Tackling Public Agency Bankruptcy!

Transcription

1 Tackling Public Agency Bankruptcy! Presented by: A. Byrne Conley, Esq. Gibbons & Conley David J. Clovis, ARM Ca. Joint Powers Risk Management Authority 1

2 Agenda Introductions Public Sector Financial Reality Departmental impacts of economic downturn Bankruptcy and related issues Questions and Answers Public Sector Bankruptcy History Orange County 1990 s Desert Hot Springs Vallejo Stockton Town of Mammoth Lakes San Bernardino Detroit 2

3 Bankruptcy Filings Since January 2010 LA Now May 21,

4 Public Sector Financial Reality Tax revenue realities Contractual Obligations to Employees Casualty Programs Worker s Compensation Impacts No Protection from California Self-Insurers Security Fund Property Rates Reasons for Bankruptcy-Stockton Stockton was ground zero for the subprime mortgage crisis. Unemployment was 22 percent; median income for a family of four was about $63,000. Property values, both commercial and residential, had declined by 50 percent. Stockton had one of the highest foreclosure rates in the nation, a fact of which this court is painfully aware from the ordeal of presiding over the tragedy of bankruptcies of literally thousands of individual Stockton citizens who had done nothing wrong other than be seduced by easy credit when purchasing a home in a housing bubble before being slammed by unexpected loss of income when laid off or furloughed. Property tax, sales tax, and other public revenues characteristic of a functioning municipal economy had plummeted. For example, sales tax revenue declined from $47.0 million in fiscal year 2006 to $32.7 million in fiscal year Recovery was far over the horizon. 4

5 Reasons for Bankruptcy-Stockton Some problems were due to excessive optimism. In better times, Stockton committed its general fund to back long-term bonds to finance development projects based on an overly-sanguine ifyou-build-it-they-will-come mentality. They did not come. Hence, project revenues were insufficient to pay project bills. Some problems were due to encrustation of a creeping multidecade, opaque pattern of above-market compensation of employees. Among other things, the City paid for generous health care benefits to which employees did not contribute, including lifetime health care regardless of length of service. It permitted, to an unusual degree, so-called add-pays for tasks that allowed nominal salaries to be increased to totals greater than those prevailing for other municipalities. And there were pre-determined automatic annual cost-of-living pay increases not tied to the state of the economy or local finances. Reasons for Bankruptcy-Stockton The submerged compensation problems included surprisingly generous retirement practices. Pensions were allowed to be based on the final year of compensation, which compensation could include essentially-unlimited accrued vacation and sick leave. This led to a phenomenon of so-called pension-spiking in which a pension could be substantially greater than the retiree's actual final salary. Nor were individual employees required to contribute to their pensions. In consequence, projected pension expenses were soaring. 5

6 Reasons for Bankruptcy-Stockton City management before the Great Recession deserves some of the blame. City accounts were in such disarray that it has taken literally years to unscramble them. Various work rules were contractually agreed upon, often without approval in public view by the City Council, that left little latitude for exercise of managerial supervision. And one wonders about what prior City Councils had been doing. In re City of Stockton, 493 B.R. 772 (Bankr. E.D. Cal. 2013). Reasons for Bankruptcy-Vallejo Chapter 9 Filing - Without reserves, facing a worsening economy, burdened by labor contracts locked in through 2010, and with limited opportunities to raise taxes due to State constitutional restrictions, in early May of 2008, the City determined that it was no longer able to meet its contractual obligations. Absent appropriations from a balanced budget required by both City charter and State constitution, the General Fund would have lacked the legal authority to continue paying for services after July 1, On May 23, 2008, the City filed a case under chapter 9 of the United States Bankruptcy Code in Sacramento seeking to adjust its debts. The City's plan of adjustment was confirmed by the bankruptcy court in August 2011, and the plan became effective on November 1, City of Vallejo, CAFR 6/30/2012 6

