High Stakes Seen for Investors in Jefferson County Appeal

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BRADENTON, Fla. -High stakes are seen for municipal bond investors as Jefferson County, Ala.'s bankruptcy case winds through the appeals process.

Investors in the financing that enabled the county to exit bankruptcy in December 2013 should not have the "rug pulled out from under them" by losing a prime security feature they relied upon in deciding to loan the county money, attorneys told the 11th Circuit Court of Appeals in Atlanta on Monday.

That security feature is the bankruptcy court's oversight of the county's plan of adjustment for the 40 years that the sewer refunding warrants remain outstanding; it's a key provision of the county's Chapter 9 exit plan questioned by a lower court last year.

While the provision is central to Jefferson County's case, it has broader implications for all bond market investors who rely on security enhancements such as promised rate covenants or court oversight as part of their investment decisions, said municipal restructuring expert James Spiotto.

"To the market, hopefully the result [of Jefferson County's case] will be a reaffirmation that rate covenants will be and should be enforced, and if you make a promise especially in a Chapter 9 plan it should be enforced as any contractual promise is," said Spiotto, a managing director at Chapman Strategic Advisors LLC.

In a 93-page brief setting the stage for the appellate panel, Jefferson County attorneys requested oral arguments to examine the constitutional, statutory, and equitable principles of the case that "are particularly important to governmental entities that may consider Chapter 9 relief now or in the future, as well as to the municipal debt market."

The case centers on whether proper legal steps were taken when Jefferson County's bankruptcy plan was appealed to the U.S. District Court in Alabama by 13 residents and elected officials on the county's sewer system, known as the "ratepayers" in court documents,

The ratepayers failed to obtain the required legal "stay" suspending the plan while the appeal proceeded, county attorneys argued.

Without any barriers to enter the bond market, Jefferson County proceeded to issue $1.8 billion in sewer refunding warrants in December 2013 that allowed the county to write down $1.4 billion in related sewer debt and exit bankruptcy.

With the sewer refunding warrants long since sold to new investors, the complex plan of adjustment cannot be unwound, the attorneys wrote.

However, U.S. District Judge Sharon Blackburn in September rejected the county's contention that the appeal is moot based on the fact that the plan has been largely consummated.

The issue of mootness also will be examined by the appellate court in coming months.

In rejecting the county's argument that the appeal is moot, Blackburn also said that she would consider the constitutionality of the adjustment plan that cedes the county's future authority to oversee sewer rates to the bankruptcy court.

Investors, county attorneys said in Monday's brief, will not lend new money absent assurance that the instruments they receive in exchange will constitute valid legal obligations of the debtor, and that the property securing repayment has been properly pledged, including the county's voluntary agreement that the "court may retain jurisdiction to enforce the municipality's newly-undertaken obligations."

"The county's plan used all these tools to make the new sewer warrants attractive to public investors," the brief said.

Jefferson County is not the first issuer to avail itself of a provision in the bankruptcy code that allows the court to retain oversight of a financing plan.

In the 1930s, the borough of Fort Lee, N.J., voluntarily sought and received 40 years of federal court oversight for refunding bonds that were issued as part of its bankruptcy plan, according to Spiotto.

Fort Lee's bankruptcy came about as a result of the construction of the George Washington Bridge and access roads that took 40% of the assessed property off the tax roll, leading to insolvency.

"They had in anticipation of the bridge done some public improvement bonds," Spiotto said.

As part of Fort Lee's plan of adjustment, refunding bonds were issued.

"The court took jurisdiction over the payment of the bonds between 1939 and 1979," he said. "It was viewed as being constructive because [Fort Lee] had the court making sure the contractual obligation was lived to up, if needed."

Spiotto said Fort Lee's case stands in contrast to the experience in Ranger, Texas.

Ranger took on debt for improvements after the discovery of oil fields boosted the city's population. When the population waned, the city encountered cash-flow problems and filed its first bankruptcy case in 1940.

"In 1940, there was no court supervision to make sure people complied with paying of the adjusted debt so Ranger, Texas went back to Chapter 9 in 1946 and again in 1971," Spiotto said.

The question in Jefferson County's case boils down to interpretation over what the bankruptcy code permits and whether the court's supervision is actually the act of setting rates or insuring that the county complies with the covenants that it promised, he said.

In its petition for an appeal before the 11th Circuit, Jefferson County said that neither the plan of adjustment or the judge's confirmation order "changes the substantive law of the state of Alabama with regard to the enforcement of rates established pursuant to contract or legislation.

"Rather, the plan merely retains the bankruptcy court as an available forum in which such substantive law may be enforced, using the same remedies available in Alabama state court," the county's petition said. "In no event will the bankruptcy court ever set sewer rates; it is simply a forum to enforce the plan and related contracts - just as an Alabama state court could."

Spiotto said that no person - or court - is attempting to usurp the right of the state or a municipality under state law.

"At the same time, no state or municipality should believe that it can make a promise and not live up to it," he said. "Whether you give it as Detroit did as a statutory lien or you have the court involved there are different roads to the same summit."

Michigan passed a law this year giving bondholders a statutory lien on Detroit's income tax revenue to ease the city's path to market for its first deal after emerging from bankruptcy.

Failure to live up to that promise through a lien or covenants can result in higher borrowing costs and limits on an issuer's ability to borrow particularly for essential government services such as sewer systems, Spiotto said.

"Basic to finance, and to the law, is that if you promise something voluntarily the other party has the right to enforce it especially when they relied on it to their detriment," he said. "That's basic fairness."

The Securities Industry and Financial Markets Association and the National Association of Bond Lawyers filed friend-of-the-court briefs urging the appellate court to take up Jefferson County's appeal.

SIFMA said that Blackburn's ruling "threatens accepted constructs under which Chapter 9 debtors can successfully emerge with new or restructured financing" and creates uncertainty for the feasibility of future bond offerings.

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