Navigating the Municipal Bankruptcy Minefield

Transcription

1 Navigating the Municipal Bankruptcy Minefield

2 Restructuring Preliminaries: How Did We Get Here? (Flavors of Pain) Structural Insolvency Examples are Vallejo and Stockton Extraordinary Event Insolvency Examples are Orange County and Desert Hot Springs Both Jefferson County 2

3 Restructuring Preliminaries: How Did We Get Here? (Financial Accounting Nightmares) The Basics: Restricted Funds vs. General Funds The Dangers of Pooled Cash The Fog of Interfund loans/transfers 3

4 Restructuring Preliminaries: Interim Emergency Actions (Katie, Bar the Door!) Debt Related Creative use of unexpended bond proceeds Refis and tenders and swaps, oh my! Asset Related Everything must go! Labor/Service Delivery Related Labor agreement opportunities (expiring agreements, reopeners, fiscal emergency provisions etc.) Furloughs and reduced service hours for non-emergency activities 4 Reorganizing medical benefit packages

5 Restructuring Preliminaries: Workout/Restructuring Principles for the Municipality (After the Pain, Getting it Right) Sustainable Operational Budget Adequate Service Levels Efficient Service Delivery (consider consolidation/outsourcing) Build Reserves and Service Levels Back over time Retire restructured debt without further default Approve Additional Revenues (Taxes) Provide Accurate and Transparent Accounting/Budget Practices 5

6 Federal Tax Law Opportunities and Pitfalls Even though a municipality s primary concerns are financial, there must be a focus on maintaining the tax exempt status of its outstanding bonds. This years IRS business plan involves an increased focus on tax law compliance relating to actions taken in response to financial hardship or liquidity constraints. The plan also indicates that the IRS will try to develop additional compliance and education programs to assist entities facing these economic problems. 6

7 What Does the IRS Mean by That On the one hand, it indicates that the IRS will try and work with municipalities in times of financial difficulties. On the other hand it is a strong reminder that the tax law compliance issues for bonds should not be ignored. Lesson is that even though the financial issues are paramount, do not ignore the need to comply with the tax rules and the IRS will be watching! Issues discussed below relate primarily to tax exempt bonds and not to BABs or other tax credit bonds. 7

8 Actions Which Might Jeopardize Tax Exemption Use unspent bonds proceeds for working capital or other use not consistent with original bond financing plan. ( Unspent Proceeds ) Sell bond financed assets to generate cash to use for working capital, debt reduction or other. ( Asset Sales ) Lease bond financed assets to a third party to generate revenues ( Leases ) Other uses of bond or sale proceeds also likely All such actions may jeopardize bonds tax favored status (tax exemption or federal subsidy) 8

9 Some Good News-Using Unspent Proceeds Certain uses of Unspent Proceeds may qualify for continued tax exemption. Long term tax exempt working capital bonds have often been issued. Requires a cash deficit and continued monitoring of on-going cash balances through maturity of the bonds. Converting bonds to fund working capital requires an analysis of projected future cash flows and modified documents Does not work for BABs as 100% must be used for capital costs 9

10 More Good News-Selling Bond Financed Assets Selling bond financed assets requires requires compliance rules on Remediation. Primary Eligibility Requirements: Sale of assets must be at FMV Sale proceeds treated as proceeds for tax purposes, arbitrage and private use analysis Remediation not available for Unspent Proceeds Sales must be for 100% cash (e.g., no installment sales) Expect to spend sale proceeds within 2 years. Sale proceeds may be spent on new capital More importantly, sale proceeds may be spent on working capital, subject to deficit analysis and post issuance compliance and cash monitoring. 10

11 More Good News, Sort Of-Leasing Bond Financed Assets Leasing of bond financed assets is a bit more difficult, tax wise (if leased to a private business entity) There may not be a clear path to preserve tax status of bonds as remediation rules require redemption of all of the bonds which financed the leased asset. Best path may be IRS Voluntary Closing Agreement Program Approach VCAP with planned violation of tax rules VCAP can be reasonable in working out a settlement Likely will involve a payment to IRS, but it may be sympathetic to an issuers financial problems. VCAP is also available for BABS and other tax credit or subsidy bonds 11

12 Summary of Tax Compliance There are a number of uses of bond proceeds and proceeds from the sale of bond financed assets which will not cause tax exemption to be lost Many of these will be consistent with helping to solve an issuer s financial distress. Requires attention to the tax issues, clear recordkeeping and may require discussions with the IRS. 12

13 Tenth Amendment Reserves powers to the States Implemented in chapter 9 by 903 and 904 States are the gatekeepers for chapter 9 filings Chapter 9 does not trump State law related to the exercise of political or governmental powers 904 provides that chapter 9 does not interfere with property or revenues of the municipality, but permits the municipality to consent to court intervention 13

