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Jefferson County, Creditors, Begin Fight Over Bonds

April 12 (Bloomberg) -- Alabama’s bankrupt Jefferson County has the right to cut payments to bondholders so it can meet operating expenses for water, sewer and other public services, the county’s lawyer said.

In a three-day hearing that began yesterday in U.S. Bankruptcy Court in Birmingham, the county and its creditors are debating the definition of “necessary operating expenses.” The phrase is used in the U.S. Bankruptcy Code and governs how to split revenue between bondholders and public agencies that borrow money to build assets like water-treatment plants.

“One of the biggest problems is overhanging debt,” said David Stern, Jefferson County’s lawyer. “There is no way in which the receiver’s bankruptcy expenses are covered and ours are not. If we don’t solve the ‘sewer debt nightmare’, as John Young described it, this system will not operate, it will not be compliant. It will not have enough money to do what it needs to do.”

John Young is the former receiver for the sewer system, whose refinancing led to the county’s bankruptcy.

For decades, municipal bond lawyers, analysts and ratings agencies assumed that the definition was narrow and required cash from water bills or similar payments, to be turned over to bondholders after deducting specific expenses spelled out in bond contracts, said Matt Fabian, a managing director at Municipal Market Advisors in Concord, Massachusetts.

Enormous Significance

“This is potentially of enormous significance to the market,” Fabian said.

The trustee for Jefferson County’s sewer bondholders is asking U.S. Bankruptcy Judge Thomas B. Bennett to force the county to turn over all sewer revenue except for the money needed to pay expenses listed in the bond contract, known as an indenture.

The county argues that under the bankruptcy code, it has the power to withhold money for items opposed by the trustee, including “project expenditures” to keep the sewer system up to date with changing laws or industry standards.

“Many participants in the municipal bond market will be monitoring developments in Birmingham,” bankruptcy attorney Bruce Bennett, co-chairman of Business Solutions & Governance at Dewey & LeBoeuf LLP in Los Angeles, said in an e-mail. “There is no authority directly interpreting ‘necessary operating expenses’ as those terms are used in Bankruptcy Code section 928(b).”

Biggest Bankruptcy

Bennett was the lead lawyer for Orange County, California, when it filed for bankruptcy in the 1990s. Orange County was the biggest municipal bankruptcy in the U.S. until Jefferson County filed last year.

Attorneys for the trustees and the county also questioned Young, who was asked about his capital improvement plan for the aging system. Young described the system in his report as being in “very poor” condition. Young had a five-year plan designed to provide a “viable, efficient” system with a cost of $178 million.

Young said in court that he’s been a consultant to the trustees and hasn’t been paid for invoices he submitted for January, February and March.

In November, Jefferson County sought court protection after Young, county and state officials, and bondholders failed to implement a tentative agreement to cut sewer debt by about $1 billion, increase rates and win assistance from the Alabama Legislature.

Bank of New York

Jefferson County’s bankruptcy was opposed by Bank of New York Mellon Corp., the trustee for more than $3 billion in sewer debt, and creditors JPMorgan Chase & Co., which owns more than $1 billion of the sewer warrants, Bank of America Corp. and Assured Guaranty Municipal Corp.

The bankruptcy is tied to a sewer refinancing tainted 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.

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 Wilmington at schurch3@bloomberg.net; Kathleen Edwards in Birmingham at kathedw@charter.net

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

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