Nov. 22 (Bloomberg) -- Jefferson County, Alabama’s sewer debt needs to be cut by about $1 billion and the state must back repayment of the remaining bonds to keep sewer rates affordable, the receiver running the sewer system said in court today.
John S. Young Jr. was responding to questions from U.S. Bankruptcy Judge Thomas B. Bennett, who is holding a hearing in Birmingham to decide whether the county’s Chapter 9 filing limits Young’s power, including his ability to raise rates.
“I’ve never seen that kind of significant debt per customer,” Young said about the $3.1 billion in bonds that county officials authorized related to the system in 2002 and 2003.
In order to limit future rate increases to single digits, the system needs to reduce its debt by about $1 billion and Alabama would need to agree to treat the remaining debt as a “moral obligation” of the state. Earlier this year, Young proposed a 25 percent increase.
The two requirements Young mentioned were part of a tentative agreement among county officials and state officials, the receiver and bondholders. That agreement fell apart earlier this month, leading to the bankruptcy filing.
Young and sewer bondholders are in court in Birmingham trying to persuade Bennett to rule that he does not have authority under the bankruptcy code to limit the receiver’s power over the sewer system.
Bennett said at the start of the two-day hearing that he isn’t being asked to oust the receiver, who was appointed by a state court on behalf of bondholders owed $3 billion.
“No matter what happens today or tomorrow, I am not removing the receiver,” Bennett said. Limiting the receiver’s power still may give the county more influence over the sewer system and its ability to set rates.
Young and bondholders claim that the county’s bankruptcy cannot change his authority to raise rates and run the sewer system in any way. Bennett said that means he is being asked to abstain from imposing any bankruptcy court control over the receiver, a request that may go too far.
“What I am pointing out is that in your current request for abstention, it is way too broad, it is way too inclusive,” Bennett told lawyers at the start of the hearing. “I am not going to step into something that is not well focused.”
Young testified after County Commission President David Carrington. Young and Carrington both testified about the history of the troubled sewer system and whether the county had the ability to take back control of the system.
Bennett didn’t say whether he will rule immediately after the two-day hearing concludes, or wait to issue a written opinion.
The court fight involves the bankruptcy code’s so-called automatic stay. The automatic stay generally prevents lawsuits and other legal actions against a debtor’s property, in this case, the sewer system.
Wresting control of the system from the receiver would strengthen elected officials in the largest municipal bankruptcy filed in the U.S., lawyers not involved in the case said.
“It gives them a stronger bargaining position,” said Dale Ginter, who represented retirees in the municipal bankruptcy of Vallejo, California. “The county certainly thinks it will increase their leverage, otherwise they wouldn’t do it.”
Young said bond investors would be weakened if he were removed, losing “their biggest potential remedy, biggest potential solution to the problem.” In a Nov. 17 interview, Young said the system is probably worth less than $1.5 billion, based on its revenue stream.
In the months before filing bankruptcy on Nov. 9, county commissioners negotiated with Young, bondholders and state officials. A tentative deal announced in September to cut about $1 billion from the sewer debt fell apart.
The day after the case was filed, Young asked Bennett to verify his control over the sewer system, and its rates, arguing that the automatic stay in bankruptcy doesn’t apply. When a private company files a Chapter 11 case under the U.S. Bankruptcy Code, it can force a receiver to turn over property.
Young claims Congress intentionally left that power out of Chapter 9, which governs municipal bankruptcies. He also says he is protected by the 10th Amendment of the U.S. Constitution, which says powers not held by the federal government are reserved for the states. Since a state court appointed him, Young argued, a federal judge cannot remove him.
County attorneys claimed in court papers that there is no constitutional conflict because Young isn’t acting on behalf of the state of Alabama or any public agency, but on behalf of the trustee for the bondholders, the Bank of New York Mellon Corp.
The county wants the sewer system back in order to control rates for its 126,000 customers, said David Hooks, chief of staff to Commissioner Jimmie Stephens. Young has proposed a 25 percent rate increase, which is opposed by the county.
Control of sewer rates is important because the bonds are so-called non-recourse debt, which means bondholders cannot force the county to pay them back. Bondholders can only be repaid by revenue from the sewer system, according to court documents filed by the county.
“The county wants to make sure that rates are at a level that are reasonable and fair, but yet supports a reasonable level of debt service,” Hooks said in an interview. “The county should be in the position to control rates, not a receiver that was appointed on behalf of the creditors.”
Should Young keep control, the county may be better off financially, Ginter said. It can simply walk away from the sewer bond debt and force bondholders to collect everything they are owed only from ratepayers.
“The county can let it go and say, ‘The receiver has that problem. I am going to just deal with my other debt,’” Ginter said. “That may not be good for the county citizens and ratepayers, but from a county fiscal point of view, I think it’s a good option.”
Walking away from the sewer debt would be “a negotiating ploy, and a good one,” said attorney Mark Schwartz, who filed Harrisburg, Pennsylvania’s Chapter 9 case. Without any cooperation from the county, bondholders may be forced to battle in court to raise rates, he said.
Abandoning any effort to help repay the bond debt may have long-term consequences for the county, Schwartz said. The bond market may refuse to lend to the county again, or make it very expensive for it to borrow, he said.
Regaining control of the sewer rates would give the county more power when officials begin developing a plan to reorganize the county’s debt and exit bankruptcy control, Schwartz said.
Jefferson County is the 12th entity to file a Chapter 9 bankruptcy this year. Three filings were by municipalities: Boise County, Idaho; Central Falls, Rhode Island, and Harrisburg. The rest were special purpose districts, or public- benefit corporations eligible to use Chapter 9.
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 case is In re Jefferson County, 11-05736-9, U.S. Bankruptcy Court, Northern District of Alabama (Birmingham).
--With assistance from Martin Braun in New York. Editors: John Pickering, Stephen Farr
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