Should Your Town Welcome Its First Czar? Receiverships in a State of Emergency

A haircut still looks a lot better than a beheading.” — Robert G. Flanders Jr., state-appointed receiver of Central Falls, Rhode Island Judicial receivers may be the greatest concentration of political power seen since the Royal Crown. Few appointments offer a court more control over the daily lives of citizens or management, and yet, not many people know or fully understand what a receiver does. Even in law, receiverships are often referred to as “smoke-filled rooms” or the Wild West of litigation. And for good reason: the job fluctuates from state to state and goes by many different names (in Michigan, they’re known as emergency managers; in some federal cases, special masters; and in the popular imagination, dictators or czars). Unlike bankruptcy proceedings, which are constrained by a robust body of federal law, receiverships have no uniform set of rules, a characteristic often advertised as a win-win by law firms. Greater flexibility! they say. Free customization! Fits like a glove! These may all in fact be advantages to receivership, but those who have actually lived through one often describe it as a bizarre, out-of-body experience. “An emergency manager is like a man coming into your house,” said Donald Watkins, a Pontiac city councilman whose city was placed under state receivership in 2009. “He takes your checkbook, he takes your credit cards, he lives in your house and he sleeps in your bed with your wife.” And as for the deed? “He tells you it’s still your house, but he doesn’t clean up, sells off everything, and then he packs his bag and leaves.” Receiverships, while rare, tend to become more popular during times of financial crisis. In the last recession, municipal receiverships in particular witnessed a renaissance, becoming the preferred solution for some states when they just needed to “get things done.” Many expect the same from Covid-stressed governments: there’s nothing like a state-of-emergency to make way for an autocratic regime. For, as leaders have been saying since Machiavelli, “Never let a good crisis go to waste.”

