BRADENTON, Fla. ? The Chapter 11 bankruptcy of a public benefits corporation, which is rattling Kentucky pension managers, highlights the risks associated with such agencies, according to Moody's Investors Service analysts.
A bankruptcy judge in Louisville ruled in May that the nonprofit Seven Counties Services Inc., a mental health services contractor with the state, could file for protection under Chapter 11 of the bankruptcy code instead of Chapter 9.
U.S. Bankruptcy Judge Joan Lloyd concluded that Seven Counties qualified as a private, nonprofit corporation instead of a government unit, and could move forward with its petition without state permission. Lloyd also ruled Seven Counties had a right to reject its contract with the Kentucky Employees' Retirement System. Seven Counties employees participate in KERS.
KERS, which is appealing the decision, calculated that the actuarial accrued liabilities for Seven Counties participants are $119.5 million, according to Lloyd's ruling; the system's other employees could be required to assume them.
"The decision demonstrates a credit risk for certain quasi-governmental entities, such as public benefit corporations [as] it may be easier for these entities to successfully file for bankruptcy than traditional municipalities such as cities, counties and school districts," Moody's analyst Karolina Norris said in a report Oct. 10. "The barriers to filing for Chapter 9 are much higher than the corporate bankruptcy options."
Norris said it is not well-established if public benefits corporations can file for bankruptcy as not-for-profit corporations under Chapter 7 liquidation or Chapter 11 reorganization, or whether they must file as municipalities under Chapter 9, because of the small number of relevant bankruptcy cases.
Public benefits corporations typically contract with a state to provide essential services such as social services, transportation and higher education.
A key issue is whether such an entity is a "municipality," Norris said. The bankruptcy code defines a municipality as a political subdivision, public agency or instrumentality of the state.
"In the Seven Counties Services case, along with a 2010 decision on the Las Vegas Monorail Co., the respective courts determined that [the public benefits corporations] qualified as not-for-profit corporations rather than municipalities," she said.
Seven Counties filed for Chapter 11 bankruptcy in the Western District of Kentucky on April 4, 2013 with about $4.86 million of unrated outstanding adjustable rate demand industrial revenue bonds issued in 1999, 2005, and 2011, according to the agency's fiscal 2013 audit.
The bonds were issued on the strength of the letter of credit provider, Fifth Third Bank, and not the credit of Seven Counties, an offering circular said.
The bonds were in default by virtue of the bankruptcy filing, the trustee, Bank of New York Mellon, said in an April 30, 2013 notice on the Municipal Securities Rulemaking Board's EMMA system. Typically, debts are not paid by an entity that has filed for bankruptcy by virtue of a stay, which gives the filer time to reorganize or dispose of debt.
The 2013 default notice said Fifth Third decided at the time not to accelerate the bonds or draw on the letter of credit. Since then there have been no other filings on EMMA related to the bankruptcy case.
