Municipalities in Distress -- Factors Responsible James Spiotto 2014

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Municipalities in Distress:What Are the Causes and What Are the Factors that Can Prevent Municipal Default and Bankruptcy

James E. SpiottoManaging Director

Chapman Strategic Advisors LLC

August 14, 2014

3646172

Wisconsin Legislative CouncilStudy Committee on Review of Tax Incremental Financing

2014 by James E. Spiotto. All rights reserved. This presentation discusses the current state of the Chapter 9 market including a detailed analysis on these issues and bondholder rights and remedies. For further reading: Remarks of James E. Spiotto of Chapman and Cutler LLP to the U.S. Securities and Exchange Commission field hearing at Birmingham, Alabama on July 29, 2011 on the State of the Municipal Securities Market, Remarks of James E. Spiotto of Chapman and Cutler LLP, and 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 to Investors in Financially Distressed Local Government Debt, and State Authorization of Municipalities to File Chapter 9 Bankruptcy, which is available from Chapman and Cutler LLP or on Amazon.com, PRIMER ON MUNICIPAL DEBT ADJUSTMENT, published by Chapman and Cutler LLP, which is available from Chapman and Cutler LLP, 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.

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Table of Contents

I.The History of Payment of State and Local Government Debt inthe United States7

A.Why is it important to pay state and local government debt?7

B.Default rate for state and local government debt has been relativelylow especially when compared to corporate debt default17

II.What Are the Causes of Municipal Defaults and Bankruptcies?24

A.Traditionally causes of municipal bond defaults in the U.S.A. havebeen more linked to inability to pay rather than unwillingness topay or political risks24

B.Current causes of municipal default25

C.New causes of default26

D.Causes of Chapter9 to be noted and financial condition ofissuers to be avoided27

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Table of Contents

III.What Factors Have Helped to Prevent Municipal Defaults and Bankruptcies?29

A.Past market discipline and state and local governments need to borrow29

B.Diversification of tax sources to prevent over-concentration of source of funding36

C.Use of debt limitation and tax limitation38

D.Refunding bonds are permitted in all states38

E.Growing and increased use of state oversight, supervision and assistance for emergencies of local governments39

F.Improved bondholder rights and remedies48

G.Limited eligibility to file for municipal bankruptcy Chapter 952

H.Our states and municipalities enjoy a favorable GDP per capita anddebt to GDP and debt to revenue ratios compared to other sovereignson a global basis54

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Table of Contents

IV.General Analysis of Chapter 960

A.What is a municipality?60

B.Chapter9 filing statistics61

C.Interested parties in Chapter 967

D.Summary of Chapter 9 priorities68

E.The role of special revenues70

F.Chapter 9 legal impact on trustees and holders of municipal debt72

G.Preference in Chapter 975

H.Limitation on the bankruptcy court jurisdiction76

I.Other issues in Chapter 977

J.Chapter 9 (municipal debt adjustment) in unlikeChapter11 (corporate reorganization)79

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Table of Contents

V.Lessons Learned from Significant Defaults and Chapter9 Cases84

A.Selected case studies of past financial emergencies of municipalities84

B.Lessons learned from recent Chapter 9 bankruptcies85

C.Developing lessons to be learned91

D.Priority of the mandate to fund needed infrastructure andessential governmental services before any other obligation92

VI.Checklist of Disclosures to Maximize Market Acceptance inEvaluating Repayment of Bond Debt 95

A.Authorized to file Chapter9?95

B.What is source of payment?95

C.Is there a lack of diversification of tax sources and limits ontaxes that could realistically be triggered?96

D.Are there required priorities, set asides or appropriations tosupport payment?96

E.Are there effective remedies available if there is a default?97

F.Is effective state oversight and assistance available toprevent defaults or aid a financially troubled municipality?97

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Table of Contents

VII.How to Deal with TIDs in Distress98

A.Historical use and benefits of TIFs98

B.Methods of stopping the bleeding, distressed TIDs andresponding to public outcry100

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I.The History of Payment of State and Local Government Debt in the United States

A.Why is it important to pay state and local government debt?

1.Who said?

No pecuniary consideration is more urgent than the regular redemption and discharge of public debt. On none can delay be more injurious or economy of time more valuable.

2.Was it said by:

A rating agency official?

A public union representative?

A member of the board of directors of a municipal bond fund?

A representative of a bond insurer or hedge fund?

An elected official of a state or local government?

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The good news is it was a President of the United States.

The bad news is that it was written over 220 years ago by George Washington in his State of the Union address of December3, 1793 referencing the debts of the Revolutionary War incurred by the states that were assumed by the federal government to insure continued market credibility for the newborn nation and its states. Washington and Hamilton were instrumental in having the federal government assume states debt of the Revolutionary War since some states were balking at paying such debt which they believed was a financial game, and they feared their taxes would go to pay northern speculators or to pay debt of big borrowers like Massachusetts. Washington and Hamilton knew the progress of a new nation could be no swifter than its financial credibility.

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3.Past economic downturns have taught us the importance of state and local governments to timely pay their public debts:

Panics, recessions and depressions. Since 1793 we have had 6 panics, 38 recessions and 4 depressions The last depression being the Great Depression of the 1930 and the last recession the Great Recession of 2008.

The price of repudiation of the obligation to pay debts timely. Between 1841 and 1843 eight states and one territory (now a state) repudiate their debt and seven states between 1843 and 1848 resumed payment. While some attribute the repudiation to the aftermath of the Panic of 1837, the real reason lies in developing states borrowing money to pay for needed transportation improvement given the success of the Erie Canal or for needed banking services in the state. By

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1844, nineteen states and two territories had borrowed money for needed economic growth. The inflationary boon of 1834-39 with the accompanying Panic of 1837 came to end by 1841 and there was a tightening of credit that put pressure on incomplete construction projects for transportation improvements in the North (Pennsylvania, Maryland, Indiana, Illinois and Michigan) and lack of credit for banks in the South (Arkansas, Louisiana, Mississippi and Florida Territory). All but the Florida Territory and Mississippi resumed payment by 1848. The reason was the cost of defaults denial of access or increase in cost of borrowing. Those that repudiated but resumed payment experienced borrowing yields to complete project of 32% until they resumed payment and then paid 4% above market to borrow. Mississippi and Florida Territory lacked access to then public market for almost two decades. (English, 1996; Wallis, Sylla and Grinath, 2004; Sturzenegger and Zettelmeyer, 2007)

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The cost of default. The price of default in either increased borrowing costs or denial of access to the market was demonstrated by those States in the 1840s who cured the repudiation or default suffered high interest rates (32% + yield) until resuming payment and even increased rates (4% + addition yield) after resuming payment on repudiated debt. Those who never cured default were denied access for decades (while financial memories lasted):

Civil War repudiation and affirmation of the obligation to pay public debt of the United States. Eight Southern States (Alabama, Arkansas, Florida, Georgia, Louisiana, Mississippi, North Carolina and South Carolina) after the Civil War repudiated indebtedness and still do. The reasons vary but generally are attributable to debt involuntarily incurred during the carpet bag governments. The Fourteenth Amendment was enacted in part to assure payment of public debt of the United States and its States but not in aid of the insurrection which shall be illegal and void. (U.S. Constitution Fourteenth Amendment Section4). The Civil War debt of the Confederate government was approximately $1.4billion and the Confederate states had individual Civil War debt of about $67million. (Noll, 2012)

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The repayment battle. In 1860, before the start of the Civil War, public debt was about $65million and after the Civil War was about $2.7billion (after deducting cash in the treasury). Public debt after the Civil War was 41 times larger than at the start. The per capita cost of public debt rose from $2.06 in 1860 to $75.01 in 1865 (in May 2014, $75.01 in 1865 equaled $14,000.00 in May 2014 using nominal GDP per capita, see Williamson, 2012). Given the 14thAmendment, Section4, the battle was over whether to pay the debt in gold or in greenbacks. The United States had gone off the gold standard and greenbacks were a devalued currency. Democrats favored paying in greenbacks. Republicans favored paying in gold. In March 1869, President Grant, a Republican, took office and in his inauguration speech following the statement of Washington and Hamilton 80 years earlier, he said, to protect national honor every dollar of government indebtedness should be paid in gold. (Noll, 2012)

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Expansion of state and local government debt and the Depression of 1873. Between 1850 to 1870, public debt of local governments in the United States rose over 10 times from $50million to $516million. The Depression of 1873 led to a flood of state and local government defaults between 1873 to 1879. Approximately 25% of the $1billion state and local government debt defaulted during this period. The cause was over- expansion and investment in railroads, real estate and nonessential services.

