In Part VI of ‘Overcoming Economic Downturns and Fiscal Distress’, James Spiotto Shows What Oversight & Assistance Illinois Provides for Financially Distressed Municipalities, and What Present Legislative Proposals May Offer

  • Part V of this series focused on the benefits of economic stimulus and business development
  • Particular attention was paid to Upside Chicago, a case study in business development, bringing manufacturing jobs to the Chicago area and Illinois.
  • In this installment, we look at the oversight and assistance that the State of Illinois makes available to its Municipal Governments.
  • We also examine legislation currently pending in the Illinois General Assembly, and its ability to address systemic problems.

by James Spiotto

What Oversight and Assistance Does Illinois Presently Provide for Financially Distressed Municipalities? What Present Legislative Proposal May Provide

Illinois Does Not Presently Authorize Its Municipalities to Be Able to File for Chapter 9 Municipal Debt Adjustment Nor any Financial Supervision or Oversight, Other Than the Illinois Financial Distressed City Law and the Local Government Financial Planning and Supervision Act

What Is a Financially Distressed City in Illinois?

  • A home rule unit. In general, a home rule unit is either a county that has a chief executive officer elected by the electors of the county or a municipality that has a population of 25,000 or more. Municipalities of less than 25,000 may elect by referendum to become a home rule unit.
  • The Department of Revenue, at the request of the municipality by local ordinance, certifies the municipality to be a home rule unit, and which:
    • Is certified by the Department of Revenue as being in the highest 5% of all home rule municipalities in terms of the aggregate of the rate per cent of all taxes levied, pursuant to statute or ordinance upon all taxable property of the municipality.
    • Is in the lowest 5% of all home rule municipalities in terms of per capita tax yield.
  • The home rule municipality has been designated by joint resolution of the General Assembly as a financially distressed city.

Financial Advisory Authority

A financially distressed city, once it is designated as such by the General Assembly, has a Financial Advisory Authority for the city appointed by the Governor (five directors, with at least two directors being residents of the city) as an agency of state government.

Role of Financial Advisory Authority

The Financial Advisory Authority is to provide assistance to and a financial basis for the financially distressed city, and to request funding by securities issued by the Illinois Finance Authority to provide financial aid to the city so it can provide municipal services to its residents, while attempting to pay creditors and bondholders.

Powers of the Financial Advisory Authority

The Financial Advisory Authority is to have all powers necessary to carrying out its purpose of assisting the financially distressed city, including but not limited to the power to organize, make, and execute contracts and leases, approve the city’s financial plan, budgets, loans, grants and financial aid from the state agencies, engage consultants for technical assistance and advice to the authority, and to determine the terms and conditions of any loans it may make to the financially distressed city.

Virtually No Power to Impair Contracts

The Financial Advisory Authority has no power to impair contracts or obligations of the city and may only during the first year of the contract approve or reject any multi-year employment or collective bargaining agreement.

Budget and Financial Plan

Within 30 days and 45 days of being designated a financially distressed city, the city must submit a budget and an initial financial plan respectively to the Financial Advisory Authority for approval. The financial plan must be submitted by the city annually at least 60 days prior to the end of the fiscal year for the Financial Advisory Authority approval. The financial plan contains estimates of revenues and expenses and a budget for approval. Any rejection by the Financial Advisory Authority must state the reasons in writing.

Estimates, Recommendations, and Material Changes to Budget

The Financial Advisory Authority may set a timetable for the city’s submission of estimates of revenue for approval of the Financial Advisory Authority and timing of the city reports on its operations. The Financial Advisory Authority can issue recommendations, directives, may make material changes to revenue or expenditure estimates, or revisions to the budget or plan. The budget and financial plan is intended to be approved by the Financial Advisory Authority or rejected.

Budget and Financial Plan Control

Any obligation entered into by the city must be consistent with the budget and financial plan.

Financial Management Officer

The Financial Advisory Authority can remove the financial management officer from the financially distressed city. The financial management officer is to sign all expenditures from proceeds of state loans and financial aid provided by the Illinois Finance Authority Act. The Financial Advisory Authority and financial manager do not have the power to hire or appoint city employees, or manage day-to-day operations of the city.

Reorganize Operations

Upon direction of the Financial Advisory Authority, the financially distressed city may reorganize its financial accounts and management.

