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2.27.13 municipalities in crisis ppt

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  • 1. California Cities In Crisis:Guidance & Options Short Of Last ResortFebruary 27, 2013Presented by:David S. Kupetz, Partner, SulmeyerKupetzdkupetz@sulmeyerlaw.comDean G. Rallis Jr., Partner, SulmeyerKupetzdrallis@sulmeyerlaw.comRobert Tormey CPA, CTP, CIRAbob@roberttormey.com1
  • 2. California Cities in Crisis:• Presenters• Current Circumstances• Guidance for Elected and Appointed Officials• Constructive Use of Fiscal Emergency• AB 506 Advantages• Purpose and Power of Chapter 9• Filing Chapter 9• Status of Pension Obligations: San Bernardino and Stockton• Chapter 9 Precedents• Conclusions• Precedents Summary• Questions and Comments2
  • 3. Dean Rallis For over 30 years, Dean Rallis has focused his practicein the areas of business reorganization, corporateinsolvency, commercial and bankruptcy litigation, aswell as the acquisition of assets and businesses inbankruptcy court and out-of-court workouts. He hasfunctioned as lead counsel for debtors, creditors (bothsecured and unsecured), creditors‟ committees andpurchasers in the bankruptcy, restructure andliquidation of companies, and represented Tri-CityMental Health Center in its successful chapter 9municipal debt adjustment case.3
  • 4. David Kupetz David Kupetz specializes in troubled transactions, crisis avoidance consultation,workouts, restructurings, reorganizations, bankruptcies, receiverships, assignmentsfor the benefit of creditors, municipal debt adjustment, and other non-bankruptcyinsolvency proceedings. He represents debtors (in restructurings and workouts andin chapter 11 reorganization cases), secured creditors, unsecured creditorscommittees, assignees for the benefit of creditors, buyers/sellers ofbusinesses/assets in distressed circumstances and other entities in insolvency andbankruptcy situations. Practicing law at SulmeyerKupetz for over 25 years, David has substantialexperience in municipal debt adjustment matters, and speaks and writes extensivelyon the subject. SulmeyerKupetz represented the Ventura Port District and Tri-CityMental Health Center in their successful Chapter 9 municipal debt adjustmentcases, the Orange County Transportation Authority in connection with the OrangeCounty Chapter 9 case, and a group of cities that were creditors in the Chapter 9case of Desert Hot Springs. In recent years, SulmeyerKupetz has represented anumber of local public entities in out of court negotiations with creditors, workouts,and restructurings that have allowed them to avoid Chapter 9. The firm has alsorepresented other governmental entities in connection with Chapter 9 cases.4
  • 5. Robert Tormey, CPA• Bob Tormey is a Certified Public Accountant and Crisis Manager who specializes inhighly leveraged situations, crisis situations and turn-arounds.• He has acted as financial advisor to Lenders, lenders counsel, equity stakeholdersand as interim management to debtors and has significant expertise in for profiteducation, municipal finance, aerospace manufacturing, business services, andacquisitions integration.• Bob holds and MBA from the Johnson School of Cornell University and a BA fromLoyola University of Los Angeles. He is also a member of the Turn AroundManagement Association and the Association of Certified Insolvency andRestructuring Advisors.5
  • 6. Current Circumstances - Federal• The Simpson Bowles Commission, i.e. the National Commission on Fiscal Responsibility andReform was a Presidential Commission created in 2010 by President Obama to identify"…policies to improve the fiscal situation in the medium term and to achieve fiscal sustainabilityover the long run.• The Commission‟s report was released on December 1, 2010.• The Commission‟s report was supported by over 60% of the members (11 out of 18), and anequal number of Democrats and Republicans; however, the report did not reach the 14-votethreshold required to formally endorse the blueprint and have it sent to Congress.• The Government took no action on the Commissions recommendations.• Proponents of the plan praised it for hitting all parts of the federal budget and for putting thenational debt on a stable and then downward path.• Prominent supporters include JP Morgan Chase CEO Jamie Dimon, Democratic Leader NancyPelosi, and Republican Senator Tom Coburn.• On August 5, 2011, Standard and Poor‟s lowered the credit rating of the United StatesGovernment to AA+, the first time the credit rating of the United States has ever been lowered.• On March 1, 2013, the United States begins the process of sequestration as a result of an inabilityto arrive at a legislative solution to its fiscal crisis.6Robert Tormey