Who Even Uses A Receiver? Will your town be among the first to welcome its next czar? Statistically, it’s unlikely, but it’s still worth knowing what triggers a receivership and who is most likely to experience one. Receivership has long been a part of insolvency law. The concept was first developed in England’s Court of Chancery to protect real estate assets from imminent damage or destruction. Colonialists reluctantly brought the practice overseas but were hesitant to use it since “one of the most common grievances in the colonies was the arbitrary and capricious behavior of Crown officials.” Nonetheless, receivership became an integral part of the American landscape thanks to their creative role in restructuring the railroads, as we’ve covered here. For the first time, receiverships were used to defend the public interest: courts recognized that the disappearance of a railroad track could crush small localities, and directed receivers “not to pay off the claims of creditors but to reorganize the insolvent company’s debts so that it could continue to serve the public under different management.” This strategy was so successful that it later became enshrined in bankruptcy code. Meanwhile, receiverships evolved to play an important role in municipal bond defaults and civic wrong doings: in the 1970s, after encountering continued opposition to Brown v. Board of Education, federal courts were forced to place entire school districts under receivership. Their usage is not evenly distributed by geography or industry. Receiverships are more likely to be deployed in Rust Belt states thanks to decades of industrial decline and population loss that have led to recurring municipal distress. In some heavily regulated industries, such as insurance and public banking, receiverships are the normal course of insolvency because their primary concern isn’t creditors: it’s the policy holders and depositors. One reason receiverships are generally cheaper is that they don’t have to deal with a creditor’s committee: once appointed, a receiver solely reports to the state. In other areas, creditors might turn to receivership because involuntary bankruptcy simply isn’t allowed or might trigger an unwelcome side-effect (for example, colleges would lose their Title IV funding). Churches, higher-ed, and, increasingly, the cannabis industry are ripe for receivership. Since marijuana is still considered an illegal good under federal law, cannabis companies can’t turn to bankruptcy protection in federal courts. Federal courts will not aid and abet criminals: state courts, on the other hand, are free to do as their state pleases, and in 2019, The Guild San Jose became the first marijuana business to sell its assets for $8.25 million through receivership. Receivership vs. Bankruptcy The main advantage of receivership is expediency. Unlike bankruptcy, which can be a long and painful process, and which tends to heavily involve (if not entrench) current management, receivership bypasses these time-sucking hurdles by simply taking an axe to them. Receivership effectively fires management and replaces them with a single, court elected official who is often given complete power over the company or locality. What are the powers of a receiver? They are many and varied. One receiver, Joe Harris, who was appointed as emergency manager of Benton Harbor, Michigan in 2011, provided a remarkable definition: “So, the fact of the matter is the city manager is now gone. I am the city manager. I replace the finance director. So, I’m the finance director and the city manager. I am the mayor and the commission, and I don’t need them.” Many receiverships have a remedial aspect to them: they are deployed in response to a bad actor or to a sequence of disobeyed orders. Most states view receivership as a method of last resort thanks to their tendency to incite public outrage when displacing management or elected officials. It also differs in intent from bankruptcy. Chapter 11 bankruptcies ostensibly begin with the intent to reorganize a company, even if only 1 in 8 companies actually succeed. Receiverships make no such lofty promises. With some exceptions, their singular goal is to maximize the returns of assets for the benefit of a secured creditor. A Receiver Comes To Pontiac No place knows receiverships like Michigan. The Northern state was blessed with rich deposits of iron and copper ore, not to mention numerous rail and water routes. Add to that mix the birth of Henry Ford, and Michigan became the natural center of the American auto-industry. “When we were affluent, we didn’t diversify,” said Pontiac city councilman Kermit Williams. “We married GM instead of dating around, and when the divorce happened, it was brutal.” In 2011, after decades of deindustrialization were further exacerbated by the Great Recession, Governor Rick Snyder and the Michigan Legislature passed Public Act 4, a measure which broke with older models of state receivership by allowing for the appointment of receivers without local consent and without emergency bailout funding. Under the new “financial martial law” legislation, the state of Michigan can conduct a financial review of any locality that has displayed symptoms of financial distress such as a poor long-term debt rating or a missed payment to a pension fund. Pontiac, Michigan, a city of 60,000, displayed many symptoms of financial distress. In 2009, its jobless rate reached 30 percent and the city’s projected deficit hit $12 million. In the wake of Public Act 4, Pontiac received its third consecutive emergency manager (the first two each resigned after a year), Lou Schimmel, who was equipped with new and improved powers. Mr. Schimmel, a native of Pontiac, immediately set about privatizing most city services, overhauling labor contracts, and putting nearly every city property, from City Hall to parking meters, up for sale. He reduced the city payroll from 600 workers to 50 public employees and outsourced the police force, fire department, garbage collection, animal control, and street maintenance. “It’s not really a city anymore,” said Steve Swift, a Pontiac resident. “There’s nothing left now.” Still, others felt that unitary power was necessary to prevent insolvency. Even Democratic Mayor Leon Jukowski, who was rendered a figurehead during the takeover, agreed with the tough measures. “People in my party say it’s union busting. To a certain extent, it is. The dilemma is, how do you send someone in and say, ‘I want you to fix this problem, but you can’t touch 80 percent of what’s under the hood?’” Rhode Island, another state that has adopted similar receivership legislation, gets even tougher. “Of course your contracts are being destroyed,” said Bob Flanders, state-appointed receiver in Central Falls. “That’s what it’s all about. If you’re a taxpayer, you probably want to nominate me for sainthood. If you’re a municipal worker, you probably think I’m the devil incarnate.” Regardless of your views, Mr. Schimmel’s severe buzz cut certainly had an effect: Pontiac’s annual spending was reduced from $57 million to $36 million and it erased nearly all of its long-term debt. And, Mr. Schimmel insists, he is not a czar. “The law I’m operating under was passed by a democracy. It wasn’t a law handed down by a king. It was passed by a legislature.” The Limitations of Autocracy Ironically, a tool that was once used for dismantling segregation is now accused by many of becoming a voting rights violation. One of the unfortunate aspects of municipal receivership is that it disproportionately targets poor, predominantly black cities. During the peak of emergency manager control in 2013, 51% of Michigan’s black population was under receivership (as opposed to 2.4% of its white population). The implication isn’t pretty. As one civil rights organization puts it, “Democracy, the governor seems to suggest, is something [poor and minority cities] can’t afford.” But what else can be expected of a bludgeoning tool known for its “unmatched coercive impact?” The results of a “don’t ask, just tell” regime, while timely and cost-effective, will likely always prove controversial. And there is an underlying assumption that the core problem lies with management. The clear message of these laws — you are incapable of self-governance, let us do it for you — offers a seductive, one-man solution: just clear through enough red tape, and the receiver’s tough guidance will lead us to recovery. Unfortunately, no management overhaul can change the fact that many of these places were a one-industry town that never moved past the automobile. Ordering a receiver to sweep through town paving streets of gold may be a satisfying fantasy, but it’s unlikely to achieve any major fiscal restructuring that would relieve the troubled area of long-term issues. And, ultimately, can any one person handle that kind of pressure? “I have a lot of respect for Lou,” said Douglas Jones, a pastor and civic leader in Pontiac. “I think he wants the best for the city of Pontiac, and his heart’s in the right place.” But, he admits, everyone needs some oversight. “I’ve still got to report to God,” said Jones. About Colbeck: Colbeck is a strategic lender that partners with companies during periods of transition, providing creative capital solutions to meet their evolving needs. You can reach the team at inquiries@colbeck.com.


Full story: https://medium.com/limited-liabilities-by-colbeck/should-your-town-welcome-its-first-czar-receiverships-in-a-state-of-emergency-87dd3f5c17ec