An [Attempted] Understanding of Detroit’s Bankruptcy

The abandoned

Michigan Central Station. Detroit, Michigan.

Understanding Detroit’s bankruptcy is hard. In fact, I’m not sure if being from the area makes it harder or easier to understand. There are a lot of unanswered social, economic, and political questions swirling around the City’s insolvency and they are all difficult.

Then there are the legal questions.

Last Monday, Judge Steven Rhodes ordered that initial oral arguments in the case begin on September 18. The first issue will be whether Detroit is actually eligible for bankruptcy. This argument will center on whether Detroit is insolvent, whether the city negotiated in good faith with its creditors, and whether negotiations are even possible with so many creditors.

The most heated issue, which will be decided after the eligibility determination, will undoubtedly be whether current and former Detroit employees will be treated differently or given priority as creditors of the City.

To make things even more complicated, there are a number of unsettled issues of law, exacerbated by differences at the State and Federal level, that govern this area. I want to try and give a 10,000 foot view of the legal argument on both sides.

Chapter 9

Like most legal issues, we can start with the statute. The US Bankruptcy Code allows for a number of different flavors of bankruptcy (Chapters 7, 11, 12, and 13 are the ones most commonly covered in law school – yes, Chapter 12, farm-ruptcy). A city, however, can only file for bankruptcy under Chapter 9 of the Code if a state allows the city to do so. Only about half the states allow their municipalities to seek Chapter 9 protection and these protections are often limited. In Oregon, for example, only irrigation and drainage districts can file for bankruptcy.

Here in Pure Michigan, statutes authorize the appointment of an emergency manager who can restructure (read: terminate) contracts with city employees in attempt to fix a municipality’s financial issues. The EM essentially displaces the city’s government and then is charged with trying to fix the city in 45 days. When this fails, as it did in our case, the EM can ask the governor to authorize a bankruptcy.

The Issue

The real legal issues arise when states attempt to adjust pension plans for current and former state employees, i.e. creditors. Even in the extraordinary context of a muni-bankruptcy, the legal authority to alter pensions is precarious.

At the heart of the issue lies one question: How can Federal bankruptcy law, which advocates for the equal treatment of creditors, be reconciled with Michigan’s law, which treats current and former city employees’ pensions as untouchable?

The Federal Argument

The Federalist argument generally rests on two points of authority. First, the U.S. Constitution (Article I, Section 8, Clause 4) states that “[t]he Congress shall have Power . . . To establish uniform rules of naturalization, and uniform laws on the subject of bankruptcies throughout the United States.”

Now add Chapter 9: “The court, on request of the proponent of the plan, shall confirm the plan notwithstanding the requirements of such paragraph if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.”

Thus, under Chapter 9, Congress has chosen to require the equal treatment of creditors, including retirees. In other words, no special treatment for current and former Detroit employees.

The State Argument

On the other hand, retirees (and States’ Rights proponents) can find constitutional firepower in the 10th Amendment: “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”

Mix that in with Michigan’s Constitution (Article IX, Section 24), and you have some persuasive law to tell Kevin Orr to keep his hands off your pension: “The accrued financial benefits of each pension plan and retirement system of the state and its political subdivision shall be a contractual obligation thereof which shall not be diminished or impaired thereby. Financial benefits arising on account of service rendered in each fiscal year shall be funded during that year and such funding shall not be used for financing unfunded accrued liabilities.”

This argument, which will likely represent approximately 23,500 retirees, advocates for retirees to be treated as a separate class of creditors who will receive special protections throughout the bankruptcy process.

* * *

I have no idea which side has the legal or moral high-ground in this fight. I do know that there are going to be some winners and some losers and some people who are and will continue to truly suffer from this crisis.

I’d also like to admit that I am really trying to wrap my head around the legal issues revolving around Detroit’s bankruptcy. If I missed something or inaccurately stated something, please feel free to correct me. This is my way of trying to understand the issues that are affecting my home, but I am by no means an expert.

However, I think that it is important that we all take a close, legal look at what is happening in Detroit:

Pay close attention because it may be coming to you soon, Los Angeles, Baltimore, Chicago, Philadelphia. In 2011, Moody’s calculated the unfunded liabilities for Illinois’ three largest state-run pension plans to be $133 billion. (It is expected to be even larger this year.) That’s the size of six Detroit bankruptcies — give or take a few hundred million.

See Charlie LeDuff: Detroit’s bankruptcy and what it means for America.

Regardless of what happens here, or anywhere else, I think there is a sense of opportunity and future in Detroit. And maybe, depending on the legality of it, “a clean balance sheet.

RT Photography (rtphoto.smugmug.com) via http://counterpoint22.wordpress.com

RT Photography (rtphoto.smugmug.com) via http://counterpoint22.wordpress.com

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