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Again the consequences of repudiation was that state and local government debt must be paid for market credibility. Railroad Cases. The Supreme Court ruled in over 300 cases between 1860 and 1896 that efforts by state and local governments to repudiate and invalidate bonds issued to subsidize railroad facilities violated the Constitution and thus the rights of secured bond investors. The Supreme Court took a consistent and clear stand upholding the validity of the bonds sometimes overruling state supreme courts. Gelpcke v. Dubuque, 68 U.S. 175 (1864); Havemeyer v. Iowa County, 70 U.S. 294 (1866):

The consequences of the 1860-1870 defaults. The reaction to these defaults, moral obligation bonds was to assure payment by legislation recognizing the validity of the debt and giving bondholders rights and protections to discourage any repudiation or default on public debt.

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Safeguards to protect bondholders. As a reaction to the events described above, in the late 1800s and early part of this century, states enacted legislation to give bondholders greater rights and protection and to prevent unnecessary defaults on municipal obligations. The municipal bond market in effect mandated necessary changes in the documentation, legal authorization, and structure of municipal financing, which included:

debt limitation on municipal issuers to prevent excessive borrowing;

clearly defined bondholder rights in the event of default supported by statutory and case law;

use of bond counsel to determine the legality of the bond issue before the sale to avoid technical legal defects that could allow an issuer to repudiate the debt;

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development of credit rating agencies as well as thorough credit review by investment firms and many institutional investors;

statutory restrictions against municipal issuers borrowing for chronic deficiencies; and

the use of indenture trustees, paying agents, and other who have certain fiduciary duties in order to protect the rights and interests of bondholders.

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B.Default rate for state and local government debt has been relatively low especially when compared to corporate debt default.

1.Historically, while political risk of non-payment was a possibility, it was a rare occurrence, if not in reality a non-existent concern, with a few exceptions (i.e. 8 States and one Territory repudiated their debt between 1841 to 1843 with 7 of the 9 resuming payment by 1849, repudiation of Civil War related debt by 8 states in the late 1860s, railroad bond and real estate defaults of the 1870s to 1890s and Washington Public Power Supply System, 1983). There are current situations that may test the long-term viability of the historical premise. Namely, it is hoped that Detroit, Stockton, San Bernardino and Jefferson County are rare aberrations rather than indicative of a growing trend:

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Historically, there is a low default rate for bonds issued by municipalities and states:

The late Dr. John Petersen of George Mason University noted in his paper on Municipal Defaults: Eighty Years Made a Big Difference (2011) that, between 1970s-2000s, the municipal default rate for municipalities averaged per decade .10% to .24% (adjusted for WPPSS and Jefferson County, Alabama) not including the fact that over 80% of the defaults were conduit financing and not essential public financings. This is a far cry from corporate bond default rate on average for investment grade and non-investment grade of about 10%. (Petersen, 2013)

States have not defaulted on general obligations bonds since the late 1880s, with the exception of Arkansas in 1933, which was thereafter refinanced.

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Historically, based on default rate, there is little support for the willingness to pay to be deemed a real problem since there is an absence of political risk.

Essential service debt financing has historically enjoyed a significantly lower default rate than healthcare, housing and conduit state and local governmental financing.

Unfunded pension obligations and deferred infrastructure cost are a more recent phenomenon Prior to 1960s, most pension obligations were treated as gratuities and a significant number of big ticket infrastructure costs are only now starting to age such as the interstate highway system, electric grid, waste water treatment facilities, etc.

We are closer to a tipping point and departure from the historical assurances than we have ever been. The difference may be whether there is Market Discipline going forward.

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Rated Municipal vs. Corporate Default Rates by Ratings Service

CorporateFitch *3S&P *2Moody's *18.8999999999999999E-31.54E-21.5699999999999999E-2MunicipalFitch *3S&P *2Moody's *14.0000000000000002E-42.0000000000000001E-41E-4

Recorded Defaults, by Type of Local Government Unit and Geographical Region

1839-1969

aThe number of local government units has changed rapidly. For example, in 1932 there were 127,108 school districts, 8,580 other districts, and 175,369 state and local government units.

bThe percent of annual default in total defaults by type divided by number of governments divided by 130 (years).

Sources:Default information in The Daily Bond Buyer, The Commercial and Financial Chronicle and The Investment Bankers Associations Bulletin: default lists from Federal Deposit Insurance Corporation, Life Insurance Commission, and U.S. Courts; and AlbertM. Hillhouse, Defaulted Municipal Bonds (Chicago: Municipal Financial Officers Association, 1935). Number of local government units from: U.S. Department of Commerce, Bureau of Census, Census of Governments, 1967, Vol.1 Governmental Organization (Govt Printing Office, 1969) and ACIR Report Bankruptcy, Defaults and Other Local Government Financial Emergencies U.S. Government 1973.

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Moodys U.S. Municipal Defaults and Recovery 1970-2013:

Municipal bond defaults for rated bonds (defaults) remains extremely low namely is 1.3 defaults per year on average between 1970-2007 period (0.01%) and 5 defaults per year from 2008-2013 period (7 in 2013 and 5 in 2012 with an average of 5 defaults) or 0.03%.

The ultimate recovery rate remains higher than corporate defaults with at least 60% recovery for the 1970-2013 period for municipal rated bonds versus 48% recovery for corporate senior unsecured rated bonds. Ranges vary by case Jefferson County at least 80% of principal and interest for sewer warrants, 100% of principal for G.O. warrants, Vallejo, Sierra King. 100% recovery for special revenues.

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Moodys concentration by sector of municipal defaults from 1970-2011:

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II.What Are the Causes of Municipal Defaults and Bankruptcy?

A.Traditionally causes of municipal bond defaults in the U.S.A. have been more linked to inability to pay rather than unwillingness to pay or political risks:

1.Economic depression.

2.Non-essential services.

3.Feasibility of projects and municipal enterprises.

4.Fraud.

5.Mismanagement.

6.Natural and man-made disasters.

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B.Current causes of municipal default. Generally, 75% of all municipal bond defaults have occurred in bonds issued by municipalities to finance revenue producing enterprises (i.e., highways, bridges, utilities, swimming pools, harbors, etc.).

There are many causes of municipal default. A number of factors, while they do not in and of themselves necessarily cause default, contribute to restricted cash flow which brings about an inability to meet scheduled debt service payments.

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C.New causes of default:

1.Unaffordable and unsustainable personnel costs.

2.Deferred costs of capital improvements and infrastructure costs.

3.Decline of urban areas.

4.Proposition thirteen mentality The popularity of tax caps and limitations.

5.Off balance sheet liabilities Unforeseen judgments and derivatives problems.

The Big Question:

Willingness to pay vs. ability to pay Willingness to pay traditionally has not been a problem but could be a growing problem.

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D.Causes of Chapter9 to be noted and financial condition of issuers to be avoided:

1.Unaffordable and unsustainable personnel costs. (Vallejo, SanBernardino, Detroit)

2.Deferred costs of capital improvements and infrastructure costs. (Detroit and Central Falls)

3.The bursting of the local government debt bubble. (Jefferson County and Detroit)

4.Decline of urban areas. (Detroit and Central Falls)

5.Proposition thirteen mentality The popularity of tax caps and limitations. (Stockton and San Bernardino)

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6.Lingering legal issues and surprise court decisions. (Town of Mammoth Lakes and Boise County, Idaho)

7.Off balance sheet liabilities. (Underfunded pension obligations Stockton, San Bernardino, Detroit)

8.Willingness to pay vs. ability to pay Willingness to pay traditionally has not been a problem but could be a growing problem. (Jefferson County, Orange County, etc.)