7 Reasons for Bankruptcy-Vallejo CalPERS losses increased unfunded liability from $403 million to $500 million in one year. Tax receipts dropped from $69 million in 2004 to $58 million in 2008 and $49 million in Licenses and permits dropped from $9.1 million in 2004 to $3.3 million in 2008 and to $2.7 million in Public Safety salaries went from $54 million in 2004 to $69 million in 2008 and $46 million as of Operating surplus went from $2.3 million in 2004 to -$21 million in 2008 and returning to surplus of $4.7 million in Reasons for Bankruptcy-Vallejo Taxable property values went from $7 billion in 2005 to $10.0 billion in 2008 dropping to $7 billion in Unemployment in Vallejo went from 7.4% in 2004 to 8.7% in 2008 and 14.0% in Building permits issued 3702 in 2004 to 2000 in 2008 and 1791 in

8 Procedural Conditions for Filing Bankruptcy Even if Vallejo could identify its unknown creditors, including retirees, the court found it would have been fruitless to include them in the complex, on-going negotiations with Unions. Since the labor costs comprised the largest slice of Vallejo's budget, it would have been futile to negotiate with other creditors without an agreement with the Unions. Finally, Vallejo had to preserve its ability to continue providing the community uninterrupted services, and the court found a delay in filing to locate and negotiate with unknown creditors would have put those functions at risk.(para) We conclude that the bankruptcy court's decision that Vallejo was unable to negotiate with creditors because such negotiation was impracticable is amply supported by the evidence in the record. No error occurred. In re City of Vallejo, 408 B.R. 280, 298 (B.A.P. 9th Cir. 2009) Procedural Conditions for Filing Bankruptcy Effective January 1, 2012, the Legislature added Government Code section 53760, which provides that before filing for bankruptcy, a local public agency must attempt to mediate with its creditors, holding a settlement conference and inviting all creditors with claims of over $5 million or 5% of the total pending claims, before a mediator experienced in bankruptcy law. In view of the multi-year effort to ratchet down expenses during which the City reduced employees and reduced employee compensation, its cash insolvency, its service insolvency, its good faith negotiations or efforts to negotiate with creditors, and its inability to achieve significant further reductions without being able to compel the impairment of contracts, the 921(c) good faith presumption in this instance is strong. In re City of Stockton, Cal., C-9, 2013 WL (Bankr. E.D. Cal. June 12, 2013) 8

9 Procedural Conditions for Filing Bankruptcy The majority of the City's debt is bond debt and legacy debt. Neither the pension debt nor the bond debt are adjustable except through consent or bankruptcy. Negotiations with retirees and bondholders were impracticable due to the sheer number of creditors, and because many of the retirees and bondholders have no formal representatives who could bind them, or even truly negotiate on their behalf. Additionally, the Court finds that the City's fiscal crisis was not self-imposed and also made negotiations impracticable. Accordingly, the Court finds that prefiling negotiations were impracticable. The City has established by a preponderance of the evidence that it meets the requirements of 11 U.S.C. 109(c)(5)(C). In re City of Detroit, Mich., 504 B.R. 97, 179 (Bankr. E.D. Mich. 2013) Procedural Conditions for Filing Bankruptcy (San Bernardino) Although the Court finds that the City did not engage in meaningful prepetition negotiations with its creditors, did not seriously consider alternatives to filing chapter 9 (other than those considered in the Budget Report) when faced with the severe cash flow shortage in July 2012, honored its contractual obligations to its terminating employees by paying large cash outs just before the petition date, and was generally unprepared to formulate a plan of adjustment either before or soon after it filed, none of these uncontroverted facts add up to lack of good faith in filing. Were the purposes of chapter 9 to give a municipality a breathing space from a cash crunch and an opportunity to address its long term solvency through an organized process of proposing a long term plan of adjustment met here? 9

10 Procedural Conditions for Filing Bankruptcy (San Bernardino continued) The Court answers this question yes. Was there an alternative available to the City when it was faced with a $45.9 million cash deficit in the upcoming fiscal year and inevitably was going to default on its obligations as they came due? The Court answers this question no. To deny the opportunity to reorganize in chapter 9 based on lack of good faith would be to ignore fiscal reality and the general purposes of the Bankruptcy Code. The Court will not deny that opportunity. City of San Bernardino, Cal., 499 B.R. 776, 791 (Bankr. C.D. Cal. 2013) Administrative Issues During bankruptcy, the current administrative staffing levels were adopted as part of a city wide cooperative "survival" mode to endure the downturn. With that was an understanding that it would be difficult to be responsive even In the short term, and there certainly could be no organizational growth given the large demand for administrative time. Since that time, the department has been able to reestablish some of the lost services and personnel, but there has been no corresponding Increase in the ability to administrate the expansion. It is certainly possible for the Fire Chief to run the organization without assistance, as has been proven in the last couple of years. However just as it is possible for a single pilot to land a passenger aircraft by themselves, it Is certainly not optimum, and some of the normal considerations and precautions ultimately suffer. The current structure severely limits the ability of the Fire Chief to be anything but reactive to the administration of the organization. Vallejo Public Safety Advisory Committee 12/12/

