Presentation on theme: "MUNICIPAL BANKRUPTCIES A Pension Deficit Disorder? Presentation to the Board Chairs and Vice Chairs State Association of County Retirement Systems May."— Presentation transcript:
MUNICIPAL BANKRUPTCIES A Pension Deficit Disorder? Presentation to the Board Chairs and Vice Chairs State Association of County Retirement Systems May 12, 2009 Harvey L. Leiderman
2 Why Are We Talking About Municipal Bankruptcies? State budgetary crisis Municipal budgetary crisis revenues declining – taxes and grants demands rising – including pension costs Municipal credit crunch
3 This Discussion When may a municipality file bankruptcy? What happens during the bankruptcy case What is the effect on the retirement system and members ’ benefits De-mystify the process De-mythify the process
4 Overview – Federal Bankruptcy Law and Chapter 9 Plans of Adjustment Federal bankruptcy law generally temporary freeze ( “ stay ” ) restructure of assets, debts relief from obligations “ fresh start ” Chapter 9 specifically just for “ municipalities ” adjustment of obligations balances federalism with states ’ rights
5 Who May File Chapter 9 Petition? To be eligible, must be all of the following: 1.A “municipality.” Includes a political subdivision, public agency or instrumentality of a state. Counties and cities are; the State is not. 2.Authorized under state law to be a debtor under federal bankruptcy law. CA counties and cities are. 3.Insolvent. Not paying debts when due, or unable to pay debts as they become due (income statement test.) 4.Desires to effect a plan to adjust its debts. 5.Has (a) obtained the consent of its creditors, or (b) has negotiated in good faith with its creditors, or (c) negotiation with creditors is futile, or (d) believes that a creditor is attempting to get an unfair recovery on a claim.
6 What Happens During Bankruptcy? Bright line between pre-petition and post-petition Snapshot of pre-petition assets and liabilities Stay (freeze) of all legal actions Muni is free to continue its operations, expenditures, borrowings and management Muni must continue to perform all contracts and leases necessary for its post-petition operations Creditors must file claims, unless clearly uncontested Muni may use, sell or lease its property in the “ordinary course of business”
7 What Are the Muni ’ s Powers Under Ch. 9? May continue to operate as usual All officials remain in power; no trustees, no court supervision May hire professionals (attorneys, accountants, financial advisors, etc.) and pay them ahead of unsecured creditors Broad powers to borrow money and grant super-secured status to new lenders May reject burdensome “executory” contracts and unexpired leases May “abandon” burdensome property that is of little value or benefit
8 What Are the Muni ’ s Powers Under Ch. 9? (cont ’ d.) May recover pre-petition preferential transfers of property, or transfers made for less than full value May file suit against others, to assert claims in its favor May object to claims against it, and bring them to trial in the Bankruptcy Court May not escape from State legislation and regulations – prohibited by Tenth Amendment to U.S. Constitution Must file a Plan of Adjustment within the time period fixed by the Court or be dismissed
9 What is a Plan of Adjustment? The Plan classifies claims according to their legal priority under state and federal law class of priority secured claims class of subordinated secured claims class of general administrative claims class of unsecured trade claims As to each class of similar claims, the Plan provides a “treatment” for how that class of claims is to be satisfied paid in full in cash paid over time with interest exchanged for new value rejected Must be confirmed by vote of creditors and Court order
10 Plan of Adjustment - The Disclosure Statement Issued with the proposed Plan of Adjustment Like a Prospectus history, description of the process, overview of the plan, treatment of claims, financial projections Ballots Each class must vote in favor requires 1/2 in number and 2/3 in $ value of each class Even without affirmative votes, the Court can confirm the Plan if it believes the Plan treats objecting creditors fairly and equitably (the dreaded “cramdown”)
11 What Is Required to Confirm the Plan? Must be in the best interest of creditors and be feasible “Best interest of creditors” – best of all reasonably possible alternatives. Ch. 9 test differs greatly from “better than in liquidation” test for Ch. 11 debtors “Feasible” – the economics of the Plan make sense; it is not likely that the muni will have to return to bankruptcy soon; the muni will have the ability to continue to provide services.
12 What Happens After Confirmation? Discharge – the muni is discharged (forgiven) from all claims not provided for under the Plan, or which the Plan provides shall be discharged. Emergence – the muni emerges from Chapter 9 with all of the rights and powers established under state law and under the terms of the Plan.
13 Questions and Answers Q:Is your plan sponsor “insolvent”? A:Case-by-case. The county or district would have to prove that it is insolvent on a “cash flow” basis (unable to pay its debts when due) rather than on a “balance sheet” basis (liabilities exceed assets). This issue would be hotly contested. See City of Vallejo case.
14 Questions and Answers Q: Could your plan sponsor reject the existing labor contracts that grant retirement benefits? A:Yes, very likely. See City of Vallejo case. The bankruptcy law provisions that limit a corporate debtor’s ability to reject labor contracts do not apply in Chapter 9 municipal bankruptcies. California counties, cities and districts have a federal constitutional right to reject labor contracts. The court may apply a less restrictive test than for corporations: do the “balance of equities” favor rejection of the contract?
15 Questions and Answers Q:Would the county or district have to reject the entire labor contract, or could it “cherry-pick” the terms it doesn’t like? A.Bankruptcy law allows rejection of the entire agreement only, not selected terms.