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A.Past market discipline and state and local governments need to borrow:

1.As noted, in the 1800s and 1900s, states and local governments in order to fulfill their mandated mission borrowed for needed infrastructure and essential governmental services at an acceptable level. It has been that ability to borrow that has funded the worlds best infrastructure.

Our states and local governments have built the worlds largest infrastructure for the worlds largest economy. The United States contains the most extensive and sophisticated public works system in the world including 4,042,778 miles of roadways, 603,259 bridges, 1,100 local bus systems, 19,750 airports (of which 5,178 are for public use), 25,320 miles of

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III.What Factors Have Helped to Prevent Municipal Defaults and Bankruptcies?

inland and intercoastal waterways, almost 84,000 dams, more than 2million miles of pipe in water supply systems and over 15,000 wastewater treatment plants provided mostly by municipalities and political subdivisions of a state. The American Society of Civil Engineers (ASCE), in its 2013 Report, estimates the cost to maintain this infrastructure at a passable level will be $3.6trillion by 2020 or about 4 times the annual tax revenues for all state and local governments. In 2009, ASCEs number for the next 5 years was $2.2trillion. Inattention has caused the number to increase by $1.4billion in 5 years.

Continued borrowing is required to fund needed infrastructure and stimulate the economy as demonstrated by increased borrowing after each economic downturn since 1949, except the last one (2008).

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2.Investment in infrastructure and governmental services returns significant benefits:

In the short run, a dollar spent on infrastructure produces roughly double the initial spending in ultimate economic output.

Over a 20-year period, generalized public investment generates an accumulated $3.21 of economic activity for each $1.00 spent. (Same ratio that was noted during the Depression of 1929-1939.)

Over 20 years, investing $1.00 in highways and streets returns approximately $0.35 in tax revenue to the federal and state/local government of which $0.23 specifically accrues at the federal level.

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Over 20 years, investing $1.00 in sewer systems and water infrastructure returns $2.03 in tax revenue to federal and state/local government of which $1.35 specifically accrues at the federal level.

The U.S. on the federal level is spending on infrastructure is the lowest percent of GDP since 1947, namely 3.6% compared to an average of 5%. (Cohen, Freiling and Kobenson, 2012)

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In Economic Downturns, Increased Issuance of State and Local Bonds Is Followed by Increases in Employment and GDP Growth

U.S. Economic Trends, 1949-2009:

State/Local Bond Issuance, Real GDP, Employment(year-on-year % change)


State and local bond issuance (3-year moving avg.) year-on-year growth rate (%)194919501951195219531954195519561957195819591960196119621963196419651966196719681969197019711972197319741975197619771978197919801981198219831984198519861987198819891990199119921993199419951996199719981999200020012002200320042005200620072008200928.55508336057534916.0203432930705715.512328767123296612.60905691732446118.686589190186329.3751942803854511.14848630466123-0.60527453523562003-5.98086124401963E-28.008269408628480711.257744421498011.2314378848243314.07423971377459983.768639078681616211.914030147424238.08140610545791038.86712999417986233.088147426019692211.4212501143955314.3080082135523610.888601470623453968.247471630027060718.83717869988597122.5025376026575519.3509897857723931-0.892746435213886979.666791776137452914.37933351079336924.88391422397074115.9731650826611296.16119183710936461.151786422182334-0.6234902628634899625.65034704296449121.71573354942157927.61907441007824149.61462160175999314.877802632774371-0.90500832547810695-21.49816547204852-9.1677199538385375.424487635181118411.4430987038997726.1453138235831832.577173975163902-6.9587922492597903E-2-10.71260202808257-18.75983518303792912.9014992704357621.9508891535123116.8190442694112336-4.95203353825403444.510219213214782921.57890375470482924.382480219158686.33033934918098414.13997622158229460.453971271926969015.9116003954837399-1.54137409065129891.7721221042023001Real GDP year-on-year growth rate (%)1949195019511952195319541955195619571958195919601961196219631964196519661967196819691970197119721973197419751976197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006200720082009-0.512349999999999978.74396999999999747.73179999999999983.83137999999999984.6035899999999996-0.630539999999999997.19858999999997361.975762.0159199999999999-0.903460000000000047.17333999999999962.47602000000000012.3314099999999766.05820000000000034.37117999999999985.78787999999999776.420426.51504999999999962.52775999999999984.84210999999999463.10639999999999980.190060000000000013.358395.31121999999999965.7942600000000004-0.55115000000000003-0.212680000000000015.36529999999999864.59806000000000035.57673000000000043.1245599999999998-0.273270000000000012.5381100000000001-1.942484.51889999999999867.18522999999999984.13860000000000033.463133.200454.11031999999999983.57241000000000011.87677-0.234013.39359000000000012.85142000000000014.07467000000000022.513893.741054.456274.35545999999999994.82617999999999464.13921999999999991.07963999999999991.813662.49026000000000013.57326999999999993.05452000000000012.67281000000000012.141610.43835000000000002-2.43987Employment year-on-year growth rate (%)19491950195119521953195419551956195719581959196019611962196319641965196619671968196919701971197219731974197519761977197819791980198119821983198419851986198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820090.19635-0.928233.47184999999971611.38172000000000011.88554-2.558441.214514.9380300000000004-0.18978999999999999-0.647469999999999991.02499000000000012.31571000000000020.656499999999999970.504739999999999971.45822000000000011.87111999999999992.44412999999999993.14442000000000022.04022000000000011.39674999999999992.81794000000000012.571450.106632.65647000000000012.71994.0812400000000002-1.07214999999999992.07060999999999982.89244999999968714.95507999999999973.77606000000000021.97144999999999997.6090000000000005E-2-0.26312000000000002-0.532644.07417999999999663.004822.43175000000000011.89738000000000012.76062999999999992.36106999999999982.03328-0.958169999999999973.2219999999999999E-20.929830000000000052.427882.21126999999999980.370599999999999982.535861.89247000000000011.760172.65510.89265000000000005-1.50750000000000011.264540.767739999999999981.28042.06566999999999992.01896999999999990.26638000000000001-2.8684400000000001

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Bars indicate recessions; width indicates thickness


In Economic Downturns, Increased Issuance of State and Local Bonds Is Followed by Increases in Employment and GDP Growth

U.S. Economic Trends, 1949-2009 (year-on-year % change):

State and local bond issuance (3-year moving avg.) year-on-year growth rate (%)194919501951195219531954195519561957195819591960196119621963196419651966196719681969197019711972197319741975197619771978197919801981198219831984198519861987198819891990199119921993199419951996199719981999200020012002200320042005200620072008200928.55508336057534916.0203432930705715.512328767123296612.60905691732446118.686589190186329.3751942803854511.14848630466123-0.60527453523562003-5.98086124401963E-28.008269408628480711.257744421498011.2314378848243314.07423971377459983.768639078681616211.914030147424238.08140610545791038.86712999417986233.088147426019692211.4212501143955314.3080082135523610.888601470623453968.247471630027060718.83717869988597122.5025376026575519.3509897857723931-0.892746435213886979.666791776137452914.37933351079336924.88391422397074115.9731650826611296.16119183710936461.151786422182334-0.6234902628634899625.65034704296449121.71573354942157927.61907441007824149.61462160175999314.877802632774371-0.90500832547810695-21.49816547204852-9.1677199538385375.424487635181118411.4430987038997726.1453138235831832.577173975163902-6.9587922492597903E-2-10.71260202808257-18.75983518303792912.9014992704357621.9508891535123116.8190442694112336-4.95203353825403444.510219213214782921.57890375470482924.382480219158686.33033934918098414.13997622158229460.453971271926969015.9116003954837399-1.54137409065129891.7721221042023001Real GDP year-on-year growth rate (%)1949195019511952195319541955195619571958195919601961196219631964196519661967196819691970197119721973197419751976197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006200720082009-0.512349999999999978.74396999999999747.73179999999999983.83137999999999984.6035899999999996-0.630539999999999997.19858999999997361.975762.0159199999999999-0.903460000000000047.17333999999999962.47602000000000012.3314099999999766.05820000000000034.37117999999999985.78787999999999776.420426.51504999999999962.52775999999999984.84210999999999463.10639999999999980.190060000000000013.358395.31121999999999965.7942600000000004-0.55115000000000003-0.212680000000000015.36529999999999864.59806000000000035.57673000000000043.1245599999999998-0.273270000000000012.5381100000000001-1.942484.51889999999999867.18522999999999984.13860000000000033.463133.200454.11031999999999983.57241000000000011.87677-0.234013.39359000000000012.85142000000000014.07467000000000022.513893.741054.456274.35545999999999994.82617999999999464.13921999999999991.07963999999999991.813662.49026000000000013.57326999999999993.05452000000000012.67281000000000012.141610.43835000000000002-2.43987Employment year-on-year growth rate (%)19491950195119521953195419551956195719581959196019611962196319641965196619671968196919701971197219731974197519761977197819791980198119821983198419851986198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820090.19635-0.928233.47184999999972811.38172000000000011.88554-2.558441.214514.9380300000000004-0.18978999999999999-0.647469999999999991.02499000000000012.31571000000000020.656499999999999970.504739999999999971.45822000000000011.87111999999999992.44412999999999993.14442000000000022.04022000000000011.39674999999999992.81794000000000012.571450.106632.65647000000000012.71994.0812400000000002-1.07214999999999992.07060999999999982.89244999999970094.95507999999999973.77606000000000021.97144999999999997.6090000000000005E-2-0.26312000000000002-0.532644.07417999999999663.004822.43175000000000011.89738000000000012.76062999999999992.36106999999999982.03328-0.958169999999999973.2219999999999999E-20.929830000000000052.427882.21126999999999980.370599999999999982.535861.89247000000000011.760172.65510.89265000000000005-1.50750000000000011.264540.767739999999999981.28042.06566999999999992.01896999999999990.26638000000000001-2.8684400000000001

