‘Overcoming Economic Downturns and Fiscal Distress’ Continues with Part II: Alternatives Available to the State of Illinois and its Municipalities to Monitor and Provide Oversight and Assistance to Financially Troubled Municipalities
In the previous part of this series on Overcoming Economic Downturns and Fiscal Distress, MuniNet Guide’s James Spiotto took us through the ‘Gathering Storm’ of financial and economic challenges in state and local governments. Particular attention was paid to the cases of the State of Illinois and its municipalities from 2000 through today. In this next part in the series, focus is kept on the State of Illinois and its municipal governments, and the policies and institutions available to provide relief and solutions. Local Government Protection Authorities are explored in detail.
by James Spiotto
Growing and Increased Use of State Oversight, Supervision and Assistance for Financial Emergencies of Local Governments:
States that Provide Oversight and Assistance. At least twenty-eight states, the District of Columbia and Puerto Rico have implemented some form of municipal debt supervision or restructuring mechanism to aid municipalities. These range from Debt Advisory Commissions (e.g. California) and Technical Assistance Programs (Florida) which provide guidance for and keep records of issuance of municipal debt to the layered approach of Rhode Island and Michigan of oversight commission and fiscal manager or receiver. Examples of state oversight, supervision and assistance for fiscal emergencies of local government.
States Recognize the Use of a Municipal Receiver
- The Rhode Island Experience and The City of Central Falls:
- Budget Commission.
- Chapter 9.
- Texas’ use of judicially appointed receiver versus financial control board, emergency financial managers, coordination overseers and refinance.
Financial Control Boards and Active Supervision Examples
- The Rhode Island experience and The City of Central Falls.
- The New York Experience – Financial Control Board.
- The Pennsylvania Experience – Act 47.
- The Michigan and Indiana experience – Emergency Managers.
- The Massachusetts Ad Hoc experience.
- The California experience – Neutral Evaluator.
- The North Carolina – Local Government Commission – oversight and approval from the cradle if debt issued to annual financial reports.
- Puerto Rico – Puerto Rico Oversight, Management and Economic Stability Act.
Development of a Local Government Protection Authority (“LGPA”) as a Quasi-Judicial Entity to Determine What Costs Are Sustainable and Affordable and Which Are Not, Including Labor Costs and Benefits and Whether Taxes Should Be Raised or Costs Reduced (Illinois H.B. 2575 modeled after a Civic Federation Proposal)
Evolution of Past Mechanisms that Worked. Under consideration by some states is the use of a local government protection authority utilizing some of the best aspects from the mediation process of the neutral evaluator and the oversight and supervision of financial control boards, emergency managers, and receivers.
State-Created Quasi Judicial Function. Under this municipal debt resolution mechanism, the state would establish an entity that would have a quasi-judicial function and power similar to a commission or special master appointed by a state supreme court or other objective nonpolitical process. The members of the authority would be independent, experienced experts in governmental operation or finance as well as in mediation and debt resolution techniques, including bankruptcy.
Initiation of Proceedings. The authority would start with those municipalities that petition for help or those municipalities that have triggered certain established criteria where the jurisdiction of the authority may be mandated by state law.
First Phase – Mediation and Consensual Agreement. The first phase is mediation and consensual agreement by the municipality and the affected creditor constituencies similar to the neutral evaluator process.
However, participation by the authority may be voluntary by petition of the municipality or other affected constituencies asserting that a financial emergency exists or, under the most direct circumstance could be required, and negotiation and discussion of positions are strictly confidential. The state law establishing the authority may have an exception to its open meetings law and its freedom of information law to allow for open discussion of any sensitive and confidential topics. If additional tax revenues or loans or grants from the state are needed, recommendations to the state by the authority may be made. The authority may be empowered to likewise call for a referendum on a local basis for increased taxes or other actions. Specified time periods for resolution will be set forth and, if the voluntary process is not successful, the second phase may be requested or may be mandatory if the authority so requires.
Second Phase – Determination of a Recovery Plan. In the second phase, the authority and its designated members turn into a quasi-judicial panel, and the municipality is required to set forth the actions proposed to be taken to address its specific financial problem (recovery plan) for authority approval.
Creditors, workers, and taxpayers will have the ability to comment and to attempt, through negotiation, to modify the recovery plan within a set period of time. Then, the recovery plan is presented to the panel members of the authority for determination of the plan’s feasibility and whether it is reasonably fair to creditors’ interests in relation to the requirement that, under all circumstances, essential governmental services, at least at an established necessary level, must be funded and maintained for the reasonable future. One of the triggers for the authority’s jurisdiction is the petition by the municipality, its workers, or taxpayers that a governmental function emergency exists. The municipality or petition must state that essential services as to the health, safety, and welfare of its residents are being threatened and that the forced reduction in services, given the municipality’s financial condition and its limited revenues, impairs the health, safety, and general welfare of its residents.
Power of the LGPA. The authority, after hearing all sides (municipality, workers, taxpayers, affected creditors), will determine:
- What is sustainable and affordable;
- What the municipality can afford; and
- What adjustments must be made to the recovery plan to allow the municipality to continue to provide essential governmental services to its residents at established mandated levels to preserve the health, safety, and welfare of its residents and to pay what is feasible to its creditors, including workers’ wages and pensions
Determination Process of the Authority.
