On July 18, 2013, the city of Detroit, Michigan declared bankruptcy. ((Monica Davey, Mary Williams Walsh, Billions in Debt, Detroit Tumbles Into Insolvency, N.Y. Times (July 18, 2013), available at http://www.nytimes.com/2013/07/19/us/detroit-files-for-bankruptcy.html ?pagewanted =all&_r=0)) The city’s debt stood at $18.5 billion, more than four times greater than any other municipal bankruptcy since the modern bankruptcy code was adopted by congress. ((Id.)) Despite the magnitude of the economic and social impacts of municipal bankruptcy, the topic is not diffusively understood. This two-part blog series will attempt to shed light on the municipal bankruptcy process and the legal mechanisms by which a municipality can default on its debt. In the first post ((link to first post)), I introduced the history of municipal bankruptcy provisions, their evolution to the current standard, and described how these provisions vary between states. In this current post, I will analyze Detroit’s bankruptcy proceeding and highlight important takeaways which may be indicative of how future municipal bankruptcies will play out.
Given the novelty and complexity of the Detroit bankruptcy, the case offers much precedential value in the areas of municipal bankruptcy and creditor lending contracts with public entity lendees. I will focus on what I think is the most important issue facing other financially distraught cities: how do public pension obligations impact a city administration’s ability to declare Chapter 9 bankruptcy?
Prior to the Detroit bankruptcy, no bankruptcy judge had addressed whether public employee pensions were protected from reassessment under Chapter 9 bankruptcy, or whether they were simply another form of contractual rights to be dealt with through bankruptcy. ((Monica Davey, Bill Vlasic, Mary Williams Walsh, Detroit Ruling on Bankruptcy Lifts Pension Protections, N.Y. Times (Dec. 3, 2013), available at http://www.nytimes.com/2013/12/04/us/detroit-bankruptcy-ruling.html?pagewanted=1&_r=0)) Further complicating the matter, the Michigan state constitution bars modification of public employee pensions through bankruptcy, while the federal Chapter 9 bankruptcy code does not. ((Id.)) Judge Rhodes, the bankruptcy judge handling the Detroit bankruptcy set a date for any party to file objections to the city’s eligibility for Chapter 9 bankruptcy, giving pension plans and other concerned organizations a chance to express their interests. Though these organizations were protesting the State of Michigan allowing Detroit to declare bankruptcy ((As explained in the first post, municipalities in Michigan cannot declare bankruptcy without state authorization.)), it’s likely their real concerns revolved around the impact the bankruptcy would have on the obligations owed by the city to the pensions. Additionally, Michigan Attorney General Schuette sided with pensioners, arguing that Detroit’s desire to diminish its retiree pension benefits through the bankruptcy process contravenes the state’s constitutional prohibition against impairment of vested obligations. ((Susan Kelly, Michigan Attorney General Back Pensioners in Detroit Bankruptcy, Reuters (Jul. 27, 2013), available at http://www.reuters.com/article/2013/07/27/us-usa-detroit-idUSBRE96Q0A220130727))
On December 3rd, 2013, Judge Rhodes issued his landmark ruling that public employee pensions could be impaired through chapter 9 bankruptcy. ((In re City of Detroit, Debtor Opinion Regarding Eligibility (Dec. 5, 2013) available at http://www.mieb.uscourts.gov/sites/default/files/detroit/docket1945.pdf)) He explained: “that the State of Michigan cannot legally provide for the adjustment of the pension debts of the City of Detroit. This is a direct result of the prohibition against the State of Michigan impairing contracts.” ((Id. at 73)). In other words, if the State of Michigan or the City of Detroit decided to deal with Detroit’s financial problems through state law, they would be barred from impairing the City’s contractual rights. Bankruptcy law, however, as a product of federal law, is not constrained by Michigan’s Constitution, and gives an outlet for financially strapped cities to impair their obligations just at it would other contractual obligations. Judge Rhodes said: “The state constitutional provisions prohibiting the impairment of contracts and pensions impose no constraint on the bankruptcy process.” ((Id. at 74))
Judge Rhodes’ finding reaches far beyond the boundaries of the State of Michigan. Large cities like Philadelphia, Chicago, and Los Angeles all have outsized public pension obligations that constrain their spending on other city services. ((Monica Davey, Bill Vlasic, Mary Williams Walsh, Detroit Ruling on Bankruptcy Lifts Pension Protections, N.Y. Times (Dec. 3, 2013), available at http://www.nytimes.com/2013/12/04/us/detroit-bankruptcy-ruling.html?pagewanted=1&_r=0)) In these politically and legally new waters, state officials must do their best to distribute the pain of financial impairment across all parties. Banks, state coffers, citizens, and pensioners are all dependent on having a financially sustainable future and should share in the burden of achieving that future. Hopefully Judge Rhodes’ authorization to impair public pension payments will be a method of fair apportionment of that burden.
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