  • 7. Current Circumstances - California• The Little Hoover Commission, officially, the Commission on California State GovernmentOrganization and Economy, is an independent California state oversight agency that investigates stategovernment operations.• Two years ago, in its February 2011 report, entitled “Public Pensions for Retirement Security,” theCommission made the following determinations:• Pension costs will crush government: the Math doesn‟t work, the system lacks discipline, oversight andaccountability.• State and local governments need the authority to restructure future, unearned retirement benefits fortheir employees. The Legislature should pass legislation giving this explicit authority to state and localgovernment agencies. This legislation may entail the courts having to revisit prior court decisions.• Failure to seek this authority will prevent the Legislature from having the tools it needs to address themagnitude of the pension shortfall facing state and local governments. The situation is dire.• The pension reform measure signed into law in September by Gov. Jerry Brown, AB 340 left currentemployees alone, focusing instead on new hires. Government officials will have to wait until 2018 tonegotiate with public employee unions to reform pensions for current employees. In short, the advice ofthe Little Hoover Commission was ignored.7Robert Tormey
  • 8. Current Circumstances - California• The California State Controller‟s office estimates the pension underfunding as of 2010 asonly $128 Billion.• However, according to the Little Hoover Commission, as of 2010, the 10 Largest PublicPension funds in California faced a combined shortfall of as much as $240 Billion.• As of February 2013, the California Public Policy Center has released a study entitled„Public Retirement Systems Annual Report for 2010” which calculates California‟s totalunfunded pension liability using the new criteria proposed by Moody‟s Investor Services foradoption in 2014. The CPPC estimates the underfunded amount to be $326 Billion.• UnionWatch has estimated both the pension underfunding and the related retirementhealthcare plan underfunding as approaching $872 Billion.• The Government Accounting Standards Board, the GASB, plans to require municipalities todisclose the unfunded pension liabilities on their balance sheets beginning in 2014. In thatyear, auditors are expected to opine as to whether the municipality can be considered agoing concern with such liabilities under GASB 67 and 68.8RobertTorney
  • 9. • Maintain flexibility• Avoid fiscal crisis• Preserve general fund liquidity• Identify unrestricted fund balances held in other funds• Investigate opportunities to reduce service levels and headcount• Negotiate plans with Unions for alternative delivery and serviceconsolidation approaches to further reduce costs• Insist on multi-year forecasts for all funds• Complete a “prospective insolvency” analysis9Robert TormeyGuidance for Elected Officials
  • 10. Guidance for Elected Officials• Analyze costs of services and opportunities for generating fees• Evaluate cost recovery opportunities that might result in additionalrevenue to aid in the restoration of needed services• Poll voters to gauge support for augmenting existing revenue sources• Consider debt restructuring – outside of court, if possible• Negotiate benefit reductions with existing employees• Implement two-tier benefit plans for new employees• Outsource and consolidate services with other agencies and JPA‟s10Robert Tormey
  • 11. Guidance for Elected and Appointed OfficialsWatch Closely for Warning Signs• Resignation of accounting personnel (San Bernardino)• Interfund borrowings - (Compton)• General fund below threshold levels (Montebello)• Prospective insolvency analysis (Vallejo)• Fiscal problems facing local school district(s) at FCMAT website• Pension obligation bonds issued or proposed (Fresno, Oakland)• Unrealistic budget projections – i.e., budgets which "assume"growth in revenue11Robert Tormey
  • 12. Constructive Use of Fiscal Emergency• Constitutional– In order to raise taxes outside of a regularly scheduled election.• Contract Impairment – Case Law Precedent– Blaisdell, 290 U.S. 473 (1937) & Sonoma County, 23 Cal.3d. 296 (1979)• Requires actual emergency• Temporary• Benefits the Public Interest• Appropriately tailored to the emergency– United States Trust Co. of N.Y., 431 U.S. 1 (1977)• Reasonable and necessary to serve an important public purpose• Statutory –AB 50612David S. Kupetz
