Say what you will about Detroit’s bankruptcy case, but when it is all said and done, the value for each of its participants most likely lies in the learning experience. And, experience is sometimes a painful teacher. One of the many take-aways is a framework for what constitutes a workable or “feasible” plan of adjustment (“Plan” or “Plan of Adjustment”) while recognizing the significant risk of implementation and post bankruptcy performance.
Detroit, the largest municipal bankruptcy in U.S. history, ended on December 11, 2014. That is when Detroit’s Plan became effective, the City closed a $275 million exit financing with Barclays and issued $280 million in bonds to creditors. After making initial payments due under the Plan, the City disbursed payments to bond insurers and other creditors as part of the settlement of over $12 billion in debt.
Detroit’s Plan sheds $7 billion of long-term debt, the bulk of it from retiree health care benefits. Assuming everything goes right, including reducing expenses and increasing revenue, the City hits its budget target and raises revenues in multiple areas over the next 10 years, the Plan projects that Detroit will be able to invest a projected $1.7 billion in new and/or improved services for Detroit residents.
Will Detroit’s Plan Work?
Time will tell, as noted by the Court’s independent expert, Martha E.M. Kopacz (“Kopacz”), Senior Managing Director of Phoenix Management Services, LLC. Kopacz filed a lengthy expert report and two supplements in the bankruptcy case (the “Kopacz Report”). (Squire Patton Boggs partners Stephen Lerner and Scott Kane represented Kopacz and her team at Phoenix.) Kopacz also testified at the confirmation hearing, defining the test for feasibility, providing a deep factual analysis of the feasibility of Detroit’s Plan and identifying specific questions that needed to be answered to determine whether the Plan met the Bankruptcy Code’s requirements.
By way of background, Kopacz was asked, among other things, to investigate and reach a conclusion on whether the City’s Plan is feasible as required by 11 U.S.C. Section 943(b)(7), and whether the assumptions that underlie the City’s cash flow projections and forecasts regarding its revenues, expenses and plan payments are reasonable. Section 943(b)(7) of the Bankruptcy Code requires that before a Plan may be confirmed the Court must determine that the Plan is feasible.
The Kopacz Standard
The Bankruptcy Code does not define “feasible” nor is there a meaningful body of chapter 9 jurisprudence on the issue. The Kopacz Report defined a threshold standard for feasibility (the “Standard”) asking:
Is it likely that the City of Detroit after the confirmation of the Plan of Adjustment, will be able to sustainably provide basic municipal services to the citizens of Detroit and to meet the obligations contemplated in the Plan without the significant probability of default?
The Court adopted the Kopacz Standard in its Confirmation Order providing the first clear and unequivocal ruling on chapter 9 feasibility. The questions and issues addressed by the Kopacz Report provide the foundation for establishing feasibility and Detroit’s feasibility lesson creates a very useful test for any municipality seeking to create and implement a truly workable Plan, whether in or out-of-court.
The Kopacz Report breaks down the assessment of feasibility into two component parts. The Standard looks to answer both quantitative and qualitative questions that are generic enough to apply in future municipal restructurings. These are questions cities should be asking themselves and their creditors and stakeholders should be following closely. They include:
Are the projections in the Plan of Adjustment mathematically correct and materially reasonable?
Are the assumptions that the City has used to develop its projections individually and when taken as a group reasonable?
Is there an adequate contingency included in the projections?
Does the City have the human resources, or can it likely recruit the human resources, required to meet its obligations under the Plan of Adjustment?
Does the City have the appropriate systems and procedures in place to monitor its financial performance and to provide early warning signs of variances in performance that might cause the City to fall short of the projections and be unable to meet its obligations under the Plan of Adjustment?
Are there appropriate structures to ensure the City’s compliance with the Plan of Adjustment and with reasonable government standards of operation?
Will the City be able to reasonably deliver a minimum level of municipal services?
Is the city’s trajectory sustainable?
Kopacz also noted the importance of considering the time horizon, stating “as the time horizon expands, so does the feasibility challenge.” Given the challenge of pension obligations, the questions regarding timeframe may be the most difficult because of the many municipalities struggling with significant pension and other post-employment benefits. Kopacz’ questions were:
Do we consider the timeframe over which financial commitments are made in the Plan of Adjustment?
That is, do we look at the restructured pension obligations of the retirees and current employees and attempt to determine whether the Plan of Adjustment is feasible during their entire lifetimes?
As to managing long term obligations, like pensions, Kopacz strongly suggested that monitoring, consistently measuring liabilities, and reporting against Projections is a critical part of Plan implementation.
Finding Feasibility for Detroit
Kopacz ultimately found Detroit’s Plan feasible stating that Detroit differs from a company emerging from Chapter 11 in that the City does not have to be service delivery solvent to emerge from bankruptcy. It will be on a trajectory toward service delivery solvency. For Detroit, emerging from essential services failure to adequate and reasonable service delivery will be a success.
In Kopacz’ last supplemental report, prepared after settlements were reached with most objecting parties, she found Detroit’s current projections to be within the range of reasonableness making the Plan feasible stating:
I want to emphasize, however, that there is little space remaining on the continuum of reasonableness. The recent settlements and corresponding amendments to the Plan of Adjustment have served the laudable goals of efficiently resolving disputes and garnering additional support for the Plan of Adjustment. Conversely, they have imposed additional financial obligations on the City.
I have already expressed concerns regarding the level of contingency provided for in the Plan of Adjustment. The financial obligations associated with the recent settlements only intensify this concern.
While the Detroit Plan is feasible for purposes of confirmation, it is going to require strict and careful implementation. There is little, if any, room for error if the Plan is to succeed post-bankruptcy. Getting out of bankruptcy is just the first step for Detroit — the real test is whether the process delivered true value and the City has the discipline to perform under the Plan.
The Take Away
The Kopacz Report provides any city looking to restructure with the essential questions that must be addressed to determine the feasibility of any Plan. This is the first time that the elements of municipal feasibility have been defined and the first time a Court has adopted a clear and unequivocal test for municipal feasibility. The Kopacz Standard and its underlying questions provide a clear starting point for what a chapter 9 plan needs to accomplish. What now exists is a paradigm that can make the plan process more efficient and more transparent for cities, their creditors and stakeholders. Answering the questions will organize the more detailed and often complicated factual analysis that is necessary to determine feasibility.
Detroit has an oversight committee, but the real test of a successful restructuring for Detroit is careful and consistent implementation of the dozens of change initiatives contemplated in the Plan. We can all hope, that like the film “The Best Exotic Marigold Hotel,” “(e)verything will be all right in the end… If it is not all right, then is it not yet the end.” And, may Detroit travel to an “all right” ending.