BRADENTON, Fla. — Appeals of Jefferson County, Ala.'s bankruptcy case will go forward, U.S. District Judge Sharon Blackburn ruled Tuesday.
Blackburn allowed one appeal to proceed after questioning the constitutionality of a premise the county used to close on $1.8 billion in 40-year sewer refunding warrants as part of its Chapter 9 exit plan last December.
The judge denied a motion to consolidate two other appeals into the main case, and ruled that they must go forward as separate proceedings.
The sewer warrant deal was the lynchpin of the plan that enabled Alabama's largest county to exit the second-largest municipal bankruptcy in U.S. history and to write down $3.1 billion in related debt.
The three appeals were filed by former broker-dealer Calvin Grigsby, a financial advisor and attorney representing group of local residents and elected officials who are ratepayers on the county's sewer system.
The Birmingham-based judge disagreed with the county's argument that a challenge of the bankruptcy exit plan is moot because the December deal cannot be unwound.
Although Blackburn said some parts of the county's bankruptcy confirmation order "may be impossible to reverse," she said the portion that cedes the county's future authority to set sewer rates to the bankruptcy court is not one of those parts.
"If, as the ratepayers contend, this part of the confirmation order is unconstitutional, this court may so declare and prohibit enforcement of that term," Blackburn wrote in a
The ruling surprised some legal experts, including bankruptcy attorney John Whitlock at Edwards Wildman Palmer LLP.
"Based on our experience with appeals of confirmed plans of reorganization in Chapter 11, many bankruptcy lawyers, including me, predicted that the court would probably dismiss the appeal of the confirmation of the plan as moot, since the plan had already been substantially consummated with the issuance of the new warrants," Whitlock said Wednesday after reviewing Blackburn's opinion.
"Instead, what the court has determined is that one aspect of the plan, namely the retention of the jurisdiction of the court to address future sewer rates, can be found to be unconstitutional and can be overturned, even though other elements of the plan would not be disturbed," he said.
David Carrington, president of the County Commission, said Wednesday that he was reviewing the judge's ruling with attorneys.
He also said that he remained "confident" in the county's legal positions, but did not explain further.
"My clients are thrilled at the district court's decision to allow us to argue the case on the merits," Grigsby said. "We're also happy to have the court make it clear at the outset that if, as we have argued, the county cannot as a matter of law cede its authority to set sewer rates in the future to the bankruptcy court, then [the district court] will strike down that provision of the confirmation order as unconstitutional."
Whitlock said it is not clear if the county can appeal Blackburn's decisions at this stage.
He also said it is difficult to predict what sewer warrant investors could do if the court's jurisdiction over the county's ratemaking authority is eventually ruled unconstitutional.
"It may depend on whether the county ultimately does not increase its rates enough to pay the warrants over time," Whitlock said.
Most, if not all, investors likely purchased the bonds because of the provision requiring the federal court to retain jurisdiction even though it was an untested legal theory, said Matt Fabian, a managing director at Municipal Market Advisors.
"This is why we said a non-investment grade rating was more appropriate," he said.
In advance of last year's sale, Standard and Poor's assigned investment grade ratings of BBB and BBB-minus to the senior and subordinate warrants, while Fitch assigned junk ratings of BB-plus and BB.
S&P analysts said at the time that its triple-B ratings recognized clearly significant ongoing challenges that the county must address, but that the ratings were "forward-looking" and not meant to be punitive or a reward for exiting bankruptcy.
Moody's Investors Service, which was not asked to rate the warrants, said in a special comment that the debt should be rated in the B or Ba range, reflecting "substantial-to-high credit risk."
Analysts at Moody's also questioned the court's jurisdiction to act if future county commissioners failed to increase sewer rates.
"While the bond trustee could then ask the court to compel the county to enforce its bankruptcy plan, we are not aware of a precedent for a federal court to compel public utility rates of this nature, given the federalism issues involved in this bankruptcy," analysts said.
Blackburn's opinion noted the comments of all three agencies.
Fabian said he believed S&P's investment grade ratings were based on Jefferson County's ability to pay debt service, backed by the ability of the court to force the county to raise rates, and not on the county's willingness to pay bondholders.
If the court's jurisdiction is lost, bondholders may worry about the county's willingness to make payments, and S&P likely will downgrade its ratings, he said.
Jefferson County's attorneys had argued that the appeals were constitutionally and equitably moot because the bankruptcy plan of adjustment is in place, and that the only issue that should be decided is the bankruptcy court's denial of the appellants' claim against the county for $1.63 billion sought on behalf of about 130,000 sewer system customers.
The $1.63 billion is the amount that Grigsby says sewer system ratepayers were overcharged due to the illegal issuance in 2002 and 2003 of the sewer warrants and related swaps, as the corruption that tainted it.
Blackburn found that a remedy can be fashioned on the issue of constitutional mootness because the ratemaking authority based on the court's oversight could be overturned, according to Whitlock.
As for the claim about equitable mootness, Blackburn found that the concept applies in Chapter 11 bankruptcy appeals but not to Chapter 9 cases, said Whitlock.
The judge said if equitable mootness applied in Jefferson County's case, the ruling would have sided with the ratepayers, he added.
"The court did not decide whether, in fact, the ratemaking authority in the bankruptcy plan is unconstitutional and did not decide whether to revoke that authority under the plan," Whitlock said. "It only decided that it has the power to decide those questions, and that the appeal is not dismissed as moot at this stage."
Grigsby said the courts decisions will give his clients a chance to argue that the county's warrants and related swaps, which were a primary basis for filing bankruptcy in the first place, were unconstitutional in part because the debt was not approved by voters.
In his interpretation of Tuesday's ruling, Grigsby said, Blackburn "expressly acknowledged our argument that the bankruptcy filing itself was in bad faith," and that will tie into complex arguments he plans to advance regarding the legality of the underlying sewer debt and warrants.
"We've got our work cut out for us," he said. "I think [the judge] understands that this is a very large consumer fraud case, and the ratepayers were clearly overcharged as a result of all the corruption."
Jefferson County filed for Chapter 9 bankruptcy in November 2011 citing a total of $4.1 billion in long-term debt. Of that amount, $3.2 billion was related to the sewer system.
U.S. Bankruptcy Judge Thomas Bennett confirmed the county's plan of adjustment on Nov. 22.