- The Authority to Be an Honest Broker. The authority will act as an “honest broker” to mandate increases in taxes, where necessary; increases in contributions by the municipality or workers for pension or other benefits, if necessary; or reduction, delay, or stretching out of payments to creditors.
- Preserve the Health, Safety and Welfare. Further, if necessary to preserve the public health, safety, and welfare of the municipality’s residents, the authority will have the power to reduce workers’ wages, pensions, or other benefits.
- Adjusting Tax Revenues. A municipality that underestimates in its recovery plan its ability to pay creditors and workers will have necessary increases recommended and found by the authority to be required for the benefits of the workers and the creditors. A municipality that overestimates its ability to pay or makes promises that are not sustainable and affordable will be subject to the recommendation of the authority that payments available to creditors be reduced and taxes possibly increased.
- Enforceable Findings of the LGPA. The findings of the authority will specify if they are final and enforceable by the parties or if further negotiations or proceedings are necessary.
- Maintain Access to Capital Markets. The authority will be charged to make sure that the municipality and the state maintain access to the financial markets, and the ability to borrow will be protected if possible. This authority process should help protect all parties, workers, vendors, and creditors and the taxpayers and the municipality so they will have needed means of continued financing credibility that can be accomplished on the local level based upon maintaining market credibility.
- Enforcing Findings Through Prepackaged Chapter 9. The authority can authorize the municipality to enforce its findings. Such means of enforcement can include having the recovery plan approved or revised by the authority as the basis for a pre-negotiated or “pre-packaged” Chapter 9 plan. Such a pre-packaged Chapter 9 plan can significantly reduce costs, expenses, uncertainty, and financial market risk of a free‑fall Chapter 9 proceeding.
The Structure for Oversight and Emergency Financing:
- Grants from federal, state and regional governmental bodies.
- Loans from federal, state and regional governmental bodies.
- State intercepts of tax revenue.
- Involvement in local government budget process.
- Required financial performance and targeted levels of essential governmental services.
- State legislative assistance in tax revenue and powers.
- Back-up by moral obligations of the state.
- Considerations regarding the appointment of authority members.
- Acceleration of loans and obligations if performance triggers are violated.
- Dealing with the press.
- What powers are essential for state oversight and assistance.
- Exploration of transfer of certain governmental services (and related costs) to other governmental bodies.
- Consolidation of regional essential governmental services.
- Power to authorize Chapter 9 if needed or bridge financing or refinancing of troubled debt.
- Use of intercept of state tax payable to municipality to ensure essential municipal service.
- Private public partnerships – Lease and sale of municipal properties to provide bridge financing and cash flow relief.
- Vendor assistance program – Providing vendor payments through securitization financing of payables. Payment from dedicated tax revenues over time. Provide current cash flow relief from current or future vendor payments.
- Explore consolidation on a regional basis of certain governmental services.
- Monitor compliance with any restructuring plan to ensure compliance and prevent financial erosion.
Applicable State Assistance, Refinancing and Restructuring Mechanism Should Be Disclosed:
To the degree state has effective and applicable mechanism to help prevent default or provide funds or assistance to prevent default or methods of solving financial problems of municipal issuers this is information important to the investor and should be considered to be disclosed to the investor. Such information may improve the perception of the issuer’s credibility in the market.
For a summary of what the various states have provided to assist their municipalities in financial distress, see the following chart summarizing a 50-state survey which indicates whether the municipality (i) can file Chapter 9, (ii) has debt limits and allows refunding bonds, (iii) has access to municipal restructuring mechanisms, (iv) allows for receivers, examiners, financial control boards, coordinators, etc. (v) has default resolution remedies, permits creditors to obtain through court proceeding an accounting, foreclosure, injunction, a writ of mandamus to levy taxes or other remedies, (vi) permits special revenues bonds, and (vii) authorized statutory liens. The chart provides an overview of the 50 state survey from the book – Municipalities in Distress?: How States and Investors Deal with Local Government Financial Emergencies (2nd edition, 2016). For more information, including information on Municipalities in Distress, please visit Chapman & Cutler’s website.
General Overview of a 50 State Survey of Rights and Remedies Provided by States to Investors Relating to Government Bond Debt and State Oversight and Supervision of Financial Emergencies and Authorization to File Chapter 9 Bankruptcy (Click to Expand)
* – The language of the statute appears to strongly support a determination that it is a statutory lien
** – While the language of the statute may appear to create a statutory lien further clarification would be helpful to reaffirm the intent to create a statutory lien
*** – While the language of the statute may appear to create a statutory lien it is insufficient and additional language is required to clarify the intent and to create a statutory lien. The language could be read as just providing for perfection of a pledge or lien without the intent and effect to create a statutory lien
**** – These numbers include both the District of Columbia and Puerto Rico where applicable and totals may differ from other materials that only review 50 states.
James E. Spiotto, Co-Publisher © James E. Spiotto. All rights reserved. The views expressed herein are solely those of the author and do not reflect the position, opinion or views of Chapman and Cutler LLP or Chapman Strategic Advisors LLC.
Up next…Solving Financial Distress with Economic Development and Stimulus from Needed Infrastructure Improvements, Reinvestment in States and Municipalities, and the need to Address Legacy Costs of Unfunded Public Pensions and Deferral of Updates to Infrastructure.
Click here to read the introduction to this series, “How State and Local Governments Can Overcome Economic Downturns and Fiscal Distress”
Click here to read Part I: The Gathering Storm