BRADENTON, Fla. – A small Kentucky city chose to file for bankruptcy rather than accept a mediated settlement that cut a big legal debt by 60%.
Hillview's strategy gets its first big test next week in bankruptcy court.
After losing a decade-long legal battle for which the city now faces a $15 million liability, Hillview rejected a mediator's recommendation to settle the debt for $6 million by issuing $5 million of bonds and paying another $1 million from a malpractice claim the city hopes to obtain against its former attorney.
Truck America Training LLC, which won the judgment in a breach of contract suit, said it would "reluctantly" accept the settlement, according to court documents filed in advance of an evidentiary hearing next week.
"We cannot borrow $5 million, and run the city, and pay those bonds," Hillview Mayor Jim Eadens said in a deposition.
Hillview, a city of 9,000 near Louisville, said in its statement of eligibility for bankruptcy that it can pay bills in the normal course of business but not the judgment. The city has also said that it negotiated with the company and was unable to reach an acceptable settlement.
U.S. Bankruptcy Judge Alan C. Stout will determine if Hillview's circumstances make it eligible for relief under Chapter 9 of the bankruptcy code following a hearing Dec. 9 and Dec. 10.
The city's solvency will be at the heart of next week's hearing, said bankruptcy attorney Michael Sweet, a partner at Fox Rothschild LLP who is not involved in Hillview's case.
"I do think that solvency is a question," Sweet said in an interview with The Bond Buyer. "It's going to be a battle of experts."
Solvency was a major issue in Vallejo, Calif.'s 2008 bankruptcy, he said, adding that Vallejo is a much bigger city with a much bigger budget than Hillview's. It was found to be insolvent.
In addition to city officials, Hillview has notified the court that its main witness next week will be Arthur J. Henson, the city's auditor with Henson & Associates.
Henson gave Hillview's 2014 audit a going concern opinion, citing the initial $11.4 million judgment plus interest accruing at 12% annually. "This amount exceeds the city's capacity to pay," the auditor said. "This condition raises substantial doubt about its ability to continue as a going concern."
Sweet said that Truck America has argued that the city can "raid taxes" to pay the judgment, and that the city does not intend to affect a plan of adjustment, because it only plans to restructure the debt of one creditor.
"I would say that goes towards good faith," said Sweet, who added that court documents indicate that the city has tried to resolve the debt. "It's not like they one day decided to file bankruptcy. They didn't make this decision lightly."
Next week's hearing will give the city an opportunity to explain how it got to this point, and what has been considered, including whether to raise taxes, he said.
"I think that beats the good faith argument," Sweet said, adding that the insolvency argument could still be an issue.
Truck America, which sued the city in 2005 for breach of contract over 40 acres of land, filed the only objection to the city's bankruptcy petition.
The company's objections will also be heard next week, including its claim that Hillview has not negotiated in good faith to settle the March 2006 jury award for $11.4 million.
Since that time, the amount has grown to $15 million with interest.
In the city's statement of eligibility for bankruptcy, Hillview said it "engaged in extensive settlement negotiations and discussions" with the company since March 2015.
Hillview made four offers to settle the judgment ranging from a low of $10,000 plus title to the disputed land, to a high of $2 million and assignment of an unrealized malpractice claim for $1 million, according to a recent court document in which Hillview and Truck America agreed to certain facts.
Truck America's settlement offers ranged from complete payment on the judgment plus the land, to a low of $6 million recommended this past April by the mediator, retired U.S. Bankruptcy Judge Steven Rhodes who presided in Detroit's Chapter 9 case.
Seven days after the mediation, Hillview rejected the proposal and stated that the debt service on a 25-year, $5 million bond issuance would be "prohibitive."
"There's no way [Rhodes] can know everything with how this city operates, and what we can pay, and what we cannot pay in two days," Eadens said in a deposition last month when asked if the mediator thought the city could afford to pay debt service on a $5 million bond.
Hillview's second-largest creditors are bondholders.
The city owes $1.39 million on outstanding general obligation bonds, and $1.78 million on GO bonds as part of a pool bond issued by the Kentucky Bond Corp.
City attorney Tammy Baker has told The Bond Buyer there are no plans to restructure bond payments in the bankruptcy.
In addition to the bankruptcy case, city officials are considering whether to take legal action against their former attorney who represented them as the suit with Truck America proceeded.
"I don't know if it was much as bad legal advice…or if he just didn't do everything he could have done to represent us, maybe," the mayor said when asked about it during last month's deposition.
The city has been told that its claim may be worth as much as $1 million, and at one time the amount was considered as a possible source of funds to pay a portion of Truck America's judgment.
It was later determined that the claim – if successful – could not be assigned to the company.
Eadens said the city is continuing to investigate whether to file a malpractice claim.
