Moving close to five years after the City of San Bernardino filed for Chapter 9 protection, it has at last fully emerged from bankruptcy, having done so by stepping out from under slightly more than $350 million in debt, leaving in its wake scores of stiffed creditors, vendors and investors, as well as claimants and successful litigants who prevailed against the city in court but who will now have nothing – or next to nothing – to show for it.
San Bernardino made the Chapter 9 filing in August 2012 after years of dwindling revenues, expenditures drastically exceeding income, and deteriorating financial numbers that resulted in $80 million in unfunded liabilities and a $49 million annual operating deficit. Chapter 9 of the United States Bankruptcy Code provides a financially distressed entity such as a municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts.
According to Andy Belknap of the firm Management Partner, Inc., which assisted the city in its sojourn through and now out of bankruptcy, “The original Plan of Adjustment approved by the city council in April 2015 has been largely implemented in the last 22 months.”
A force that drove the city into financial distress was its commitments to employees in terms of salaries and pensions. While initially city officials had hoped the bankruptcy process could result in the city successfully negotiating those commitments downward by drastically lowering salaries and pensions, that did not for the most part occur. There was early on a struggle of will between city officials and CalPERS, the California Public Employees Retirement System. In the first year after the filing was made, the city withheld more than $14 million owed to the state pension system. By the 14th month after the filing, that arrearage had grown to over $16 million. Efforts to force CalPERS to accept that the city was not in a position to continue to lay out millions and millions of dollars, escalating at a double digit rate annually, to pay for employees no longer working for the city failed when CalPERS proved every bit as intransigent as the city and spent in excess of $7 million on attorneys fighting the city in bankruptcy court over the issue. As a consequence, CalPERS proved to be the entity that forged the best deal with the city. In May 2014, the city paid $1.5 million to CalPERS as a down payment toward erasing its debt with the pension fund, and agreed to pay nearly $600,000 a month for the two years between July 2014 and June 2016, as well as committing to shell out five annual payments of $400,000 to cover interest and late payment penalty assessments and fines.
Among the city’s creditors that did not fare as well were Luxembourg-based EEPK, holders of the city’s pension bonds, and Ambac Assurance Corp, which indemnified some of those bonds. When the city failed to provide them with the same terms of repayment as CalPERS, they sued, asserting the bonds and whatever fees are associated with them fall under the same pension obligation as the payments to CalPERS. That lawsuit was settled in March 2016 on the basis of an agreement by which the city is to pay not 100 percent but rather 40 percent of what is owed to EEPK and Ambac.
One class of creditors who were really stiffed were litigants and claimants against the city, including ones who had prevailed in certain lawsuits, among them those alleging they had endured civil rights violations relating to excessive use of force by the police department. Those entities and the lawyers representing them will get just a penny on the dollar for the first $1 million in judgments against the city.
City employees and retirees did relatively well under the plan, which preserves pension benefits for current and former workers, though current employees will be called upon to make a greater contribution toward those pension plans, and some benefits were reduced or modified. Employees will have to contribute more to their pension plans and the same level of benefits given to employees in the past will not be available for new employees.
A majority of the city’s creditors agreed to the plan, though some stragglers have refused to compromise or are otherwise insisting that the pittance the city has offered does not truly qualify as a compromise. But on February 7, 2017 U.S. Bankruptcy Judge Meredith Jury signed the city’s confirmation order and agreed with the city’s requested third party injunction, preventing any remaining disputed claims from interrupting the bankruptcy exit.
Belknap gave a report to the city council Wednesday night hailing the exit.
“Per the order confirming the city’s third amended plan of adjustment and the plan itself, the city was required to meet a number of conditions prior to the effective date of… the city’s subsequent exit from bankruptcy,” Belknap said. “The plan conditions having been met, the city’s effective date occurred on June 15th. A notice of the occurrence of the effective date will be sent to all city creditors and parties in interest.
As expected, some civil litigants have appealed, but those appeals have not prevented the city from moving forward on implementing the plan.”
Belknap said, “Following the occurrence of the plan’s effective date, the city began making the payments due under the plan, which were budgeted for payment under the bankruptcy fund.”
Along the way, the city last year dissolved it 137-year old municipal fire department, placing the entirety of the city in a county fire service protection zone that imposes a $143 per parcel per year assessment on residents. The city also outsourced its refuse hauling division to a private company, Burrtec Industries.
Belknap said the city had spent $25,193,340 on professional services relating to its bankruptcy filing, the lion’s share of which went to the law firm of Stradling Yocca Carlson & Rauth, which represented the city in bankruptcy court and billed the city $19,470,878 for doing so. Urban Futures, Inc. was paid $2,327,665 for bankruptcy related services, including refinancing loans and bond financing and managing the disposition of various municipal assets. Belknap’s firm, Management Partners Inc., received $1,466,190. Other providers of services relating to the bankruptcy were Bartel Associates, LLC, which was paid $214,050; Bienert Miller & Katzman PLC; which was paid $441,340; the Law Office of Linda Daube, which was paid $644,317; Rust Omni, which was paid $284,646; and McDermott Will and Emery, which was paid $283,103.
“Bankruptcy was extremely painful for city employees, retirees and creditors, who absorbed financial losses,” said Belknap. The city’s plan provides at least $350 million in one-time and ongoing expenditure savings, plus increased revenue and cost restructuring over a 20-year period. The city has a solid plan for rebuilding municipal service delivery and a governance structure that can support efficiency and effectiveness.”
The old bugaboo of pensions continues to bedevil the city, Belknap said.
“In late December, 2016 CalPERS voted to drop its investment earnings assumption from 7.5% to 7% over three years, which adversely impacts the city’s plan. The fiscal model will be updated based on adopted 2017-18 budget and latest CalPERS actuarial.”
With San Bernardino’s reputation for reliability and its good name shattered, Belknap said, there is a positive side to all this.
“The city is now in a position to carefully improve service levels, particularly for police and infrastructure maintenance,” Belknap said. “The city’s fiscal situation is much better but the budget and fiscal model must be monitored carefully. The city’s original plan of adjustment has generally worked as designed, except for the CalPERS sub-par investment earnings, which have been a constant challenge, but the city plan reduced employee count, which is the best mitigation.
Belknap said, “Like other cities, the city still must discuss cost containment and cost recovery options to fully or adequately fund services. Now that city is out of bankruptcy and has reformed its manner of governance, it has opportunity to move forward.”