Legal Challenge Over $14 Billion in State Debt Is Sidelined For Now

The head of a conservative Illinois think tank is vowing to appeal after a judge rejected his attempt to challenge the legality of about $14 billion of outstanding state bond debt and to block further state payments on the bonds.

John Tillman, CEO of the Illinois Policy Institute, filed a petition in Sangamon County Circuit Court in July asking the court to allow for a “taxpayer complaint” lawsuit over two bond issues to proceed. Warlander Asset Management, a New York-based hedge fund that says it owns about $25 million in Illinois general obligation bonds, signed onto the petition as well.

"I strongly disagree with the court’s decision, will appeal and am confident that I will prevail,” Tillman said in an emailed statement on Friday. Tillman mounted the case in his capacity as an individual state taxpayer, not as an initiative of the Illinois Policy Institute.

Judge Jack Davis in a ruling issued on Thursday denied the petition requesting that the lawsuit be allowed to move ahead. In doing so, he said the proposed complaint read more like a “political stump speech” than a legal pleading.

“The court finds that to allow the filing of the Complaint would result in an unjustified interference with the application of public funds,” Davis wrote in a four-page order.

Gov. J.B. Pritzker, a Democrat in the first year of his term, has derided the case as politically motivated and Illinois Comptroller Susana Mendoza described it as “ridiculous.”

The state argued before the court that the proposed lawsuit rested on an “erroneous premise” that the General Assembly can only incur debt for “projects in the nature of capital improvements,” with narrow exceptions to that rule.

“Fused with this incorrect statement of law is a policy paper masquerading as a complaint, positing that Illinois has not been wise in its fiscal decisions,” the state added in a court filing.

While the lawsuit was seen as a long shot in many quarters, it drew attention within the municipal finance community given the possible precedents it could set if it advanced.

Ted Hampton, vice president and senior credit officer with Moody’s Investors Service, said in a statement that the judge’s ruling was positive for Illinois and in line with the ratings agency’s view that the plaintiffs’ arguments lacked merit. 

But he added that “an appeal by the plaintiffs could still complicate the state’s near-term debt issuance plans.”

Illinois for years now has been grappling with budget shortfalls, badly underfunded pensions, and among states has some of the worst-off finances in the nation. 

The proposed complaint from Tillman and Warlander argued that $10 billion of pension funding bonds issued in 2003 and $6 billion of “income tax proceed bonds” issued in 2017 violated a section of the state constitution requiring debt to be issued for a “specific purpose.”

These bond proceeds, they said, were used for deficit financing and to effectively make a loan to the state’s pension system to be used for speculative investments—uses, they argued, that are outside the bounds of the debt restrictions imposed by the state’s constitution. 

About $14 billion of the debt is still outstanding. Tillman and Warlander wanted the court to prohibit the state from making further payments to service the bonds.

Judge Davis wrote that allowing the case to proceed would require the court to address “a non-justiciable political question and substitute its judgment for the Illinois Legislature.”

“To do so would be improper and would violate the separation of powers,” Davis added. “The court rejects Tillman’s invitation to do so.”

Tillman said he disagreed with the court’s conclusion that whether general obligation bonds have a specific purpose is a purely political question. “The Illinois Supreme Court has ruled that the judiciary is in fact required to determine whether a challenged purpose is specific or not, and has done so on other occasions,” he said.

Two investment firms, Nuveen Asset Management and AllianceBernstein, filed a court brief in support of the state earlier this month. In it the companies said they together held a principal sum of $2 billion in Illinois general obligation bonds and upwards of $600 million of the challenged debt.

Warlander had made a case that payments on the challenged debt threatened to harm the $25 million of bonds it held. But Nuveen and AllianceBernstein raised concerns over the possibility Warlander held “credit default swaps” that would pay off if the case involving the bonds caused Illinois to default on its debts.

“Permitting activist investors to litigate against the validity of widely held municipal bonds based on their credit default swap bets could introduce a significant destabilizing force into the municipal markets and harm investors and government entities,” the companies warned. 

Illinois this week released its financial report for the fiscal year that ended on June 30, 2018. It showed that the state reduced its general fund deficit to $7.7 billion, from $14.6 billion in fiscal 2017, largely through refinancing high-interest debt, according to Mendoza’s office.

Between fiscal 2009 and 2018, the state had general fund deficits every year, which ranged from $6.6 billion to the roughly $14 billion shortfall in 2017. Illinois continues to face a massive pension funding gap as well, with the report showing a net liability of $133 billion.