  • 13. AB 506• Adopted after the City of Vallejo filing• Promotes mediation with key creditors before Chapter 9• Requires either a– Completion of a 60 day neutral evaluation (mediation) process, or– A declaration of fiscal emergency• Stockton first California city to use evaluation process• San Bernardino declared fiscal emergency and filed Chapter9 without the neutral evaluation process• Costs of process to be shared between debtor and creditors13Dean G. Rallis
  • 14. AB 506 - Advantages• Signals seriousness of fiscal circumstances to all stakeholders• Allows "confidential" negotiations out of court and without scrutiny ofBrown Act disclosures• May help manage or avoid potential embarrassment and scandal factorsas information can be disclosed to stakeholders in confidential fashion• Opportunity to shape perceptions of liquidity and feasibility• If agreement can be reached with some or all key creditors, Chapter 9may be avoided or made more efficient if still necessary14Dean G. Rallis
  • 15. Purpose & Power of Chapter 9• Provides a framework for eligible governmental entities to restructuredebt• Was drafted solely for municipalities• Allows insolvent local public entities to remain viable• Similar to Chapter 11, main benefits of Chapter 9are:o The automatic stay; ando Adjusts debts through a plan• The Goal of a Chapter 9 Case is Confirmation of aPlan of Debt Adjustment15David S. Kupetz
  • 16. Purpose & Power of Chapter 9• The bankruptcy court cannot interfere with the municipalitys ability tocontinue its operations or dictate what type of services or level ofservices the governmental entity may provide.• Municipalities are permitted to adjust burdensome contractualrelationships under the power to reject executory contracts andunexpired leases, subject to court approval.• Municipalities may also reject collective bargaining agreements(Vallejo and Orange County) or potentially retiree benefit plans.16David S. Kupetz
  • 17. Purpose & Power of Chapter 9• Creditors cannot expect that all excess funds go to the payment oftheir claims under a Chapter 9 plan.• The Municipality must retain sufficient funds from which tooperate, make necessary improvements and maintain its facilitiesand assets, and continue to fulfill its governmental responsibilities.17David S. Kupetz
  • 18. Filing Chapter 9 - Last Resort AB 506 process is completed before filing. Sale of assets or new bonds, raising taxes, assessments, and fees,and other alternatives have been exhausted. All opportunities to reduce costs and increase revenues have beenexamined. Consensual debt restructuring, debt moratoriums, and debtadjustment potential solutions have been explored, or have provenimpossible to arrive at through consensual negotiation (Stockton). Municipal dissolution or merger has been considered.18David S. Kupetz
  • 19. Filing Chapter 9 - Last ResortEligibility for Chapter 9• Chapter 9 has significant eligibility requirements• Requirements– Municipality– Specifically authorized by State Law– Must be determined to be „Insolvent‟19Dean G. Rallis
  • 20. Filing Chapter 9 - Last ResortProspective Insolvency• Bridgeport almost required cities to fail.• In Vallejo, the bankruptcy judge (McManus) determinedVallejo was „prospectively insolvent‟:o The Citys General Fund will begin fiscal year 2008-09with no reserves, and possibly with a negative balance;o Absent the Chapter 9 case, the General Fund wouldoperate at a multi-million dollar deficit in fiscal year2008-09, with projections by the City ranging from a$10 million to $17 million deficit;20Dean G. Rallis
  • 21. Filing Chapter 9 - Last ResortEligibility for Chapter 9 – Cont.• Desires to effect a plan to adjust debt• Obtain agreement, negotiate in good faith, unable tonegotiate, or reasonably believe creditor mayattempt to obtain a preference21Dean G. Rallis
  • 22. Status of Pension Obligations:San Bernardino and Stockton• San Bernardino –– City suspended postpetition contributions to CalPERS– CalPERS filed opposition to City‟s eligibility for Chapter 9• Asserting (i) City cannot demonstrate desire to effect aplan to adjust its debts because City had not comeforward with a plan and (ii) Chapter 9 petition was notfiled in good faith because City did not negotiate withcreditors before filing– Matter is still pending22David S. Kupetz
