Jefferson County to Defend Bankruptcy at Hearing Next Month

Jefferson County, Alabama, which filed the biggest municipal bankruptcy in U.S. history yesterday, faces a hearing next month over whether it can remain under court protection from creditors.

The county, whose seat is Birmingham, the state’s largest city, won court approval today to hold an initial hearing in about 30 days on whether it is eligible to be in bankruptcy. Creditors including Bank of New York Mellon Corp. (BK), acting as trustee for lenders, had sought at least 60 days to prepare.

U.S. Bankruptcy Judge Thomas B. Bennett said creditors and bondholders had ample warning that the bankruptcy was coming. The threat of bankruptcy has loomed over the county for more than three years and inspired provisions in the federal Dodd- Frank law seeking to protect localities from complex financial trades involving derivatives.

“Most of the bondholders in this case have known for a number of years” about the possibility of a bankruptcy, Bennett said in court in Birmingham.

The Chapter 9 filing leaves creditors including JPMorgan Chase & Co. (JPM), the biggest U.S. bank by assets, facing hundreds of millions of dollars in losses and may revive concern that defaults will rise in the $2.9 trillion municipal bond market. The move also could leave county residents facing unsustainable sewage fees to repay the debt that led to the debacle.

County commissioners had asked creditors to forgive about $1 billion of the debt to spare residents from ballooning sewer rates needed to pay off the bonds.

Chapter 9

The receiver who runs the county’s insolvent sewer system said the bankruptcy does not give it the right to take over the system’s finances, including the power to raise rates.

Because he was appointed by a state court judge, John S. Young Jr. claimed in court papers today that Bennett lacks authority to return the system to the county. Young claims the 10th Amendment of the U.S. Constitution, which describes the powers of the states and the federal government, trumps bankruptcy law.

The county’s lead bankruptcy attorney, Kenneth Klee, said in court that a fight over control of the sewer system’s finances may take place before the hearing next month on whether the county should remain in bankruptcy.

Modern Code

Klee helped write the modern bankruptcy code in the 1970s, including Chapter 9, the section that sets the rules for cities, counties and special tax districts to seek court protection.

Young claims Chapter 9 does not specifically give Bennett the power to remove a receiver, as does Chapter 11, which governs corporations.

In an interview today, Klee claimed that once the county filed its bankruptcy petition, Young’s powers became limited by the code’s automatic stay, which prevents creditors from taking legal action to seize property owned by a debtor.

The county now must show Bennett that it can’t pay its bills and then draw up a plan for meeting obligations, which the court may reduce. Unlike corporate cases, creditors can’t try to seize or sell off county assets, and the court can’t appoint a trustee to run the county.

Small Municipalities

Jefferson County is the 12th entity to file a Chapter 9 bankruptcy this year. Three of those filings were by small municipalities: Boise County, Idaho; Central Falls, Rhode Island, and Harrisburg, Pennsylvania. The rest were special purpose districts, or public-benefit corporations eligible to use Chapter 9 of the U.S. Bankruptcy Code.

Jefferson County supplanted Orange County, California, as the largest municipal bankruptcy. Orange County entered court protection in 1994 after losing $1.7 billion on interest-rate bets. While its petition initially listed more debt than Jefferson County, most of that liability was reduced in the early weeks of the case.

The filing by Alabama’s most-populous county, with about 660,000 residents, came after state lawmakers failed to back a September agreement with creditors led by JPMorgan that would have reduced its sewer-system debt of more than $3 billion. Governor Robert Bentley and local leaders worked unsuccessfully for two months to rally support for the deal.

Burden on Poor

The September accord provided $1.1 billion in concessions. It also called for annual sewer-rate increases for the first three years of as much as 8.2 percent, which drew opposition from lawmakers concerned about the burden that would place on the poor. The county also couldn’t get signed commitments from creditors, said Commission President David Carrington.

Jefferson’s bankruptcy is the legacy of a sewer project dogged by political corruption. In 2009, JPMorgan agreed to a $722 million settlement with the Securities and Exchange Commission over payments its bankers allegedly made to people tied to county politicians to win business. Former Commissioner Larry Langford was convicted on charges of accepting bribes and the shenanigans behind the financing inspired elements of the Dodd-Frank law to protect municipalities.

In 2008, the derivative-laden refinancing set up by JPMorgan unraveled as fallout from the subprime-mortgage market collapse rippled through Wall Street, sending debt costs soaring.

Concessions

JPMorgan didn’t want the county to enter bankruptcy, said Justin Perras, a bank spokesman. The company held more than $1.2 billion of the county’s sewer debt as of May, according to a document provided by Bentley’s office in September. It had offered $750 million in concessions in the proposed settlement. to work toward a fair and reasonable solution.”

The bankruptcy will have “no material impact” on the firm’s earnings, Perras said.

The filing comes less than a month after Pennsylvania’s capital, Harrisburg, sought court protection, citing millions in overdue bond payments tied to a trash-to-energy incinerator. On Aug. 1, Central Falls, Rhode Island’s smallest city, entered bankruptcy, citing pension costs it can’t afford.

Municipal bankruptcies are rare. Since November 1981, fewer than 40 local governments have sought to restructure in bankruptcy, according to court records. Most of the more than 200 Chapter 9 cases filed since then involved special tax districts, or entities such as hospitals that were funded with state-issued bonds. In the same period, companies filed more than 20,000 Chapter 11 cases.

Bond Defaults

Municipal bond yields were little changed as of 10 a.m. New York time today, according to BVAL index data. They fell to a five-week low yesterday as investors sought safety in U.S. Treasuries amid concern that European governments won’t be able to avoid bond defaults.

Jefferson County can’t impose a tax or raise existing levies without legislative approval. Its money struggles intensified in March when the state’s highest court struck down a local wage tax that generated $70 million annually, or almost a quarter of the county’s general fund.

More than 500 county employees lost their jobs in response to the revenue drop and satellite courthouses were closed. Lines for services became so long that the county installed portable toilets.

Along with its sewer debt, Jefferson County owes about $1 billion, including $201 million of general-obligation securities and school-construction bonds totaling $814 million, according to its bankruptcy petition. The county listed the top three unsecured creditors related to the its general-obligation debt as Bayerische Landesbank in Munich, as well as a unit of JPMorgan and the Depository Trust Co., both based in New York.

The case is In re Jefferson County, 11-05736-9, U.S. Bankruptcy Court, Northern District of Alabama (Birmingham).

To contact the reporters on this story: Steven Church in Birmingham, Alabama, at schurch3@bloomberg.net; William Selway in Washington at wselway@bloomberg.net; Margaret Newkirk in Atlanta at mnewkirk@bloomberg.net

To contact the editor responsible for this story: John Pickering at jpickering@bloomberg.net.

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