Detroit's "Fiscal Cliff" and Michigan's Response

by Mintz Levin - Public Finance Matters
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Detroit’s increasingly distressed financial condition has created a dynamic and rapidly evolving situation where the potential of a Chapter 9 filing appears to be the subject of renewed discussion and legislative attention.  In particular, state legislation providing Detroit a menu of options for addressing its finances appears headed to enactment this month.  Although such legislation includes one option expressly protective of debt service payments on Detroit’s public debt, several of the options may lead to a Chapter 9 filing as a first or last resort. 

Estimates suggest that Detroit is on pace to be $113 million short on cash by the end of its fiscal year on June 30, 2013.    Earlier this year Detroit signed a “Consent Agreement” with the State of Michigan to address its financial challenges and to fend off the threat of the appointment of an emergency fiscal manager (an “EFM”) by the governor.  The Consent Agreement required the city to meet certain financial milestones.  Both Michigan Gov. Rick Snyder and State Treasurer Andy Dillon claim that Detroit has defaulted under the Consent Agreement.  Consequently, the State is withholding $30 million in bond proceeds that would otherwise serve as bridge financing for Detroit to the end of its June 2013 fiscal year.  In addition, last week, Dillon recommended, and on December 10 the Financial Advisory Board established under the Consent Agreement unanimously supported, commencement of a 30-day financial review process to determine whether an EFM should be appointed for Detroit under Public Act 72.  The financial review is expected to begin this week, and to result in Gov. Snyder appointing an EFM for Detroit, which may eventually result in Detroit filing for Chapter 9 bankruptcy.

At the same time Detroit appears to be headed toward the appointment of an EFM, the State legislature is considering a bill known as the “Local Financial Stability and Choice Act” (the “Financial Stability Act”). The Financial Stability Act would provide additional restructuring choices for local governments facing financial emergencies, but would also increase the authority of the governor and any appointed emergency manager (an “EM”) over local operations.  The Financial Stability Act is intended to replace Public Act 72.  On Wednesday, December 12, 2012, the House voted to approve the Financial Stability Act, largely along party lines.  The Senate approved the legislation on Thursday, December 13, 2012. It is anticipated that Gov. Snyder will sign the legislation before the end of December, 2012, paving the way for the Financial Stability Act to become effective 90 days thereafter, likely in March 2013.  It is important to note that until that time Public Act 72 should remain in effect.

The Financial Stability Act, if passed, would require completion of a financial review by the state treasurer within 30 days to determine whether there is probable financial stress.  Then, if a review team appointed by the governor determines a financial emergency exists, the local government must initially select one of the following options to address its asserted financial emergency:

a)     Consent agreement;

b)     Emergency manager;

c)      Neutral evaluation process (i.e., mediation with creditors); or

d)     Chapter 9 bankruptcy.

If under such proposed legislation Detroit were to choose the consent agreement option, it would put together a restructuring plan that satisfies the restructuring requirements of the Financial Stability Act and meets the approval of the state treasurer.  If that consent agreement is breached, the state treasurer could place Detroit in receivership under an EM or put it into the mediation process.

If Detroit were to choose the EM option, the governor will appoint the EM, who will propose a financial and operating plan within 45 days of appointment and oversee the plan until Detroit is no longer determined to be in a financial emergency.  However, under the Financial Stability Act, unlike Public Act 72, a local government may remove an EM that has been in place for over a year by a 2/3 vote of its governing body.  If the EM were removed by such vote, Detroit would be required to proceed to the mediation process.  Under the proposed Financial Stability Act, any EFM in existence at the time the law goes into effect becomes an EM.  Thus, if Gov. Snyder appoints an EFM for Detroit prior to the law becoming effective, he or she would become an EM under the new law. 

An EM under the proposed Financial Stability Act will have significantly more powers than under Public Act 72, including greater latitude in modifying or terminating contracts.   

One significant advantage for bondholders if the Financial Stability Act is enacted is that an EM’s plan for the local government may not attempt to modify debt service payments on public debt.  Specifically, the Financial Stability Act requires that any EM plan provide the following:

The payment in full of the scheduled debt service requirements on all bonds, notes, and municipal securities of the local government, contract obligations in anticipation of which bonds, notes, and municipal securities are issued and all other uncontested legal obligations.

If an EM determines that a restructuring of the local government is not possible outside of Chapter 9 bankruptcy, the EM may recommend filing a bankruptcy case.  Unlike Public Act 72 where an EM has direct authority to file a Chapter 9 case, the proposed Financial Stability Act requires the governor’s consent to any Chapter 9 filing.  

If Detroit were to choose the neutral evaluation process  and its creditors consented to this process, the parties would participate in a mediation process for a period of 60 days.  The proposed mediator must be experienced in municipal restructuring and, in particular, advise the local government and creditors regarding the scope and authority of a Chapter 9 bankruptcy case.  Any recommendation to proceed to a Chapter 9 bankruptcy process must be approved by the governor.  If the neutral evaluation concludes without a global resolution of the issues, the local government must pass a resolution recommending the local government to proceed to a Chapter 9 bankruptcy.  