16 Questions and Answers Q:Could the plan sponsor unilaterally reduce some benefits under a labor contract before deciding whether to assume or reject it? A:Untested. The Bildisco case, a Ch. 11 corporate reorganization, said “ yes ”… but Judge Ryan in In re Orange County said Ch. 9 is different, for constitutional and public policy reasons. Ryan ordered “ meet and confer ” before Orange County could unilaterally change its labor contracts. Note: There are additional requirements under California labor law.
17 Questions and Answers Q:If the plan sponsor rejects any of its labor contracts, what happens to active City employees? A:The unions and bargaining units would have to negotiate new contracts.
18 Questions and Answers Q:If the plan sponsor rejects the labor contracts, what happens to members’ retirement benefits? A:Also untested. Benefits granted to current retirees are unlikely to be affected. The contract is not “executory” as to them, since no further performance is due from them by way of service or contributions into the system. For active employees, the contract is still “executory,” BUT – For both, the “vested rights protected by the ‘contract clause’ of the Constitution” argument may prevail. BUT –
19 Questions and Answers A, continued: Don’t forget that there is an exception under California law to the “vested rights” guarantee: “An employee’s vested contractual rights may be modified prior to retirement for the purpose of keeping a pension system flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system.” Betts v. Board of Administration. Are the proposed changes reasonable? Do they bear a material relation to the theory of a pension system? Will any disadvantage come with a comparable new advantage?
20 Questions and Answers Q:May the plan sponsor suspend transferring employee contributions over to the retirement system while in Ch. 9? A:No. Payroll deductions for retirement contributions are not property of the plan sponsor but are collected in trust for the retirement system.
21 Questions and Answers Q:What about employer contributions? A:Very complex. There are strong legal reasons why the plan sponsor may not suspend its payments, as required by statute. At the very least, the “normal cost” portion of the employer contribution should be treated as a post-petition obligation and would have to be paid timely. The “UAAL” portion of the employer contribution, being the amortization of a debt from past service, might be treated differently.
22 Questions and Answers Q:May the plan sponsor suspend its “pick up” of employee contributions while in Ch. 9? A:No, not unless it rejects the labor contract that provides for “pick-up.”
23 Questions and Answers Q:May the plan sponsor reject its obligations to fund vested benefits? A:No. Ch. 9 does not authorize rejection of state law mandated obligations. Would violate two provisions of the U.S. Constitution – reservation of rights to the states, and ban on impairment of contracts. Fact that state and local governmental systems are exempt from ERISA indicates limitations of federalism in this arena.
24 Questions and Answers Q:Could the plan sponsor freeze or seize retirement system assets in Ch. 9? A:No. The retirement system is a distinct governmental entity under the state Constitution. Its assets are not property of the plan sponsor but rather held in trust for members and their beneficiaries.
25 Questions and Answers Q:Would a plan sponsor’s Ch. 9 bankruptcy filing affect the retirement system’s assets or investments? A:No, the retirement system is a distinct governmental entity – a trust. Its assets and investments are not commingled with those of the plan sponsor (unless the Treasurer is holding plan assets, as in In re Orange County.) However, if the plan sponsor suspends contributions, it could affect your cash flow, and thus your asset allocation policies and earnings assumptions.
26 Questions and Answers Q:Could the retirement system make a loan or other financial accommodation to the plan sponsor during Ch. 9 or under a Plan of Adjustment? A:No legal prohibition. BUT – likely unlikely: Would have to meet all prudent fiduciary, administrative and investment requirements and the system ’ s Investment Policy Statement, to “ assure the competency of the assets ” to meet benefit obligations. If appropriate, could take the form of an interim or long-term loan, sale-leaseback of property, credit enhancement, extended amortization of UAAL or other creative financing – with many caveats. If you explore this route, watch out for Lexin-like pitfalls!
27 Questions and Answers Q:How much would a bankruptcy cost taxpayers? A:Big bucks. Plan sponsor professionals and professionals for committees of interested parties – bondholders, retirees, unsecured creditors, etc. Plus professionals for labor unions, creditors, investment pool participants and bondholders who make a “substantial contribution” to the case. In the 1994-96 Orange County bankruptcy, professional fees cost over $100 million – excluding investment manager fees. In addition – higher borrowing costs due to poor credit ratings. Today, 15 years later?
29 About the Speaker Harvey L. Leiderman practiced bankruptcy law for over twenty years, on behalf of national banks, commercial lenders, public bondholders and private investors. He was fiduciary counsel to the Orange County Employees’ Retirement System during that county’s Ch.9 case, instrumental in recovering over $132 million in pension funds frozen in the Treasurer’s Pool and in restructuring the County’s future contributions to the system. More recently Mr. Leiderman guided a California municipal water district through a successful Chapter 9 bankruptcy. His firm also represents the largest bondholder trustee in the City of Vallejo case. Harvey and his firm currently serve as general, fiduciary, litigation, investment and tax counsel for multiple state and municipal public pension systems in California and across the country. Reed Smith LLP · Two Embarcadero Center, Suite 2000, San Francisco, CA 94111-3922 +1 415.659.5914 · HLeiderman@reedsmith.com