3.Historically, government finance officers did anything they could to avoid default due to the essential need of any government of size to access the municipal market to cover financing of infrastructure and essential services at a low cost (the investment mandate).

4.Municipalities and states fear default would lead either to limited or no access to the Municipal Bond Market or significant increase in the cost of borrowing (increased interest costs). This would limit or deprive states or municipalities of their present ability to decide locally what infrastructure improvement or what essential services they will finance and to finance such themselves rather than to obtain the consent or approval of a higher government that has the ability to obtain financing and possibly a different agenda.

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B.Diversification of tax sources to prevent over- concentration of source of funding. Since the Depression of the 1930s, state and local governments have diversified the source of tax revenues to reduce reliance on property taxes and to spread the burdens and reduce the risk of concentration that diversity of tax sources has made a real difference in the eleven economic downturns since 1949 especially in 2008.

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General State and Local Governments Revenues1922-2008: Totals and Percentage Distribution

(Petersen, 2013)

Property, income and sales taxes made up over 70% of state and local governments revenues in 1922-1940 but only 50% of state and local governments revenue by 2008. More diverse and varied tax base in 2008 with more federal assistance.

Property taxes which made up over 60% of the revenues of state and local governments between 1922-1932 was only 16.7% of revenue by 2008 with increases in sale, income other, miscellaneous and federal aid making up the difference.

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1922192719321936194019682008Amount of Gen. Rev.(billions of dollars)4.87.37.38.49.6101.32425.8Percent DistributionProperty Tax69.565.161.748.846.127.416.7Sales Tax3.26.510.317.720.622.618.5Income Tax2.12.22.13.24.09.714.8Other Tax9.210.010.610.210.67.04.5Misc. Rev.13.714.712.08.98.916.325.7Federal Aid 2.3 1.6 3.2 11.3 9.8 17.0 19.8TOTAL100.0100.0100.0100.0100.0100.0100.0

C.Use of debt limitation and tax limitation:

1.Virtually all states impose some sort of limitation on the amount of debt or tax limitations or both.

2.Municipal debt limits range from a percentage of a valuation of assessed property to a monetary amount.

3.States handle debt for essential services differently than non essential.

4.There have been recent attempts in states to tighten local debt limits while others strengthen protections.

5.Generally revenue bonds paid from the revenues of a municipal enterprise (water, sewer, bridge, tollway, electric system) are exempt from debt limits. So also are tax increment financing and appropriation bonds.

D.Refunding bonds are permitted in all states.

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E.Growing and increased use of state oversight, supervision and assistance for emergencies of local governments:

1.At least twenty-five states have implemented some form of municipal debt supervision or restructuring mechanism to aid municipalities:

These range from Debt Advisory Commission (e.g. California) and Technical Assistance Programs (Florida) which provide guidance for and keep records of issuance of municipal debt to the layered approach of Rhode Island and Michigan of oversight, commission and fiscal manager or receiver.

Examples of state oversight, supervision and assistance for fiscal emergencies of local government.

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40


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2.States recognize the use of a municipal receiver:

The Rhode Island Experience and The City of Central Falls:

Overseers.

Budget Commission.

Receiver.

Chapter 9.

Texas use of judicially appointed receiver vs. financial control board, emergency financial managers, coordination overseers and refinance.

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3.Financial Control Boards and Active Supervision Examples:

The Rhode Island Experience and The City of Central Falls.

The New York Experience Financial Control Board.

The Pennsylvania Experience Act 47.

The Michigan and Indiana Experience Emergency Managers.

The Massachusetts Ad Hoc Experience.

The California Experience Neutral Evaluator.

The North Carolina Local Government Commission oversight and approval from the cradle if debt issued to annual financial reports.

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4.Development of a municipal protection commission as a quasi judicial entity to determine what costs are sustainable and affordable and which are not including labor costs and benefits and whether taxes should be raised or costs reduced.

5.The structure for oversight and emergency financing:

Grants from federal, state and regional governmental bodies.

Loans from federal, state and regional governmental bodies.

State intercepts of tax revenue.

Involvement in local government budget process.

Required financial performance and targeted levels of essential governmental services.

State legislative assistance in tax revenue and powers.

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Backup by moral obligations of the state.

Considerations regarding the appointment of authority members.

Acceleration of loans and obligations if performance triggers are violated.

Dealing with the press.

What powers are essential for state oversight and assistance.

Exploration of transfer of certain governmental services (and related costs) to other governmental bodies.

Consolidation of regional essential governmental services.

Power to authorize Chapter9 if needed or bridge financing or refinancing of troubled debt.

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Use intercept of state tax payable to municipality to ensure essential municipal service.

Private Public Partnerships Lease and sale of municipal properties to provide bridge financing and cash flow relief.

Vendor Assistance Program Providing vendor payments through securitization financing of payables. Payment from dedicated tax revenues over time. Provide current cash flow relief from current or future vendor payments.

Explore consolidation on a regional basis of certain governmental services.

Monitor compliance with any restructuring plan to ensure compliance and prevent financial erosion.

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F.Improved bondholder rights and remedies:

1.The critical differences between revenue bonds and general obligation bonds, lease appropriation bonds and conduit financings:

Conduit financing (non-recourse to municipality, must be for a general public purpose and the credit support is the non-profit or corporate entity benefited).

Upon default on lease appropriation bonds the remedies are limited to those set forth in the documents and applicable law and generally limited to the municipalitys loss of use of the leased facility and ability to relet the facility. In conduit financing the remedies are generally limited to the not-for-profit or corporate entity benefitted without recourse to the municipality.

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Revenue bonds are generally only payable from the pledged revenue, specific tax source or revenue related to the municipal enterprise financed and no other recourse to the issuing municipality.

General obligation bonds are backed by the full faith and credit of the municipality and may also have a contractual or statutory pledge of revenue.

Upon default, bondholder may institute lawsuits requesting the debt be immediately paid or certain actions be taken by the municipality or be required to specifically perform under the documents.

Municipal lease or appropriation backed bonds (non-recourse to municipalitys full faith and credit but recourse to annual appropriation or leased property. Note: cannot legally bind successor legislature to appropriate funds).

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2.Upon Default (breach of covenant or failure to make payment of principal or interest), Bondholder may institute a lawsuit for a money judgment, mandamus, specific performance, or equitable relief such as for injunction or an accounting or for foreclosure on collateral (if permitted) or other relief:

Mandamus all States would permit a bondholder upon default to petition for mandamus that in essence requires a Municipal official to levy taxes to pay an obligation. The problem is constitutional and statutory debt limits and time, cost and delay.