If Detroit were to choose to proceed directly to a Chapter 9 bankruptcy process, Detroit must first (i) obtain the written consent of the governor, and (ii) conduct at least one public hearing.  If the governor does not consent to the Chapter 9 filing, then Detroit would need to select one of the other 3 options outlined above.

Estimates suggest that Detroit is on pace to be $113 million short on cash by the end of its fiscal year on June 30, 2013. Earlier this year Detroit signed a “Consent Agreement” with the State of Michigan to address its financial challenges and to fend off the threat of the appointment of an emergency fiscal manager (an “EFM”) by the governor. The Consent Agreement required the city to meet certain financial milestones. Both Michigan Gov. Rick Snyder and State Treasurer Andy Dillon claim that Detroit has defaulted under the Consent Agreement. Consequently, the State is withholding $30 million in bond proceeds that would otherwise serve as bridge financing for Detroit to the end of its June 2013 fiscal year. In addition, last week, Dillon recommended, and on December 10 the Financial Advisory Board established under the Consent Agreement unanimously supported, commencement of a 30-day financial review process to determine whether an EFM should be appointed for Detroit under Public Act 72. The financial review is expected to begin this week, and to result in Gov. Snyder appointing an EFM for Detroit, which may eventually result in Detroit filing for Chapter 9 bankruptcy.

At the same time Detroit appears to be headed toward the appointment of an EFM, the State legislature is considering a bill known as the “Local Financial Stability and Choice Act” (the “Financial Stability Act”). The Financial Stability Act would provide additional restructuring choices for local governments facing financial emergencies, but would also increase the authority of the governor and any appointed emergency manager (an “EM”) over local operations. The Financial Stability Act is intended to replace Public Act 72. On Wednesday, December 12, 2012, the House voted to approve the Financial Stability Act, largely along party lines. The legislation, which has been endorsed by Gov. Snyder, now goes to the Senate for consideration. It is anticipated that the Senate will approve the Financial Stability Act and that Gov. Snyder will sign the legislation before the end of December, 2012.

The Financial Stability Act, if passed, would require completion of a financial review by the state treasurer within 30 days to determine whether there is probable financial stress. Then, if a review team appointed by the governor determines a financial emergency exists, the local government must initially select one of the following options to address its asserted financial emergency:

a) Consent agreement;

b) Emergency manager;

c) Neutral evaluation process (i.e., mediation with creditors); or

d) Chapter 9 bankruptcy.

If under such proposed legislation Detroit were to choose the consent agreement option, it would put together a restructuring plan that satisfies the restructuring requirements of the Financial Stability Act and meets the approval of the state treasurer. If that consent agreement is breached, the state treasurer could place Detroit in receivership under an EM or put it into the mediation process.

If Detroit were to choose the EM option, the governor will appoint the EM, who will propose a financial and operating plan within 45 days of appointment and oversee the plan until Detroit is no longer determined to be in a financial emergency. However, under the Financial Stability Act, unlike Public Act 72, a local government may remove an EM that has been in place for over a year by a 2/3 vote of its governing body. If the EM were removed by such vote, Detroit would be required to proceed to the mediation process. Under the proposed Financial Stability Act, any EFM in existence at the time the law goes into effect becomes an EM. Thus, if Gov. Snyder appoints an EFM for Detroit prior to the law becoming effective, he or she would become an EM under the new law.

An EM under the proposed Financial Stability Act will have significantly more powers than under Public Act 72, including greater latitude in modifying or terminating contracts.

One significant advantage for bondholders if the Financial Stability Act is enacted is that an EM’s plan for the local government may not attempt to modify debt service payments on public debt. Specifically, the Financial Stability Act requires that any EM plan provide the following:

The payment in full of the scheduled debt service requirements on all bonds, notes, and municipal securities of the local government, contract obligations in anticipation of which bonds, notes, and municipal securities are issued and all other uncontested legal obligations.

If an EM determines that a restructuring of the local government is not possible outside of Chapter 9 bankruptcy, the EM may recommend filing a bankruptcy case. Unlike Public Act 72 where an EM has direct authority to file a Chapter 9 case, the proposed Financial Stability Act requires the governor’s consent to any Chapter 9 filing.

If Detroit were to choose the neutral evaluation process and its creditors consented to this process, the parties would participate in a mediation process for a period of 60 days. The proposed mediator must be experienced in municipal restructuring and, in particular, advise the local government and creditors regarding the scope and authority of a Chapter 9 bankruptcy case. Any recommendation to proceed to a Chapter 9 bankruptcy process must be approved by the governor. If the neutral evaluation concludes without a global resolution of the issues, the local government must pass a resolution recommending the local government to proceed to a Chapter 9 bankruptcy.

If Detroit were to choose to proceed directly to a Chapter 9 bankruptcy process, Detroit must first (i) obtain the written consent of the governor, and (ii) conduct at least one public hearing. If the governor does not consent to the Chapter 9 filing, then Detroit would need to select one of the other 3 options outlined above.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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