District's filing tests Florida's policy on municipal bankruptcy

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A Florida community development district’s bankruptcy filing promises to test the state’s unwritten policy of preventing Chapter 9 bankruptcy filings.

That policy has prevented cities, counties, schools and special districts from obtaining the governor’s consent to file for reorganization since at least 1995, according to a state official.

That policy is a factor in the Clearwater Cay CDD's Chapter 9 filing in the United States Bankruptcy Court Middle District of Florida on June 4.

U.S. Bankruptcy Judge Catherine Peek McEwen on Sept. 13 heard a motion from the district’s bond trustee, U.S. Bank NA, and two municipal investment funds owned by Invesco Oppenheimer Rochester to dismiss the case because the CDD had not obtained the governor’s required permission to file for bankruptcy.

The hearing will resume in Tampa on Oct. 7.

To file a Chapter 9 bankruptcy case, a municipality in Florida must be specifically authorized by the state, according to James Spiotto, a municipal restructuring expert and managing director at Chapman Strategic Advisors.

Florida is among a dozen states that authorize municipal bankruptcies only if the filing entity obtains approval from an elected official or state entity. The other states with such requirements are California, Connecticut, Kentucky, Louisiana, Michigan, New Jersey, North Carolina, New York, Ohio, Pennsylvania, and Rhode Island.

The governor’s office didn’t immediately respond to an email requesting information about Gov. Ron DeSantis’ position on bankruptcy filings. The office did respond to a public records request from The Bond Buyer providing a May 25 document showing that the district was aware of the requirement to obtain the governor’s approval.

Ben Watkins, director of the Florida Division of Bond Finance, said the state offers distressed municipalities the opportunity to apply for assistance from the state.

The state will provide expert financial oversight under a financial emergency assistance program, although it doesn’t provide any funding to the distressed entity.

“It’s been the long-standing policy not to grant permission for local governments to file for bankruptcy. I do not anticipate that will change,” said Watkins. “It has been policy since I have been here and that goes way back to 1995.”

Watkins said he didn’t know how many entities may have requested permission to file Chapter 9 cases during his tenure, which has encompassed six gubernatorial administrations of both parties, because those requests go to the governor’s office. He also said the policy of denying such requests is unwritten and that he hasn’t discussed it with DeSantis.

“There’s a whole statutory scheme dealing with local governments that are in financial distress that provides for a remediation [as opposed to] the nuclear solution, which is bankruptcy,” he said. “The real policy reason behind it is everyone, all local governments in Florida, would end up paying the price because of the uncertainty caused by the bankruptcy risk.”

Watkins said if the governor asked for his recommendation about bankruptcy filings, he would advise against approving any because of his "instinct and understanding of how investors think, which is if there’s uncertainty there’s a price.”

Florida’s policy makes sense, Spiotto said, and its one reason the state has “real credibility” in the bond market because of its “perceived” bankruptcy policy.

Spiotto also said bond investors study states to determine which ones have a significant number of Chapter 9 filings and which ones don’t.

There’s an increase in market risk if municipalities can file for bankruptcy without some state oversight, he said, adding, “Anything states do to require approval significantly reduces the risk.”

In the case of the Clearwater CDD, whose bonds have been in default since 2009 when reserves were tapped to pay debt service, Spiotto said there is a procedure in state law if a community development district doesn’t collect enough special assessments to pay its bond debt.

“If they are having a problem and people aren’t paying [assessments] the district has a tax sale,” Spiotto said. “It’s a harsh remedy but it protects people buying into the district.”

Special non ad valorem assessments are placed on homeowners’ property tax bills by the district, which pays for debt service, operations and maintenance.

District developers that own undeveloped land also pay assessments until lots are sold.

A CDD homeowner or landowner must pay all of the tax bill or a lien is placed on the property. The lien can be cleared when all charges are paid by the property owner, or the property is sold at a tax sale.

Donald Dwyer, the assistant secretary for the Clearwater Cay CDD, said multiple problems have prevented the district from paying its bond debt over the years.

Those problems, he said, include the fact that the former owners, David W. Schwarz and Fred Davis Clark Jr., are serving 40 years in federal prison for bank and tax fraud.

According to federal court records, Schwarz and Clark operated luxury resorts in the Florida Keys, Clearwater, Orlando, Las Vegas, and elsewhere.

In 2004, the men began their clubs with “fraudulent sales of Cay Clubs units to insiders, using money from Cay Clubs bank accounts to fund the cash to close for purchases, while obtaining mortgage financing from lending institutions,” according to Department of Justice press releases in 2016 and 2017.

“These fraudulent sales were used in marketing materials to falsely show demand for Cay Clubs units and to inflate prices, as Cay Clubs was in reality purchasing units from itself,” the DOJ said. “Proceeds of these sales were diverted to Schwarz and Clark.”

The Ponzi scheme, as some people have called it, led to their convictions by a federal jury in 2017.

Dwyer said the district defaulted on its bonds “because the crooks made off with some of the money and we don’t know how much.”

When the first payment default occurred in 2010, a material event notice posted on EMMA to bondholders said: “The trustee has been made aware that the district's failure to make such payment arises from landowners' failure to make payment on the special assessments.”

Since he became a member of the district board in November 2018, Dwyer said the district has also unsuccessfully requested from the trustee a detailed financial accounting of how the original bond proceeds, $34.8 million issued in 2006, were spent.

“I want to see where all that money went,” he said, adding that the district has been making debt service payments to the trustee, but that those payments haven’t been applied to the bonds.

Dwyer owns a unit at the Grand Venezia at Baywatch in the Clearwater Cay CDD.

The Grand Venezia Condominium Owners Association sued the district in 2016 “to have the CDD dissolved or otherwise contracted such that the unit owners in the Grand Venezia are no longer burdened with special assessments levied by the CDD,” according to the third amended complaint in the litigation.

In the Grand Venezia case, Dwyer said Circuit Court Judge George Jirotka wouldn’t allow the district to be dissolved, but he did order a new assessment methodology to be prepared.

Dwyer said the district hired new financial advisers and attorneys to work on the plan, which is now complete but still needs to be approved by Judge Jirotka.

“We know we have to defend it in state court,” he said. “It pays what we believe we owe. It pays what we believe is payable and justifiable.”

Dwyer said it was his idea to file for bankruptcy because the district needed to finish the new assessment methodology and it can’t afford to pay off all the outstanding bonds.

The district’s five most recent audits, he said, have been inconclusive because neither the trustee nor Oppenheimer will provide financial documentation.

In the district’s 2017 audit, the most recent available, auditors gave the district an adverse and qualified opinion because “the district was unable to provide sufficient, competent evidential matter for certain expenditures paid for by the trustee from the debt service fund.”

In the bankruptcy case, the automatic stay prevents litigation from moving forward and it remains to be seen how that will affect the district’s ability to have the new assessment methodology approved in state court.

Bankruptcy Judge McEwen has ordered mediation in the Clearwater Cay CDD’s case, Dwyer said. The case number is 8:19-bk-05320.

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Bankruptcy Community development districts Revenue bonds Public finance Ron DeSantis Ben Watkins Florida