Receiver 46 States and Puerto Rico permit bondholders to petition a Court to appoint a Receiver upon default especially in the case of a default on the Revenue Bond for financing of a Municipal Enterprise.

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Accounting At least 23 States and the District of Columbia and Puerto Rico allow for Bondholders or Representative to bring an action for an accounting to require the local government to account for how bond funds have been spent.

Foreclosure At least 28 States permit some form of foreclosure on mortgaged or secured real property upon default on a financing of that facility or structure generally related to conduit financing.

Injunction At least 15 States permit bondholder to obtain some form of injunctive relief upon default to protect and preserve their rights and remedies.

Other Relief.

(For more detail see Municipalities in Distress? Chapman and Cutler LLP, 2012)

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G.Limited eligibility to file for municipal bankruptcy Chapter9:

1.The municipality must be specifically authorized by state law:

Less than half of all states specifically authorize their municipalities under state law to be a debtor in Chapter9. Twelve states have statutory provisions in which the state specifically authorizes filing (AL, AZ, AR, ID, MN, MO, MT, NE, OK, SC, TX, WA without any conditions), another twelve states authorize a filing conditioned on a further act of the state, an elected official or state entity or neutral evaluator (CA, CT, FL, KY, LA, MI, NJ, NC, NY, OH, PA, RI). Three states (CO, OR and IL) grant limited authorization, two states prohibit filing (GA) but one of them (IA) has an exception to the prohibition. The remaining 21 are either unclear or do not have specific authorization so they cannot file for Chapter9.

Those municipalities that are in states that have a condition to filing Chapter9, namely a second look by an elected official or state agency, are approximately 5 times less likely to file than those that are in states that unconditionally allow their municipalities to file.

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H.Our states and municipalities enjoy a favorable GDP per capita and debt to GDP and debt to revenue ratios compared to other sovereigns on a global basis:

1.The per capita GDP of each of California, Texas, Florida, NewYork, Illinois and New Jersey (certain Major U.S. States) is higher than Portugal, Greece, Italy and Spain.

2.The percentage of debt to revenue ratio is lower for major U.S. states than Portugal, Italy and Greece.

3.The percentage of debt to GDP is lower for certain major U.S. states than Spain, Ireland, Portugal, Greece and Italy.

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GDP per capita of Selected U.S. States and European CountriesThousands of 2009 USD

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Source: US Bureau of Economic Analysis; US Census Bureau; OECD.


GDP per CapitaPortugalGreeceSpainItalyMichiganIrelandFloridaIndianaWisconsinTexasIowaIllinoisCaliforniaNew JerseyNew York25.0023533841664329.06345830009750132.23406153444449332.430099134853336.95196468268010639.73146067415729739.75829283132363740.89092002585039943.21481282894770746.19001899016490147.30346133591501748.82866220582167251.17093754220589855.46411071806355256.202433823324142

Debt-to-Revenue Ratio of Selected U.S. States andEuropean Countries (2008 figures)

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Source: US Bureau of Economic Analysis; US Census Bureau; Eurostat; OECD.


Debt-to-Revenue Ratio of Selected U.S. States and European Countries (2008 figures)IowaIrelandWisconsinSpainMichiganCaliforniaFloridaIndianaNew JerseyNew YorkIllinoisTexasPortugalItalyGreece0.667674629573631990.925656514098422981.00295266215830091.0204192906736481.0291032426592271.04050102489014011.04450742027956811.05205107921799091.0816565033265611.1787069832334641.29995274376984391.31492564066858011.93992373615573912.33350907433190093.212343727248876

Debt-to-GDP Ratio of Selected U.S. States andEuropean Countries (2008 figures)

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Source: US Bureau of Economic Analysis; US Census Bureau; Eurostat; OECD.


Debt-to-GDP Ration of Selected U.S. States and European Countries (2008 figures)IowaWisconsinIndianaCaliforniaNew JerseyTexasFloridaIllinoisMichiganNew YorkSpainIrelandPortugalItalyGreece0.1086293417298040.172361582845685010.1772264674639340.180342966950289010.1821484987587140.1885896968188030.1928374466445420.1969594097697010.2042529743404610.246740829605047010.344380263977701990.396702016345691020.620724774096385051.0948782702065011.1122251260204381

4.The most recent example of our states enjoying a favorable GDP and Debt to GDP and Debt to Revenue Ratios compared to other Sovereigns on a global basis is China.

China has:

31 provinces and regional governments.

391 cities.

2,778 counties.

33,000 townships.

The combined debt of these local governments is approximately $3trillion or 36% of Chinas GDP (2012) (China National Audit Office).

99 cities, 195 counties and 3,465 townships in China had direct debt 2013 exceeding 100% of their respective annual economic output (GDP).

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The USA has:

50 states.

3,031 counties.

19,522 municipalities.

16,364 townships.

37,203 special districts.

12,884 independent school districts.

The combined debt of state and local governments is approximately $3trillion (Federal Reserve Bank of St.Louis 2013) or 18.52% of the USAs GDP.

The highest debt to GDP for any state and its local government is approximately 26% New York with the lowest being Wyoming at 5.25%. The percentage of debt to local GDP for large city issuers in the USA is generally less than 20% and in most instances less than 10%.

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A.What is a municipality?

Under 11 U.S.C. 101 (15):

An entity includes a person, estate, trust, governmental unit, and United States Trustee.

Under 11 U.S.C. 101 (27):

An governmental unit means United States, State, Commonwealth, District, Territory, municipality, foreign state, department, agency, or instrumentality of the United States (but not a United States trustee while serving as a Trustee), a State, a Commonwealth, a District, a Territory, a municipality, or a foreign state or other foreign or domestic government.

Under 11 U.S.C. 101 (40):

A municipality means political subdivision or public agency or instrumentality of a state.

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B.Chapter9 filing statistics:

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1. FREQUENCY OF MUNICIPAL BANKRUPTCIES 1937-2014

(as of 6/12/2014)

1938-721973-791980-2014*1937-20143627290659

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2. FREQUENCY OF MUNICIPAL BANKRUPTCIES

BY DECADE

(as of 6/12/2014)

1938-19391940s1950s1960s1970s1980s1990s2000s2010-20141062153189711046847

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3. CHAPTER 9 FILINGS BY STATE 1980-2014

(as of 6/12/2014)

AL AKARAZCACOCTFLGAIDILINKYLAMIMSMOMTNCNENHNJNMNYOKPARISCTNTXUTVAWAWV111134442324146141351241611213135156381144

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4. CHAPTER 9 FILINGS BY YEAR 1980-2014

(as of 8/4/2014)

198019811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006200720082009201020112012201320141235561120991119131116117925986669554106131288

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Municipal Utilities and Special DistrictsCity, Village or CountyHospital, Health CareTransportationSchool, Education172535186

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Cases ConfirmedCases DismissedCases Pending or Disposition UnknownCases ConfirmedCases DismissedCases Pending1954-August 4, 20141994-August 4, 2014171101421034120

C.Interested parties in Chapter9:

The municipality.

Bondholders or their trustees.

Landowners and other tax payers.

Unsecured (trade) creditors (unsecured creditors committee).

The state.

Unions.

Judgment and other secured creditors.

Issue:

How are professionals paid for?

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D.Summary of Chapter 9 priorities:

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TYPE OF CLAIMEXPLANATION1.Obligations secured by a statutory lien to the extent of the value of the collateral.abDebt (Bonds, Trans, Rans) issued pursuant to statute that itself imposes a pledge. (There may be delay in payments due to automatic stay - unless stay is lifted - but ultimately will be paid.) 2.Obligations secured by Special Revenues (subject to necessary operating expenses of such project or system) to the extent of the value of the collateral.abThese obligations are often non-recourse and, in the event of default, the bondholders have no claim against non-pledged assets. Special Revenue Bonds secured by any of the following:(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 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.bThere should be no delay in payment since automatic stay is lifted under Section 922(d).
a Chapter 9 incorporates Section 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 Nos. 3 and 4) incorporates Section 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.

b In a Chapter 9, 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 Section 552 of the Bankruptcy Code.