11 Stay and Adjustment of Claims Chapter 9 of the Bankruptcy Code was added in the 1970s in response to the insolvency of the City of New York. The treatises claim that municipal bankruptcy does not discharge the city s debts; it only stays collection to allow the city to refinance with minimum, or no loss to creditors. (McQuillin, The Law of Municipal Corporations, Section 39:72.) Stay and Adjustment of Claims In practice, however, the bankruptcy courts do adjust third party liability claims in the process of approving a Plan under which the public agency comes out of bankruptcy. In Re County of Orange (C.D. Cal. 1995) 179 B.R. 185 establishes the stay applies to all claims. (At p. 189.) It even provides protection against secured claims, as for example when a public agency enters into a security agreement promising to pay a note out of first available tax revenues. (At p. 190.) The two main benefits of a Chapter 9 filing are (1) the breathing spell provided by the automatic stay, and (2) the ability to adjust debts of claimants through the plan process. (At 191.) 11

12 Claims Management Despite this statement of the general rule, there is a published case in which some objecting, unsecured creditors were forced to take partial payment as part of a plan that was approved by a majority of the creditors, and deemed fair and nondiscriminatory, overall. In re Corcoran Hospital District (E.D. Cal. 1999) 233 BR 449. It appears to be based on the notion that it was a practical impossibility for the district to pay the unsecured debts in full, with the assets available or the future income that could be expected. Reviewing Fairness of Adjustment Plan A Chapter 9 debtor is required to file a plan with the petition, or by such date the court fixes. See 941. Unlike Chapter 11, there is no provision in Chapter 9 allowing creditors or other parties in interest to file a plan. This limitation is required by the United State Supreme Court's decision[...], interpreting the Tenth Amendment to the Constitution as requiring that a municipality be left in control of its governmental affairs during a Chapter 9 case. Neither creditors nor the court may control expenditures for municipal services or otherwise control the affairs of a municipality indirectly through the mechanism of proposing a plan of adjustment of the municipality's debts that would in effect determine the municipality s future tax and spending decisions. See

13 Reviewing Fairness of Adjustment Plan Under 1129(a)(3), made applicable to Chapter 9 by 901(a), it is a requirement of confirmation that the plan be proposed in good faith. Although the term good faith is not defined in the bankruptcy code, nor is there significant case law exploring its meaning in the context of a Chapter 9 plan, courts have looked to cases interpreting its meaning under Chapter 11 and Chapter 13 for guidance, as these chapters also require that plans be proposed in good faith. See 1129(a)(3); 1325(a)(3). (para) Most courts agree that the determination of whether a plan has been proposed in good faith requires a factual inquiry of the totality of the circumstances. (Citation.) Factors a court should examine include: (1) whether a plan comports with the provisions and purpose of the Code and the chapter under which it is proposed, (2) whether a plan is feasible, (3) whether a plan is proposed with honesty and sincerity, and (4) whether a plan's terms or the process used to seek its confirmation was fundamentally fair. (Citation.) In re Pierce Cnty. Hous. Auth., 414 B.R. 702, 715, (Bankr. W.D. Wash. 2009) RETIREE BENEFITS The retired employees of the City of Stockton want this court to order the City to keep paying for their health benefits during this chapter 9 case. The difficulty is that 11 U.S.C. 904 forbids the court from using any of its powers to interfere with property or revenues of a chapter 9 debtor. Accordingly, although the City's unilateral interim reduction of retiree health benefit payments may lead to tragic hardships for individuals in the interval before their claims are redressed in a chapter 9 plan of adjustment, the motion for injunctive relief must be DENIED. No relief being available and determining that this is an arising in core proceeding under 28 U.S.C. 1334(b) and 157(b)(2), the adversary proceeding will be DISMISSED. In re City of Stockton, Cal., 478 B.R. 8, 13 (Bankr. E.D. Cal. 2012) 13