  • 23. San Bernardino• CalPERS filed motion for relief from automatic stay topursue debt collection action in state court– Asserting City‟s failure to make contributions violatedstate law (including Public Employees‟ RetirementLaw, California Labor Code, and CaliforniaConstitution)– CalPERS contended automatic stay not apply to itbecause it is an arm of the state exercising its policepower23David S. Kupetz
  • 24. San Bernardino– To extent stay applies, CalPERS argued cause forrelief because City had failed to comply withapplicable state law and failed to pay postpetitionadministrative expenses– Court denied CalPERS motion for relief from staywithout issuing written opinion24David S. Kupetz
  • 25. San Bernardino• Capital Market Creditors (IndentureTrustee, Bondholder, and Bond Insurer) opposed reliefsought by CalPERS, asserting:– City‟s insolvency caused by rising employee salariesand benefits coupled with declining revenues– CalPERS is seeking to bully the City into providingCalPERS with special treatment25David S. Kupetz
  • 26. Stockton• City has not suspended payments to CalPERS• City defaulted on bond payments• Bond Creditors have filed objection to City‟s eligibility for Chapter 9• Primarily arguing, among other things, that (i) City did not negotiate withCalPERS, its single largest unsecured creditor, and negotiation was notimpracticable, and (ii) City‟s decision not to negotiate with CalPERS wastainted by conflicts of interest, made without due care, and thus not made ingood faith• Matter still pending• CalPERS is opposing relief sought by Bond Creditors26David S. Kupetz
  • 27. Chapter 9 Precedents – Stockton (478 B.R. 8)– Federal bankruptcy power of the Supremacy Clause of the U.S. Constitutiontrumps the contracts clause in the California state constitution.– Stockton suspended payment of retired employees‟ healthcare benefits.– Retirees contended these were vested contractual rights.– Court found the Bankruptcy Clause of the U.S. Constitutioneclipses the Contracts Clause– Authorizes Congress to make laws that impair contracts.27David S. Kupetz
  • 28. Chapter 9 Precedents – Stockton– Federal bankruptcy power trumps California law.– Accordingly, while a state cannot make a law impairing theobligation of contract, Congress has properly done so in the U.S.Bankruptcy Code.– Moreover, the goal of the Bankruptcy Code is adjusting thedebtor-creditor relationship. The court determined that, even ifthe retirees held vested property interests, "the shield of theContracts Clause crumbles in the bankruptcy arena.“– The court held "although the Citys unilateral interim reduction ofretiree health benefit payments may lead to tragic hardships . . .before their claims are redressed in a chapter 9 plan of debtadjustment, the motion for injunctive relief must be denied."28David S. Kupetz
  • 29. Chapter 9 Precedents – Stockton(2013 Bankr. LEXIS 533) Debtor’s Freedom to Act during Pendency Debtor does not need court approval to settle claims. Stockton settled a damages lawsuit and requested court rulethat it was precluded from approving or disapproving thesettlement. Creditors argued city required to seek Court approval. Court determined its approval was prohibited without debtorconsent. Court indicated the debtor‟s actions are subject only to reviewin connection with plan of debt adjustment.29Dean G. Rallis
  • 30. Chapter 9 Precedents• Collective Bargaining Agreements May be Rejected –Vallejo and Orange County Cases• Jefferson County Decisions re Section 928 and AutomaticStayo special/pledged revenues and necessary operatingexpenseso automatic stay and extension of stay to protectmunicipal officials and representatives30
  • 31. Observations– Vallejo – „Prospective Insolvency‟ (i.e. looking forward) will likely bethe test for eligibility. This has significant implications as GASB 67 &68 are enforced in 2013 and 2014. The insolvency of an increasingnumber of municipalities will be apparent.– Stockton - Federal bankruptcy power trumps California constitution.Contracts can be impaired in bankruptcy.– San Bernardino – CalPERS vested contract rights and sovereigntyarguments will likely fail when tested.– Stockton - Debtor municipalities have broad powers to act duringpendency without court involvement.31
  • 32. Observations• Despite California‟s resolution of current year deficit staggeringunfunded obligations remain.• Legislative initiatives fall short of what is required.• Negotiations are not accomplishing enough.• Stockton‟s test of mediation under AB 506 inconclusive – noconfirmable plan emerged.• Ballot initiatives in San Diego and San Jose quickly challenged incourt.• California municipal obligations will increasingly require restructuring.32