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TYPE OF CLAIMEXPLANATION3.Secured Lien based on Bond Resolution or contractual provisions that does not meet test of Statutory Lien or Special Revenues to the extent perfected prepetition, subject to the value of prepetition property or proceeds thereof.bcUnder language of Sections 922 and 928, liens on such collateral would not continue postpetition. After giving value to the prepetition lien on property or proceeds, there is an unsecured claim to the extent there is recourse to the municipality or Debtor. You may expect the creditor to argue that pursuant to Section 904, the Court cannot interfere 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 Section 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 include expenses incurred in connection with the Chapter 9 case itself).d Chapter9 incorporates Section 507(a)(2) which, by its terms, provides a priority for administrative expenses allowed under Section 503(b). These would include the expenses of a committee or indenture trustee making a substantial contribution in a Chapter 9 case.Pursuant to Section 943, all amounts must be disclosed and be reasonable for a Plan of Adjustment to be confirmed.
b In a Chapter 9, 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 Section 552 of the Bankruptcy Code.

c State law or constitution that mandates a priority of payment, appropriation, set aside of revenues for payment of debt may create the argument that any plan of debt adjustment that does not recognize this mandate cannot be confirmed because it is contrary to state law.

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.The role of special revenues:

Many municipal bonds are revenue bonds secured by a pledge of revenues derived from the project or a special tax levy.

Section 552 of the Bankruptcy Code generally provides that property acquired post-petition is not subject to a lien resulting from any security interest created pre-petition.

Section 928 of the Bankruptcy Code, one of the Municipal Bankruptcy Amendments, renders Section 552(a) inapplicable to revenue bonds secured by special revenues.

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The security interest in special revenues remains valid and enforceable even though such revenues are received after a Chapter9 filing.

Subsection (b) of Section 928 provides that in the case of project or system financing, the bondholders lien on special revenues is subject to necessary operating expenses of the project or system. Thus, these expenses can be put in front of bondholder claims.

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F.Chapter9 legal impact on trustees and holders of municipal debt:

Creditors are subject to automatic stay upon filing of Chapter9 petition.

Automatic stay prohibits collection efforts by creditors or taking remedies to repossess or siege leased property.

Automatic stay impacts holders of general obligation bonds or unsecured debt greater then in Chapter 11 because municipalities are afforded great freedom in the use of revenues and assets to perform their governmental functions.

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Bonds or obligations secured by special revenues are exempt from automatic stay (for a statutory lien a lift stay motion may have to be filed) but the tax revenue pledge to pay those bonds is not to be used for any other purpose or otherwise impaired.

Bonds secured by statutory lien and special revenues are intended to have the lien on pledged tax revenue continue after the filing of a Chapter 9 unlike a corporate pre-petition lien on account receivables or inventory that is terminated as to property created after filing a Chapter9.

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How have general obligation bonds been treated in recent Chapter 9?

Note:Section552 of the Bankruptcy Code has been interpreted to date to terminate a contractual pledge or promise to pay future tax revenues to be levied and collected after filing may be limited to pre-petition tax revenues levies and not revenues levied and collected from levies after the petition date. Any attempt of a municipality to deprive a general obligation bond of tax payments created and that come into existence solely by (a)means of a state statute (Statutory Lien) or (b)that are constitutional or statutory mandated priority, set aside, or appropriation or (c)means that qualifies as Special Revenues will create a confirmation objection of failing to comply with state law.

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BankruptcyTreatmentSierra King Health Care DistrictThe unlimited ad valorem tax G.O. Bonds were paid in full and recognized as having a statutory lien and being secured by special revenues.Jefferson CountyG.O. Warrants were basically paid in full on principal and no objection by Holders.DetroitRevised proposed treatment in plan of adjustment of LTGOs and ULTGOs from being unsecured debt with 20%-15% recovery and impaired to settlement with ULTGOs as secured 74% recovery Bondholders to be paid 100% but insurers to make-up the differences between 74% and 100% and Distributable State Aid G.O.s treated as fully secured and unimpaired with 100% recovery. LTGOs have a proposed settlement, which pays LTGO Holders 34% recovery.

G.Preference in Chapter 9:

The Municipal Bankruptcy Amendments not only address the problem of revenue bondholders, but actually provide assurance to holders of all municipal bond or note obligations. Section 926(b) of the Bankruptcy Code now provides that a transfer of property to the debtor to or for the benefit of any holder of a bond or note on account of such bond or note may not be avoided under Section 547. While this section refers to bonds or notes, there is nothing in the legislative history to support the view that this provision is limited only to instruments bearing such titles. The legislative intent appears to be that Section 926(b) should be applicable to all forms of municipal debt.

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H.Limitation on the bankruptcy court jurisdiction:

The Bankruptcy Court in a Chapter 9 proceeding cannot interfere with the government and affairs of the municipality.

Other than the lack of revenues to pay creditors, municipal services are provided and determined as to whether they will be provided by the governmental body, not by the Bankruptcy Judge.

Unlike Chapter 11, the municipality can sell its assets, incur debt and engage in governmental affairs without necessarily having to obtain the approval of the bankruptcy court.

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I.Other issues in Chapter 9:

Labor issues:

Burdensome labor contracts can be rejected for cause (City of Vallejo, Detroit and San Bernardino).

Unfunded pension liabilities are unsecured obligations and no priority for wages, vacation, pension or healthcare in Chapter9 (but see pending Bill of Senators Warren and Rockefeller The Bankruptcy Fairness and Employee Benefits Protection Bill introduced on June3, 2014 that proposes to change this).

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Non-bonded debt or contracts:

No priority among unsecured claims unless they qualify as administrative.

In a Chapter 9 proceedings, the municipality may assume or reject an executory contract or unexpired lease.

Municipal lease financing presents issue of true vs. financing lease (United Litigation).

Priming of bonded debt by:

Necessary operating expenses.

Priming of unsecured debt by:

Administrative claims.

Duration of Chapter 9:

Long enough to accomplish objectives. In complicated actual city or county filing, measured in years.

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J.Chapter9 (municipal debt adjustment) is unlike Chapter11 (corporate reorganization):

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IN A CHAPTER 9IN A CHAPTER 11Only the municipality can initiate a Chapter9 if authorized by state law.The corporation (voluntary) or its creditors (involuntary) can initiate a Chapter11 case if the corporation is a moneyed entity (not a non-for-profit) and insolvent.Only the municipality can file a Plan of Debt Adjustment.The corporate debtor (during the exclusive period) or any creditor (after the exclusive period) may file a Plan of Reorganization or Liquidation.

IN A CHAPTER 9IN A CHAPTER 11The Plan of Debt Adjustment can only adjust debt. It cannot liquidate the municipality.A corporate plan can be for reorganization or liquidation.A Labor Agreement can be rejected in a Chapter9 if the Labor Agreement burdens the municipality and the equities balance in favor of rejection. This is a lower standard that a Chapter11.Section1113 of the Bankruptcy Code sets forth the requirements for sharing information with employee representatives and workers and the process of information sharing, and the proposal by the debtor prior to the rejection of the Labor Agreement. It is a higher standard than Chapter9.
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IN A CHAPTER 9IN A CHAPTER 11There is no limitation on damages on real estate leases held by a Trustee or Municipal Building Authority for a lease financing and the lease financing will be treated as a secured debt financing.There is a limitation of the greater of one years rent or 15% of the remaining terms of the lease not to exceed three years for lease damages in a corporate Chapter11. It is not treated as secured debt of the corporate debtor if it is a true lease. Payments to defease or pay current interest or principal on bonds or notes within the 90 day preference period before a Chapter9 filing are not capable of being voided or deemed a preference.Payment of principal or interest not secured by collateral could be voided or deemed a preference during the 90 day period prior to filing a Chapter11 if the holder would receive more than what it would be entitled to in a Chapter7 liquidation.
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IN A CHAPTER 9IN A CHAPTER 11There are no priorities ahead of unsecured claims for prepetition claims due to employee wages, pensions, accrued vacations, healthcare and other employment benefits.There is a priority ahead of unsecured claims of up to $12,475 per employee for pre-petition wages, benefits, accrued vacation and healthcare benefits.Special Revenues and Statutory Liens are not limited or terminated by a Chapter9 filing and are intended to continue to be paid to secured creditor and are unimpaired by the Chapter9 filing (there is no Chapter11 provisions comparable).Accounts receivable and inventory created post petition are not covered by the pre-petition lien of a secured lender and the pre-petition lien is terminated except for proceeds of the pre-petition lien.
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IN A CHAPTER 9IN A CHAPTER 11A Bankruptcy Court cannot interfere with any restrictions or requirements of state law regarding a municipalitys exercise of its governmental powers (including payment of statutory liens). The Bankruptcy Court cannot interfere with the property, revenue and affairs of the municipality.The corporate debtor cannot take any action outside the ordinary course of business without Bankruptcy Court approval.The municipality can sell its assets, incur debt, borrow money and engage in governmental affairs without the necessity of having to obtain the approval of the Bankruptcy Court.The corporate debtor cannot borrow money, sell assets or expand or contract its business without Bankruptcy Court approval.
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V.Lessons Learned from Significant Defaults and Chapter9 Cases

A.Selected case studies of past financial emergencies of municipalities:

The New York and Cleveland experiences (problems of financial controls and state and federal bailouts payment on bond debt deferred but paid in full).

