BRADENTON, Fla. - Few details are known about the remedial plan Jefferson County, Ala. is proposing to avert bankruptcy, leaving bondholders in the dark about the future of their investment.

Jefferson County, which includes Birmingham, has been unable to pay certain obligations in its massive $3.2 billion sewer debt portfolio because costs have risen dramatically due to the unexpected meltdown of the variable- and auction-rate markets.

Attorneys for the county say the detailed remedial plan, which has been presented to banks, bond insurers, and swap counterparties in New York, constitutes confidential settlement negotiations and therefore is not public record.

Publicly, county officials have discussed a general outline of their proposal. They have said they want to apply excess sales tax revenues - currently dedicated to county-issued school warrants - to help pay off sewer debt and avoid raising sewer rates.

Denver attorney Jeffrey Cohen said the proposed solution could raise legal issues that could take the county all the way to the U.S. Supreme Court and potentially delay a resolution to the financial crisis.

"I can't conceive of why educational bondholders would agree to allow those sales tax revenues to be invaded," said Cohen, lead attorney at Cohen & Associates PC. "In any event, the question is how they would propose to do it without even speaking to or forming a bondholder committee and giving nothing in return."

Cohen - whose practice includes creditors' rights, bankruptcy, business reorganization and municipal bond work for more than 20 years - said he has been shadowing events in Jefferson County. His firm works with hedge funds and has spoken with at least two funds holding tens of million of dollars of the county's school warrants, he said.

Jefferson County sold $650 million of fixed-rate limited obligation school warrants, Series 2004A, and $400 million of variable- and auction-rate school warrants, Series 2005A and B, all backed by a locally collected one-cent sales tax authorized by the state that could be leveraged for local schools.

The county covenanted that excess sales revenues would be deposited into a specific fund and used only for early redemption of the 2004 and 2005 warrants.

The extra cash gives bondholders a cushion for repayment, especially during economic downturns, Cohen said, adding: "that's how they priced that deal and it was the basis on which people made investment decisions."

He said the statute requires the tax money be used only for educational expenses. "If you use that money for something other than the state purpose then it would be general obligation revenue of the county," Cohen said.

In late March, when Moody's Investors Service downgraded Jefferson's sewer revenue warrants to Caa3 from B3, the rating agency also downgraded $996.8 million of outstanding limited-obligation school warrants to Baa2 from A1.

"The downgrade of the sewer revenue debt reflects the heightened probability of default on the county's sewer obligations within the next year and a lack of a concrete plan to avoid such default," Moody's analyst Geordie Thompson said at the time.

"The downgrades of the non-sewer debt reflect the risk that the financial crisis that has embroiled the sewer system may affect the credit strength of the county's other obligations, particularly given the uncertainties of the effects of a possible bankruptcy filing, should the county pursue that option," Thompson said.

On April 1, Standard & Poor's lowered its underlying rating on the county's Series 2003 B-2 through 2003 B-7 sewer revenue refunding warrants to D from CCC due to a missed payment on an accelerated repayment schedule. Standard & Poor's rates the Series 2003 B-1-A through 2003 B-1-E and Series 2003 C-1 through 2003 C-10 auction-rate sewer bonds CCC.

The county's other credit ratings, including the sales tax warrants, have been placed on negative watch, "reflecting the uncertainty as to whether the sewer system's deteriorating credit quality could lead to a county bankruptcy, which could disrupt other county revenue flows," the agency said.

A material change in the structure of the school warrants, such as diverting excess revenues, could impact their A rating, Standard & Poor's analyst James Breeding said yesterday.

"One of the rating strengths was the closed flow of funds and the ability for the county to prepay those longer maturities early and for all of the excess revenues to stay within the fund," he said.

One of the county's attorneys, Patrick Darby, a partner in the Birmingham office of Bradley Arant Rose & White LLP, has said a solution to the financial problems is being sought and the county has no present desire or intent to file Chapter 9. He also said that the sewer system's debt problems do not pose any risk to the county's other debt.

"The [remedial sewer] plan would be to refund the existing bonds," Darby said yesterday, in the first explanation of how the plan to use school tax revenues would be implemented. "Therefore, I see no impairment of contract."

Jefferson County on April 15 obtained a 30-day extension of a forbearance agreement with investors, further delaying a $53 million principal payment owed to redeem variable-rate sewer warrants. Repayment of the warrants has been accelerated because of bond insurer downgrades.

The forbearance agreements are between the county and liquidity providers, bond insurers, and swap counterparties and are designed to give everyone more time to work on a solution to the county's financial crisis.

Cohen's firm wrote a memorandum on Alabama and federal law as it relates to using educational warrant proceeds. The memorandum concludes that under state law the sales tax revenues cannot be used for anything other than for educational purposes.

Even if the Legislature changed the law allowing Jefferson County to use the sales tax revenues for purposes other than to pay off the school bonds "they'd run into a line of [U.S.] Supreme Court cases," Cohen. He noted that the county's plan could violate federal laws regarding the constitutional proscription regarding the impairment of contracts, and possibly even a taking without just compensation.

"There have many Supreme Court cases where states tried to modify existing bondholder rights and our research reveals there was only one case where it was allowed, and that was in New Jersey in the early 1940s," Cohen said.

Faitoute Iron & Steel Co. v. City of Asbury Park in 1942 allowed bondholders' rights to be modified under the contract clause, but only after a receivership was established and 85% of bondholders approved the modification, according to Cohen.

The Supreme Court disallowed a similar modification in U.S. Trust Co. of New York v. New Jersey in 1977, he said.


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