersey, 431 U.S. 1, 52 L. Ed. 2d 92, 97 S. Ct. 1505 (1977). xxxiii Id. xxxiv Id. xxxv Id. at 32. xxxvi For example, In Royal Liquor Mart, Inc. v. City of Rockford, the Illinois Second Judicial District identified this test as a three-step test including (1) whether the action in question has operated a substantial impairment of a contractual relationship; (2) if such impairment is found, whether the State can show a significant and legitimate public purpose behind the regulation; and (3) whether the change in rights is based upon reasonable conditions and is of a character appropriate to the public purpose of the regulation. 479 N.E.2d 485, 491, 133 Ill.App.3d 868, 877 (Ill.App.Ct. 1985). xxxvii Bricklayers Union Local 21 v. Edgar, 922 F.Supp. 100, 105 (N.D. Ill. 1996) (citing Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U.S. 400, 411, 74 L. Ed. 2d 569, 103 S. Ct. 697 (1983)).
  • 46. xxxviii Id. at 106-07 (citing Allied Structural Steel Co. v. Spannaus, 438 U.S. 234, 246, 57 L. Ed. 2d 727, 98 S. Ct. 2716 (1978)). xxxix U.S. Trust, 431 U.S. at 25. xl Faitoute Iron & Steel Co. v. City of Asbury Park, 316 U.S. 502, 504 (1942). xli Id. at 511. xlii In re City of Stockton, California, 478 B.R. 8 (Bankr. E.D. Ca. 2012). xliii 478 B.R. at 15. xliv Id. xlv Id. xlvi Id. At 16. xlvii In re: City of Detroit, Michigan, United State Bankruptcy Court Eastern District of Michigan, Southern Division, Order Regarding Eligibility Objections, Notices of Hearings and Certifications Pursuant to 28 USC § 2403(a) and (b), August 26, 2013. xlviii In re: City of Detroit, Michigan, United State Bankruptcy Court Eastern District of Michigan, Southern Division, Attorney General Bill Schuette’s statement regarding the Michigan Constitution and the Bankruptcy of the City of Detroit. August 19, 2013. xlix Id., at p. 10. l Id. li Id. at p. 14 n. 2. lii Id. at pp. 15-16. liii Id. at p. 16. liv In re Jefferson Cnty., Alabama, 474 B.R. 228 (Bankr. N.D. Ala. 2012) (discussion of nature of special revenues); Bank of N.Y. Mellon v. Jefferson Cnty., Ala. (In re Jefferson Cnty., Ala.), 482 B.R. 404 (Bankr. N.D. Ala. 2012) (analysis of necessary operating expenses); In re Sierra Kings Health Care Dist., Case No. 09-19728 (Bankr. E.D. Ca. Sept. 13, 2010). lv In re Jefferson Cnty., 474 B.R. 228, 267 (Bankr. N.D. Ala. 2012). lvi lvii Id. at 271.
  • 47. lviii Id. lix For further discussion on the importance of the 1988 Amendments, see In re Jefferson Cnty., Ala., 474 B.R. 228 (Bankr. N.D. Ala. 2012); Bank of N.Y. Mellon v. Jefferson Cnty., Ala. (In re Jefferson Cnty., Ala.), 482 B.R. 404 (Bankr. N.D. Ala. 2012) (analysis of necessary operating expenses). lx H.R. Rep. No. 100-1011 (1988) at 3. lxi Jefferson Cnty., 474 B.R. at 268. lxii Id. at 268-69. lxiii Jefferson Cnty., 474 B.R. at 753 (quoting Senate Report, p.1). lxiv Id. at 754. lxv Id. lxvi See generally Jefferson Cnty., 474 B.R. at 268 (“It is clear from both the House and Senate Reports accompanying the 1988 amendments that eliminating the potential loss of a creditor’s lien on revenues was a critical purpose behind the enactment of § 928 and § 922(d).”) lxvii Id. at 271 (quoting Senate Report at 11). lxviii Id. at 270 (emphasis in original) (quoting Senate Report at 12). lxix Senate Report, at 12 (emphasis added). lxx11 U.S.C. § 902(2). lxxi 11 U.S.C. § 902. lxxii See Heffernan Memorial Hospital District, 202 B.R. 147 (Bankr. S.D. Cal. 1996). lxxiii In re County of Orange, 189 BR. 499 (C.D. Cal. 1995). lxxiv Id. lxxv The states include: Alabama, Alaska, Arkansas, California Colorado, Connecticut, Florida, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, Nevada, New Jersey, New York, North Carolina, North Dakota, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Vermont, Virginia and West Virginia. lxxvi In re Sierra Kings Health Care District, Case No. 09-19728 (Bankr. E.D. Ca. Sept. 13, 2010). lxxvii11 U.S.C. § 926.
  • 48. lxxviii See All Eyes on Detroit: What Happens to Unfunded Pension Liabilities When a Municipality Files for Bankruptcy?, MUNINET GUIDE (August 21, 2013), http://www.muninetguide.com/print/php?id=604.