The San Jose School District and Medley, Florida cases (excessive labor costs or judgments payment on bond debt in San Jose paid when due even in bankruptcy).

Washington Public Power Supply System (projects fail when expected demand evaporates payments on bond debt significantly discounted and impaired).

City of Philadelphia (successful legislation and state and local cooperation avoid disaster payments on bonds paid in full).

Orange County, California (creative financing to solve tax revenue shortfalls all statutory lien bond debt paid in full with a delay during bankruptcy).

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B.Lessons learned from recent Chapter 9 bankruptcies (For detailed presentation on a case-by-case basis see AppendixA):

Eligibility. In order to file a Chapter9, the municipality must be specifically authorized under state law and must negotiate in good faith with its creditors. This requirement does not require the municipality to perform an impossible task. If the position of a creditor group has so crystallized as to make it in impossible to negotiate in good faith, the good faith requirement will be deemed to have been met. (Jefferson County, Stockton and Detroit)

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Rejection of burdensome contracts. Any executory contract (one not fully performed such as labor contracts, pension obligations, etc.) if burdensome to the ability to propose a plan of debt adjustment may be rejected resulting in an unsecured claim for damages by the parties affected. [Vallejo, Jefferson County, Detroit, Stockton (in dicta), San Bernardino (in dicta)]

Settlements without court approval. Since the court under Section904 of the Bankruptcy Code cannot interfere with the revenues, property, governmental power and political affairs of a municipality without its consent, a settlement between a municipality and a creditor can be reached without necessarily having court approval of the settlement. However, in confirming a plan of debt adjustment, that settlement must be meet the criteria of Section943 of the Bankruptcy Code. (Stockton)

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Special revenue bonds are to be unimpaired. The bankruptcy court does not have jurisdiction to alter the terms of payment or to impair special revenues, as defined in the Bankruptcy Code, provided the necessary operating expenses of such projects or a system, as the case may be that generates special revenues, is provided for. (Jefferson County, Vallejo, Stockton) [There will be an issue in the Detroit case as to whether the water and sewer bonds are really unimpaired given the proposed elimination of certain no call provisions and change in certain interest rates].

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Statutory liens cannot be voided or impaired. A statutory lien that comes into existence by the terms and provisions of a state statute and requires no further action for its existence, cannot be set aside or in any way have the revenues pledged and dedicated to the payment of the bondholders impaired. [Orange County, Central Falls, Detroit (distributable state aid bonds).]

Municipal leases are debt financing. A municipal lease should be treated consistent with Section929 of the Bankruptcy Code as a debt financing and not as a true lease subject to the discounted claim treatment provided for under Section502(b)(6) of the Bankruptcy Code. [Stockton, Vallejo, Jefferson County]

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Third party can gift to the municipality or specified creditors but cannot treat creditors of a similar class dissimilarly. A municipality or a specified group of creditors can receive from a third-party funds or consideration from a third party but if it is in connection with the purchase or transfer of a municipal asset or rights thereto, it raises questions of dissimilar treatment of creditors of a similar class and the appropriate sharing of value to be distributed to creditors of equal priority. [See Detroit, Institute of Art and the contributions by $330million of donations from private foundations directed to fund unfunded pension obligations and the $195million payment by the state for the Detroit Institute of Art to stay open and to be separately operated.] The question is whether unsecured creditors of similar priority may be able to argue they should receive equal or comparable benefit in the plan of debt adjustment in order for the plan to be fair and equitable.

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Validity of the transaction or debt obligations may be contested. Swaps or COPs in the Detroit bankruptcy case have been subject to questions raised about their validity and enforceability. A municipality may raise the question of the validity or enforceability of an obligation but this may raise other questions as to whether or not the proceeds of any bond issue were used to pay off another valid obligation of a municipality and whether the questioned bondholders debt is subrogated to the purported valid claim of the other party that was paid off with the proceeds of the bond issue. Further, if the transaction is determined to be illegal, can the proceeds of the Bond issue be traced to a third party who has no right to retain those proceeds since the municipality in the case of an illegal transaction had no lawful right to retain the proceeds of the transaction. Accordingly, in the case of COPs, do they have a claim for $1.4billion against the pension funds who receive the proceeds of their issue or do they succeed to the purported valid claim of the pension underfunding for $1.4billion. In the Jefferson County case, the validity of the sewer warrants was raised by the municipality and others but the issue was ultimately settled.

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C.Developing lessons to be learned:

Bankruptcy court cannot interfere with state statutory pledge or dedication of revenue especially those that have been voter approved. The limited jurisdiction of the bankruptcy court prevents the court from depriving bondholders of a pledge or dedication of revenue provided for by state statute or constitution especially if it has been approved by the voters that dedicate that source of payment to the bondholders debt and does not authorize any other lawful use of those proceeds. (Detroit - ULTGOs, Jefferson County - Net Sewer Revenues, Vallejo - Water Bonds, Stockton - Water Bonds.) This issue has been settled in Detroit as to the ULTGOs purportedly with a 100% recovery to the Holders, 74% to the Insurer and the Limited Tax General Obligation Bonds (LTGOs) with a 34% recovery. If the municipality were to take a contrary position that it could deprive the bondholders of the statutorily pledged and dedicated revenues, how can the Plan of Debt Adjustment be confirmed as consistent with state law?

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D.Priority of the mandate to fund needed infrastructure and essential governmental services before any other obligation:

The cost of workers, pensions and other obligations cannot be allowed to impair the funding in full of needed infrastructure and essential services at an acceptable level. It has been the failure to fund essential services and infrastructure at an acceptable level and the accompanying raising of taxes beyond that which is acceptable that has caused, in a number of circumstances, corporate and individual taxpayers to leave the municipality, resulting in the death spiral, namely cutting services, raising taxes which cause reduced revenues due to the reduction in taxpayers. The requirements for confirmation of a Chapter9 case include the best interest of creditors and feasibility. This should be interpreted as a priority matter namely essential governmental services at an acceptable level and needed infrastructure so that both

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are sustainable and affordable. Without it, the systemic problems of the municipality will not be addressed and the long-term success of the municipality is threatened. It is in the best interest of creditors to ensure that there is a reinvestment in the municipality so that there is a stimulation of economic opportunities and businesses. Businesses will desire to either expand their business or move their business into the municipality, thereby creating new jobs, especially for the younger workers which creates new taxpayers and additional revenues that bring about the recovery. Without this, the municipality will have less revenues and as corporate and individual taxpayers move out, there will be increasingly less revenues to pay workers, to pay pensions or to pay other obligations. Accordingly, so that it is in the best interest of creditors and it is essential to the feasibility that this priority be maintained. This is a current issue in Stockton, Detroit and other Chapter 9s pending. (It is an issue which may not have been fully addressed in Vallejo, Jefferson County and Central Falls. See also Bridgeport, CT and the effects of the death spiral with raising taxes and reducing essential governmental services.)