Issues with Illinois Financially Distressed City Law

  • Do the highest and lowest 5% categories work?
  • Is obtaining a joint resolution of the General Assembly practical and efficient?
  • What professional advisors and qualified persons are available to serve as an uncompensated director of the Financial Advisory Board?
  • What are the criteria for state aid and how available is it?
  • Are financial plans the same as recovery plans, and does the city have the ability to develop such?
  • Is the city the best person to develop a budget and financial plan?
  • If you really cannot impair contracts, how is there a recovery?
  • Ultimately, does the Financial Advisory Authority take control of the city even though it is prohibited from active management?
  • Why have so few Illinois cities ever used the Financially Distressed City Act?
The Illinois Local Government Financial Planning and Supervision Act (“LGFPSA”) Only Applies to Local Governments with a Population Less Than 25,000

How does LGFPSA work?

Under LGFPSA, a local government with a population less then 25,000 and suffering a “fiscal emergency” in certain instances may, upon two-third vote of the members of its governing body, petition the governor for establishment of a financial planning and supervision commission in order to remove the “fiscal emergency.” A unit of local government may contract out the LGFPSA.

LGFPSA has rarely been used.

The Act sets forth a definition of fiscal emergency such as (i) a default in paying principal and interest on any debt obligation, for more than 180 days, (ii) the failure to make payments of over 20% of all payroll to employees that continues for 30 days unless two-thirds of the employees agree in writing to an extension, (iii) insolvency of the local government by not paying debts as they become due unless there is a bona fide dispute or the inability to pay them as they become due. There recently have been two examples of state supervision; the Chicago Board of Education in 1980 and East St. Louis in 1989.

Legislation Pending Before 100th General Assembly of the State of Illinois Provides a Promising New Law Relating to Monitoring, Oversight and Assistance to Distressed Municipalities, Use of a Neutral Evaluator and Chapter 9, As Well As Technical Assistance to Address Systemic Problem, Increase Financial Market Access, and Lower Borrowing Costs

H.B. 644 creates a Municipal Financial Distress Alert System Act
  • The Act requires the state comptroller to establish an indexing system to identify municipalities in or approaching financial distress.
  • Other states have financial monitoring as well as established indicators of financial distress such as Pennsylvania, Michigan, Nevada, etc.
  • Early detection and prompt remedial action has been the hallmark of successful efforts to recovery from financial municipal distress.
HB 2575 Creates the Local Government Protection Authority (“LGPA”)

The LGPA is established for the purpose of achieving solutions to financial difficulties faced by municipalities. It is a quasi-judicial authority to help determine what is sustainable and affordable by a municipality and what is not, in order to eliminate budget deficits and foster full funding of essential services and necessary infrastructure improvement at an acceptable level.

The LGPA provides a forum for municipalities, its taxpayers, public employees and creditors to address financial difficulties and develop a recovery plan this is feasible and affordable.

If the municipality, its taxpayers, public workers, and creditors cannot agree on the financial numbers and an appropriate recovery plan, the LGPA has the powers and process to foster a determination and transparency into what is affordable and sustainable, and the appropriate recovery plan that does not adversely impair funding of essential services and needed infrastructure. LGPA will develop criteria to determine the financial health of municipalities and uniform calculation method for the funding ratio of pension funds.

LGPA is an alternative to Chapter 9 municipal bankruptcy but can, if necessary, enforce a recovery plan of a municipality that LGPA has approved, and can authorize a Chapter 9 filing as an expedited, prepackaged plan consisting of the approved recovery plan.

The LGPA process attempts to assist the municipality to develop a recovery plan for financial stability, assuring taxpayers of prudent use of tax dollars, public employees of sound operational and financial practices, and creditors including workers and retirees of payment of as much as reasonably possible without pushing the municipality into a financial death spiral that provides far less for creditors.

The LGPA is a refinement of the Municipal Assistance Corporation for New York City in 1975, Pennsylvania Intergovernmental Cooperation Authority for Philadelphia in 1991 and the related Act 47, the Financial Control Board for the District of Columbia in 1995, PROMESA for Puerto Rico in 2016, and the use of Emergency Managers in Michigan and Receiver in Rhode Island. LGPA attempts to address the local issues of “buy-in” to the process and the adverse comments of mayors and local officers to Emergency Managers and Receivers in having the municipality develop the first draft of the recovery plan, to the extent possible.

HB 438 Creates the Local Government Bankruptcy Neutral Evaluation Act, and HB 501 Amends the Illinois Municipal Code to Authorize Illinois Municipalities to File a Petition Pursuant to Federal Bankruptcy Law

The Local Government Bankruptcy Neutral Evaluation Act (HB 438) is virtually identical to the California Neutral Evaluation law. It provides for a process of selection by the municipality and participating creditors of a neutral evaluator, and a 60 or 90 day process of good faith negotiations and if resolution of the financial difficulties of the municipality is not reached, then and only then may a municipality file Chapter 9 municipal bankruptcy.