14 EMPLOYEE BARGAINED AGREEMENTS This Court declines to legislate from the bench and create a new exception to federal preemption. State labor law is not explicitly identified in California Government Code as an exception to the general grant of authority for municipalities to pursue Chapter 9 bankruptcy. If California had desired to restrict the ability of its municipalities to reject public employee contracts in light of state labor law, it could have done so as a pre-condition to seeking relief under Chapter 9. Its failure to take such action convinces this Court that the City was unequivocally authorized to exercise its right under Section 365 and reject the IBEW CBA without interference from the state. In addition, state labor law has never been carved out as an exemption to the Bankruptcy Code's federal preemption in case law from this circuit or other circuits. or law. In re City of Vallejo, CA, 432 B.R. 262, 270 (E.D. Cal. 2010) CALPERS Obligations This holding instructs this Court that by granting eligibility for the City and overruling CalPERS objections, the Court is not condemning CalPERS to an unfair or injurious outcome in the proceeding. The plan process is complex and will be lengthy, involving potentially extensive negotiations before the Courtappointed mediator. This Court is well aware, as observed by Judge Klein in his City of Stockton opinions, that most chapter 9 plans are consensual, having been achieved after good faith and willing participation in a mediation process. However, if that process fails to reach consensus, ultimate approval of any plan of adjustment lies with this Court, which would have to bless any creditor impairment. CalPERS will have further opportunities to argue its potential injury to the Court and to protect its interests, just as the other creditors have those remedies. 14

15 CALPERS Obligations (continued) As the Court observed when making its oral ruling on this motion, at least six other major creditors or classes of creditors exist here: the guarantors of the Pension Obligation Bonds 0 ; the guarantors of other general obligation bonds; the police and fire unions; the remaining five unions of City employees; the potential class of unsecured creditors (which might have subclasses); and the potential class of City retirees. Each of these creditor groups stands to be substantially impacted by the City's chapter 9 proceeding; each of these creditor groups was given the opportunity to object to the City's eligibility or good faith in filing. None of them objected because they conceded the City was insolvent and needed a long term, orderly process to sort out its finances and propose a path out of its abyss. The Court rightly notes that the best interest of all these creditor groups is served by proceeding forward in chapter 9. CALPERS Obligations (continued) Only the interest of CalPERS would be served if the Court dismissed this case. Exactly how that interest would be served is far from crystal clear. The cash deficit of the City is real and unchallenged. The City cannot pay its obligations with money it does not presently have. Impairment of contracts seems inevitable in order for the City to reach cash stability and only the chapter 9 process accords the City the legal opportunity to do so. How far that impairment might reach is a question to be negotiated or answered by this Court on a later day. Dismissal would leave this quagmire without orderly court oversight. This Court believes that oversight is critical to the financial future of the City and its creditors. City of San Bernardino, Cal., 499 B.R. 776, 792 (Bankr. C.D. Cal. 2013) 15

16 Stay of Action against the City The City of Stockton's fired Fire Chief is suing the City, the City Manager, and the Deputy City Manager on a variety of federal and state theories to redress his termination. Conceding that the 362 automatic stay protects the City from his lawsuit, he wants to keep proceeding against the City Manager and Deputy City Manager during the chapter 9 case. (para) This court holds: (1) that the 922(a) automatic stay augments the basic 362 automatic stay specifically to protect the individual defendants during the pendency of this chapter 9 case; and (2) that the City has satisfied its statutory burden of proof to demonstrate the absence of cause for stay relief. In re City of Stockton, Cal., 484 B.R. 372, 374 (Bankr. E.D. Cal. 2012) Stay of Action Against City The action against the individual officers is an exercise of the well-known strategy of suing a sovereign by falsely pretending to sue an officer. To the extent that there is a judgment against the individuals, the City, having undertaken their defense, will be required to pay the judgment. Cal. Gov't Code 825 & Hence, the civil action against the individuals seeks to enforce a claim against the debtor within the meaning of 922(a). 11 U.S.C. 922(a)(1). (para) It follows that the motion is deemed to have been made under 922(a). In re City of Stockton, Cal., 484 B.R. 372, 376 (Bankr. E.D. Cal. 2012) 16