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Recovery plan essential to a successful plan of debt adjustment. A plan of debt adjustment must be preceded, if not accompanied, by a recovery plan which hopefully has received buy-in from all of the critical elected officials, taxpayers, public workers and creditor constituencies. A recovery plan provides for reinvestment in the municipality, assures appropriate funding for needed infrastructure and essential governmental services at an acceptable level and makes sure that obligations that are part of the plan of debt adjustment, including payments to workers, pensions and others are sustainable and affordable over the long term. It is essential to the ultimate success and continued viability of a city that it has the infrastructure and essential governmental services to attract new business and to have existing business expand because, in that way of stimulating economic opportunity, you will be able to assure increased revenues which is the ultimate goal for the recovery of the municipality and the success of plan of debt adjustment. A plan of debt adjustment that merely adjusts debt and does not address the systemic problem that caused the Chapter 9 will be doomed to fail.

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A.Authorized to file Chapter9? Can the issuer file for Chapter9, if not, then right to enforce obligation in state court by mandamus and other remedies without a required restructuring?

B.What is source of payment? Is the general obligation debt a naked full faith and credit promise or does it have a pledge of special revenues or statutory lien pledging and dedicating a specific and adequate tax revenue source for payment. (Alexander Hamilton in the 1790s said the secret of making public credit immortal is that whenever public debt is increased, it ought to be accompanied by a sufficient tax increase dedicated to its payment. (Syrett, The Papers of Alexander Hamilton, Vol.6, p.106 and Vol.18, p.103))

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VI.Checklist of Disclosures to Maximize Market Acceptance in Evaluating Repayment of Bond Debt

C.Is there a lack of diversification of tax sources and limits on taxes that could realistically be triggered? Are sources of tax revenues too limited or are there tax limits and debt limits close to being triggered that may prevent the raising of taxes to pay the obligation?

D.Are there required priorities, set asides or appropriations to support payment? Do state constitutions or statutes provide for a priority of payment for general obligation debt or mandatory set aside of revenues or appropriations for payment of the debt? (Can plan of debt adjustment be confirmed if it is not in compliance with state law by not permitting mandatory priority of payment, set asides or appropriations? Could be a real obstacle to confirming a plan).

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E.Are there effective remedies available if there is a default? Do the state statutes and case law provide effective remedies (mandamus, intercept, constitutional or statutorily, required set asides, priority of payment, or appropriation) and does state court effectively enforce them?

F.Is effective state oversight and assistance available to prevent defaults or aid a financially troubled municipality? Does the state provide by statute or practice the ability to monitor and oversee a financially challenged municipality, provide financial guidance and support to bridge the economic downturn and avoid litigation meltdown and Chapter9.

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VII.How to Deal with TIDs in Distress

A.Historical use and benefits of TIFs:

1.TIDs and TIFs have provided a valuable tool for addressing economic stimulus of blighted areas and needed redevelopment.

2.TIFs started in California, spread to 49 states and California just recently reversed course which had an effect on its local government. In the past, active states included Illinois, California, Florida and Texas and least active states were NewYork and North Carolina.

3.TIFs do not provide any outside money or new revenue raising authorities.

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4.TIFs have been used for a variety of purposes that must pass the statutory language including the but for test that the incremental value would not be achieved without the benefit of the TIF.

5.TIFs are intended to leverage value incentives for a specific public purpose that would not occur without the influence of the TIF.

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B.Methods of stopping the bleeding, distressed TIDs and responding to public outcry:

1.Periodic monitoring and review. Make sure there is a credible feasibility study justifying the TID and TIF. In addition, there should be periodic monitoring of the function of the TID, the cash flow, compliance with the documentation and incremental value developed. Adjustments to the TIF plan can be made.

2.Permitted base value adjustments. Make sure debt not only does not exceed 12% of municipalitys assessed value but in a feasible and affordable number based on base value and incremental value. If base value declines due to economic conditions, make sure adjustments are made consistent with statutory language and coordination with TID-basic assumption with projected rates.

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3.Maintain guarantees and collateral. The development agreement should provide for lookbacks and reevaluating as needed, additional collateral to be provided as well as, if appropriate, letters of credit and personal guarantees.

If value targets are not met or if there are long-term questions about ability to meet value targets or barely meeting such targets, the guarantees and collateral should be maintained until the TIF debt is paid off.

4.Declare annual surplus. To the extent the documentation and state authorizing statute permit, declare surplus, Chicago declared surplus of 20% in 2012 and 29% in 2013 of TIF fund.

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5.Benefit of refinancing. If there is a mismatch between TIF revenue from incremental value and debt service, address the mismatch before the negative arbitrage becomes too great. Use of privatization, lease and sale as mechanisms of unlocking additional value.

6.Restructure, if necessary. If there is insufficient cash flow to pay scheduled or intended debt service on TIF, then consider ability for voluntary or involuntary restructuring.

7.Maintain transparency. The affected citizens and local citizens require transparency so there can be no second guessing or finger-pointing.

8.Donor or gifting districts. If you have the same tax levying districts in two or more TIDs you may allow sharing of TIF funds between the successful TID and the distressed TID.

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9.Encourage increased porting with distressed TIDs. The use of porting by means of having TIF funds in successful TID port to distressed TID for needed improvements to stimulate the incremental value of the contiguous, distressed TID.

10.Use of other non-property tax sources for TIDs. Since 1970s, there have been at least 18 states that at one time or another allowed sales tax, utility tax or other local taxes to be used for TIF debt service payment.

11.Use TIF revenues for land bank. In the situation of high foreclosures, some municipalities have used TIF funds to purchase foreclosed and tax-delinquent properties to add to the value of TIF sources of payment.

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12.Increased judicial oversight. Whether resorting to the courts for monitoring or enforcing compliance with TIF terms and the development agreement and collection efforts is prudent. The issue is if the time, costs and uncertainty are worth the efforts.

13.Making sure TIF participants are on the same page. The JRB should provide a careful review of the TID proposal. The state oversight and approval should make sure a public purpose but for is intended and achieved. Essential services and infrastructure are always better than the exotic. (Sports venues, video game manufacturers, international spy museum, outdoor camping, fishing, hunting retailers, etc.)

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14.Review of TID process and efficiency:

Should caps on TIF or taxes be put into place?

Should state school district aid be affected by TIF use?

Should taxing bodies be able to opt out?

Should inflation factor be included in base value?

Should terms such as blighted area be narrowly defined?

Should but for test have more teeth?

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The services of Chapman Strategic Advisors LLC do not include legal services and the protections of the client-lawyer relationship will not exist. Only Chapman and Cutler LLP can provide legal services, if retained pursuant to a separate engagement agreement with a client. This document has been prepared by Chapman Strategic Advisors LLC for informational purposes only. It is general in nature and based on authorities that are subject to change. It is not intended as a recommendation or advice with respect to municipal financial products or the issuance of municipal securities. Accordingly, readers should consult with, and seek the advice of, their own independent registered municipal advisor with respect to any individual situation that involves the material contained in this document, the application of such material to their specific circumstances, or any questions relating to their own affairs that may be raised by such material.

2014 Chapman Strategic Advisors LLC

1839-49

1850-59

1860-69

1870-79

1880-89

1890-99

1900-09

1910-19

1920-29

1930-39

1940-49

1950-59

1960-69

TotalDefaults

Number

of LocalGovernmentsin 1967a

% of AnnualDefault RateOver130 Yrs.b

By Type of Units

Counties and parishes

7

15

57

30

94

43

7

15

417

6

12

24

727

3,049

.183%

Incorp. munics.

4

4

13

50

30

93

51

17

39

1,434

31

31

114

1911

18,048

.081%

Unincorp. munics.

4

9

46

31

50

33

5

10

88

7

4

26

313

17,105

.014%

School districts

4

5

0

11

14

1241

5

23

60

1,272

21,782

.048%

Other districts

2

1

12

11

7

107

1,590

30

42

70

1,872

21,264

.067%

Totals

4

15

37

159

97

258

149

36

185

4,770

79

112

294

6,195

81,248

.058%

State

Intervention Provision

1.

Arizona

School District Receivership

2.

California

Debt and Investment Advisory Commission

3.

Connecticut

Ad Hoc State Intervention

4.

District of Columbia

Financial Responsibility and Management Assist

Municipalities in Distress -- Factors Responsible James Spiotto 2014

Documents

Transcript of Municipalities in Distress -- Factors Responsible James Spiotto 2014