The Neutral Evaluation Act does provide, in the case of financial emergency as it defines it, the use of a neutral evaluator can be eliminated and the municipality may file for Chapter 9.

The use of a neutral evaluator in the only state that has it, California, has been questionable at best. In the Stockton bankruptcy, the case was delayed for at least a year by battles over whether there was good faith negotiation during the neutral evaluation process.

Some have commented that the neutral evaluation process does not produce resolution, only delay to the detriment of all. Disputing creditors, workers, and the municipality in the 60 to 90 day process do not have time or the willingness to reach agreement so they merely hold “their collective breaths” and wait 60-90 days and then there is a bankruptcy.

HB 501 is an unconditional authorization to file a Chapter 9 bankruptcy by a municipality, based solely on the determination of the municipality, and can be viewed as counter to the recent trend to restrict filing of Chapter 9 or require conditions and approval by a state agency or elected official (“Second Look”) before a Chapter 9 filing can be authorized by the state.

States cannot file Chapter 9 due to being a co-sovereign with the federal government, with state rights guaranteed by the 10th Amendment. But states as sovereigns can authorize their municipalities to be able to file for Chapter 9 under the federal bankruptcy law. Under the U.S. Constitution the federal government has the exclusive power to enact bankruptcy law – states cannot.

Presently twelve states have statutory provisions in which the state specifically authorizes filing by the municipality based on the sole decision of the municipality (AL, AZ, AR, ID, MN, MO, MT, NE, OK, SC, TX, WA). Another twelve states authorize a filing conditioned on a further act of the state, an elected official or state entity, a second look, or a restriction on filing (CA, CT, FL, KY, LA, MI, NJ, NC, NY, OH, PA, RI). Three states (CO, OR and IL) grant limited authorization to a specific type of entity; power agencies, irrigation districts, and special tax districts, respectively. Two states prohibit filing, namely (GA) but one of them (IA) has an exception to the prohibition. The remaining 21 are either unclear or do not have specific authorization.

Analysis of the 303 Chapter 9 proceedings filed since 1980 show the likelihood of filing a Chapter 9 bankruptcy is six times higher in the unconditionally authorized states, where the municipality can decide by itself, as compared to the conditionally authorized states, where second look or a further approval or process of the state is required. It appears that once others become involved, other alternatives and resolutions to the financial condition are developed, and Chapter 9 is avoided.

HB 2584 Amends the Illinois Local Government Debt Reform Act, and Provides All Bonds Including General Obligation Bonds and Revenue Bonds Issued under the Act Shall Be Secured by a Statutory Lien

This statutory lien legislation follows the 2010 statutory lien legislation in Rhode Island that was passed to assure access to the financial market without any significant increase in borrowing costs given the anticipated filing of Chapter 9 by Central Falls and possibly others.

California in 2015 passed legislation SB 222 that granted a statutory lien on unlimited ad valorem tax general obligations for cities, counties, school districts and special districts. This legislation was to again assure access to the financial markets and a lower borrowing cost by reducing, if not eliminating, any risk to the statutory lien bondholders from Chapter 9 filing.

As noted above, there is a trend of new legislation by states to use statutory liens to facilitate municipal borrowing at a low cost and reduce the distress- or bankruptcy-fear-increased borrowing costs, which can be 200-300 basis points a year, or an additional 2% or 3% interest cost, each year on the principal amount.

SB 10 Provides for a Form of Securitization Financing of Receivables to Reduce Credit Risk and Lower Borrowing Costs for Home Rule Municipalities
  • SB 10 provides that a home rule municipality may enter into an agreement to assign, sell, transfer or otherwise convey its interest in all or part of any revenues or taxes it receives from the State Comptroller, the State Treasurer, or the Department of Revenue, and sets forth the requirement for such agreements.
  • SB 10 provides that the State pledges not to limit or alter the disposition of receipts transferred as part of the structured financing under the provisions thereof.
  • This structure makes the chances of bankruptcy remote, since the municipality has sold and transferred its right to such transferred taxes or revenues from the state, and has no ownership or interest therein. The state has pledged, as long as the financing is outstanding, to pay such revenues and taxes to the entity that has purchased the transferred revenues or taxes as part of the financing.
  • This legislation is similar to that used by other states such as Sales Tax Asset Receivables Corporation (“STAR”) in New York and Municipal Financial Authority in Michigan. Securities issued through the Municipal Financial Authority in the Detroit Bankruptcy were unimpaired.

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…What Should We Take Away From All This? And, final thoughts on the series.

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

Click here to read Part II: Alternatives Available to the State of Illinois and its Municipalities

Click here to read Part III: Solving Financial Distress with Economic Development

Click here to read Part IV: The Need to Successfully Address Public Pensions