14 Filing the Chapter 9 Case The Chief Judge of the Circuit assigns the bankruptcy judge Automatic stay Applies to the municipality and to its officers and inhabitants Does not apply to application of current and future pledged special revenues to debt secured by the revenues There may be official committees Role of United States Trustee is very limited List of creditors mandatory, but no schedules, statements or operating reports are not required, so no U.S. Trustee oversight Primary U.S. Trustee function is appointment of committee(s) 14

15 Eligibility to Be a Debtor Petition does not constitute an order for relief. Court first must hear and determine objections to eligibility. Debtor must: Be a Municipality Be specifically authorized by state law to be a chapter 9 debtor No authorization in half the states Particular issues in California, New York, Alabama, Pennsylvania, among others Be insolvent Either generally not paying its debts as they become due; or Unable to pay its debts as they become due in the next fiscal year 15

16 Eligibility to Be a Debtor Desire to effect a plan to adjust its debts Prove at least one of the following: Agreement of creditors holding a majority in amount of impaired claims in each class Municipality has negotiated in good faith and has failed to obtain agreement Municipality is unable to negotiate with creditors because negotiation impracticable. Municipality reasonably believes creditor may attempt to obtain a preference In addition, the municipality must act in good faith 16

17 Plan of Adjustment Contents of plan Must classify claims, provide equal treatment for claims in each class May modify claims or leave classes of claims unimpaired May assume or reject executory contracts and unexpired leases Must provide adequate means for implementation, including asset sales May contain any other provisions not inconsistent with chapter 9 17

18 Plan of Adjustment Confirmation Plan and proponent must comply with applicable provisions of Bankruptcy Code Plan must be proposed in good faith Plan must provide for the payment of administrative expenses Plan is in best interests of creditors Class acceptances or cram down Actions needed to carry out the plan are not prohibited by applicable nonbankruptcy law; any electoral or regulatory approval required under nonbankruptcy law must be a condition to the plan 18

19 Creditor Rights & Remedies in Bankruptcy Role of creditors is more limited under chapter 9 than under chapter 11 Creditors are not entirely powerless: Can challenge the municipality s eligibility to be a chapter 9 debtor Special revenue bonds secured only by special revenue of project or system No recourse to debtor s other property Limited to net revenue expect to litigate what constitutes net revenue Can object to motions filed by debtor Right to vote on and object to a plan 19

20 Serve on Creditors Committee Once a chapter 9 case is filed, negotiations between debtor and creditors should start or resume, as applicable, as soon as possible. Creditors with liens on special revenues and other secured creditors will play a major role in negotiating a plan of adjustment. Their interests may or may not be aligned. Committee may have a significant role in negotiating a plan as well Reaching agreement and dismissing case. Reaching agreement with requisite majorities and confirming a plan of adjustment. Municipality does not have to pay costs of counsel for an official committee, but municipality may opt to pay such costs in the interest of creating an informed and organized creditor body that will assist in expediting resolution of the case. 20

21 Treatment of Bonds General Obligation Bonds General obligation bondholders are not entitled to post-petition interest and as such are subject to cramdown. Special Revenue Bonds Continue to be secured and are entitled to debt service payments during the pendency of the chapter 9 case. Subordinate to the operating expenses of the project or system from which the revenues are derived Not all revenues pledged are protected only certain types supported by net revenues Difference between treatment of statutory liens and consensual liens 21

22 What Happens Under Plan of Adjustment: Recovery May Be Limited Experience from certain bankruptcy cases Sierra Kings Connector 2000 City of Vallejo Las Vegas Monorail New York Off-Track Betting 22

23 The SEC Enforcement Division Is Focusing On Municipal Securities Created a specialized unit within Division of Enforcement devoted to municipal securities and public pension funds. New unit is staffed with 35 attorneys spread across the national office and a number of regional offices. Steady drumbeat of public statements from senior SEC officials emphasizing SEC s municipal enforcement agenda. 23

24 Points Of Emphasis While scope of new municipal enforcement unit s mandate is broad, it will seek to expand relatively limited decisional law by focusing on five specific areas: potential misrepresentation or omission in offering documents; tax or arbitrage-driven fraud; pay-to-play practices and public corruption; fraud involving valuation and pricing; and public pension accounting and disclosed violations. Recent enforcement actions and investigations have targeted these priorities 24

25 Disclosure Issues Make sure all 15c2-12 Notices are up to date. Assemble team to respond to rating changes and other events. Be transparent and thorough the truth will out eventually. Avoid selective disclosure when communicating with key constituents (creditors, rating agencies, unions, etc.). 25

26 First Steps Upon Learning of Investigation Take investigation seriously. Retain experienced counsel. Investigate quickly and thoroughly. Preserve documents. Preserve attorney-client privilege. Seek to narrow scope of document request. Evaluate whether there is a duty to disclose the investigation. 26