17 SETTLING PENDING CASES 11 U.S.C. 904 gives a chapter 9 debtor freedom to decide whether to ignore or to follow the Rule 9019 compromiseapproval procedure, but the debtor may need to account for prior compromises during plan confirmation proceedings. Hence, 904 means that the City can expend its property and revenues during the chapter 9 case as it wishes. It can pay any debt in full without permission from this court. If it wishes to spend $55,000 settling a lawsuit, it is entitled to do so without needing a permission from this court; such permission would imply a power to disapprove and thereby to interfere with the City's property or revenues that would offend 904. In re City of Stockton, Cal., 486 B.R. 194, 195, 199 (Bankr. E.D. Cal. 2013) SUITS AGAINST EMPLOYEES These concerns are inapplicable here: the City is not a party to this action, plaintiffs have dismissed their Monell claims against the City and Chief Nichelini with prejudice, the automatic stay has been lifted, and the City's plan of adjustment has already resolved any pending litigation between the City and its creditors. Even if an action against an officer in his individual capacity must be stayed during ongoing Chapter 9 proceedings, defendants have cited no authority for the proposition that a judgment against that officer is discharged upon approval of the City's plan of adjustment. Deocampo v. Potts, 2014 WL (E.D. Cal. May 21, 2014) 17

18 Rights and Obligations between JPA and Member JPA Agreement/ Bylaws Deposit premiums Assessments JPA Actions to remove member Cancellation of coverage Anti drop down language Memorandum of Coverage Rights and Obligations between JPA and Member Obviously, there is a risk involved if a member declares bankruptcy and attempts to avoid or compromise its obligation to pay retrospective deposit premiums. One important consideration for a member agency, however, is that nonpayment of any deposit amount, including retrospective deposit amounts, is grounds for cancellation and terminates coverage. The Authority is not required to initiate litigation to take this step, and cancellation of coverage would not be subject to a stay. It seems more likely that a member declaring bankruptcy would still pay its retrospective premiums in full, but may request terms stretched over time. Assuming the reorganization puts the agency on a stronger financial footing, and it is committed to meeting its obligations over time, such a result would not impair the Authority s position or create a bad debt. 18

19 Claims arising from the filing of bankruptcy It does not appear that the act of a filing for bankruptcy by a member should give rise to additional third party liability covered by the Pool. Typically there are exclusions for liability arising from adoption of a resolution, such as a Council resolution to file for Chapter 9 bankruptcy; or breach of contract claims, including failure to pay as agreed per contract; or claims for diminished value of securities such as municipal bonds, and any claims arising from the issuance of bonds or similar securities; or claims based on failure to pay benefits as promised, or insolvency of employee benefit programs. Claims by third parties Bankruptcy by a Member does not terminate the contract between the Member and the Authority, which is the Joint Powers Agreement, including subsequent amendments. Nor is the liability coverage terminated by the bankruptcy filing. Standard Commercial General Liability (CGL) policies provide that bankruptcy or insolvency of the member shall not relieve the obligation of coverage. If there is a final judgment, the plaintiff can proceed to make a claim under the Memorandum. These provisions are required in commercial insurance policies per Ca. Insurance Code section 11580(b). Since the Pool is not an insurer, per Government Code section 990.8, it is not required to include this language in the MOC. 19

20 Workers Compensation Claims For workers compensation, the Pool MOC typically does not address the bankruptcy issue. The general assumption under workers compensation policies is that the JPA agrees to be bound by the workers compensation law and subject to the jurisdiction of the workers compensation system. This is because Labor Code section 3700(c) permits the member public agencies to self insure only upon demonstrating ability to pay claims, including by joining the joint powers authority, and 8 California Code of Regulations section (b), requiring annual reports, refers to JPAs as being solely responsible for the self insurance claims of its members. Department Focused Impacts Public Works Police & Fire Water & Sewer Schools Administration 20

21 LESSONS LEARNED Pay attention to the financial strength of your members Understand the needs of your members Review your JPA Agreement and Memorandum of Coverage to protect the organization Notice of Cancellation, anti-drop down clause Define a financial policy that benefits your organization and the health of the membership Understand the norm of today is very different than in 1986 Utilize actuary standards to formalize funding policies Questions? Byrne Conley abcjr@gibbons-conley.com David Clovis david@cjprma.org 21