At least a partial win for bondholders in Chester, Pennsylvania, Chapter 9

Bonds

A bankruptcy court recently ruled for the most part in favor of Chester, Pennsylvania, bondholders in an adversary proceeding filed by the city challenging liens on revenues for bonds issued in 2017 as part of a financial recovery plan for the city.

Chester, which filed for bankruptcy in November 2022, has faced decades of financial struggles and adopted an initial recovery plan in 1996, which was then amended in 2006, 2013, and 2016 due to difficult economic circumstances.

As the city slid deeper into debt, then-Pennsylvania Gov. Tom Wolf declared a fiscal emergency and placed the city under receivership in 2020.

The city of Chester, on the Pennsylvania side of the Commodore Barry bridge, has been in Chapter 9 bankruptcy for more than a year.

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The governor’s office said in a declaration of fiscal emergency issued in April of that year that it projected the city had just 180 days until insolvency, with “ongoing fiscal distress jeopardizing the health, safety, and welfare of its citizens and threatens the fiscal stability of neighboring communities.”

The state-appointed receiver, Michael Doweary, filed for Chapter 9 bankruptcy, saying in a statement that though he worked for two years to avoid bankruptcy, the city’s issues persisted and it would face a $46.5 million deficit in 2023, $39.8 million associated with to past due pension payments.

In its Chapter 9 filing, he estimated liabilities between $100 million and $500 million with assets of between $10 million and $50 million. Chester as an unfunded pension liability of more than $100 million and simply didn’t make its more than $39 million of legally required pension payments between 2014 and 2020, according to the receiver’s final pre-bankruptcy report.

Among the city’s listed creditors at the time of filing were U.S. Bank N.A, as paying agent for $9.149 million of 2017A bonds and $6.107 million of 2017B bonds.

The adversarial proceedings challenged the perfection of the liens securing two issuances of revenue bonds in 2017.

In his final pre-bankruptcy report, the receiver said the city could save more than $3.6 million of debt service if those costs were eliminated.

The Series 2017A bonds were issued by the Chester Economic Development Authority to cover general fund liabilities and create a reserve fund.

“These bonds essentially take the city’s deficient and unpaid liabilities in 2017 and spread the costs of partially repaying them over 10 years,” Doweary said.

The second issuance of $7.2 million of Series 2017A revenue bonds was used to finance the acquisition of properties leased by the city and also boost required reserves, refinancing the original debt issuance.

The bonds were backed by liens on three major revenue streams: a portion of annual slot machine license operation fees collected by the state and distributed to Chester, a portion of gambling table revenues collected by the state, and revenues associated with fees paid to the City by a waste incinerator operator servicing the city.

In the adversary proceeding, Chester’s officials contended that liens on revenues backing the bonds were unperfected and did not extend to post-petition, and asserted claims against Preston Hollow, the sole holder of the 2017 bonds, the trustee, Delaware Valley Regional Finance Authority, Delaware County, waste management operator Covanta, horse racing track Chester Downs and Marina, and Harrah’s Philadelphia Casino and Racetrack.

“The City asks this Court to enter an order declaring that the pledged revenues payable to the city after the petition date do not qualify as “special revenues” under the bankruptcy code and therefore are not subject to any liens,” the court ruling read.

According to court documents, as of the petition date, the total outstanding balance on the Series 2017A and Series 2017B Bonds was $9,149,365 and $6,107,250, respectively. The city held $4,445,242.41 in the revenue fund at the time.

The court’s ruling this month to an extent favored bondholders who argued that “they have sufficiently perfected their security interests in the pledged revenues, as the pledged revenues are classifiable as “general intangibles” or “accounts,” and any security interest in such collateral can be perfected by the filing of a financing statement.”

“Confirming the municipal bond market’s longstanding understanding, the Court concluded that the liens on revenues were properly perfected by the filing of UCC financing statements,” the law firm Cadwalader, Wickersham & Taft LLP wrote in an analysis of the situation.

“However, the Court also held that the liens had ceased to attach to postpetition revenues by virtue of Section 552(a) of the Bankruptcy Code, which generally provides that prepetition liens cease to attach to property acquired after the commencement of a bankruptcy case,” the firm wrote.

The court agreed with bondholders that pledged revenues were “more akin to an account or payment intangible than money” for purposes of perfection.

“As the Trust Indenture states, the pledged revenues are revenues payable to or to be received over the course of ten years,” it said.

“In Chester’s case, the City argued that the pledged revenues constituted ‘money,’ a security interest in which can be perfected only by ‘possession,'” Cadwalader said in its analysis. “Because the City alleged that the bondholders did not have “‘possession’ of post-petition revenues as of the petition date, the City argued that their liens could be avoided under Section 544 of the Bankruptcy Code.”

The court agreed with Chester on one complaint in which it asserted that trustee breached its indenture after it failed to transfer excess funds due to the city before the suit filing.

Cadwalader said liens had ceased to attach to postpetition revenues “which generally provides that prepetition liens cease to attach to property acquired after the commencement of a bankruptcy case.”

The bankruptcy court concluded “that no relevant exception applied,” in the process analyzing issues related to statutory liens, the nature of postpetition “proceeds,” and the nature of “special revenues.”

When Wolf appointed Doweary as receiver, he said the city was in danger of failing to be able to provide vital and necessary services to its citizens.

Receiver Michael Doweary said in the city’s recovery plan that, given the city’s “dire financial condition,” all options were on the table and it had two cash crises; one in the general fund and one in the Police Pension Fund.

The police pension fund was “dangerously close to insolvency” and being unable to pay out monthly benefits to pensioners.

Chester also had to address its structural budget deficit, it also faced management and operational issues weighing on the city’s finances and, while the city’s debt burden was not extremely high, it consisted of riskier issuance targeted at repaying debt and covering operating expenses, Doweary said.

The city instituted various emergency fiscal measures, including furloughing city employees along with the debt issuances. It also attempted to monetize its two biggest business assets, its water system and its parking system, issuing a request for proposals for the purchase of both which would net between $60 million and $410 million, Doweary said. However, court challenges to the sales have meant the assets have failed to materialize.

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