Jefferson County Can’t Divert Bond Payments, Judge Rules

Alabama’s bankrupt Jefferson County can’t reduce payments to bondholders so it can spend more on its aging sewage system, or pay legal fees, a federal judge ruled.

The ruling is a victory for bondholders, shielding them from reduced payments while Jefferson County remains in bankruptcy and tries to win approval for a so-called plan of adjustment. Such plans attempt to match a public agency’s debt with income from taxes and revenue from water and sewer payments. No municipality has ever won court approval for a plan that cuts principal payments to bondholders.

“Operating expenses as determined under the indenture do not include (1) a reserve for depreciation, amortization, or future expenditures, or (2) an estimate for professional fees and expenses,” U.S. Bankruptcy Court Judge Thomas B. Bennett wrote in the opinion.

Bondholders are owed more than $3 billion, debt that is backed by the payments made by business and residents in Alabama’s biggest county. The bondholders, led by their trustee, Bank of New York Mellon Corp., have filed multiple legal attacks against Jefferson County since the municipality filed its Chapter 9 case in November.

The county filed the biggest municipal bankruptcy in the U.S. after elected officials and creditors failed to implement a proposal to cut the sewer debt by about $1 billion.

Split Revenue

Bennett made his ruling on the bond payments following a three-day hearing in early April in Birmingham during which the county and its creditors debated 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.

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.

The bondholder trustee asked 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.

‘Project Expenditures’

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

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).

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