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Detroit Becomes Largest City to File For Bankruptcy; Fight Begins in State Court

Monday, July 22, 2013
DETROIT--Detroit July 18 became the largest city ever to file for protection under Chapter 9 of the U.S. Bankruptcy Code, as the city's emergency manager said he did not see any other way out of a 60-year-long decline In re City of Detroit, Bankr. E.D. Mich., No. 2:13-bk-53846, petition filed 7/18/13.

Meanwhile, unions and pension funds took the issue to state court, where a circuit judge July 19 found the bankruptcy filing to be in violation of the Michigan Constitution and ordered that it be withdrawn. Michigan Attorney General Bill Schuette (R) immediately appealed the matter to the Michigan Court of Appeals.

“The city is basically broke,” Gov. Rick Snyder (R), who appointed Kevyn Orr as emergency manager in March in a last-ditch attempt to stem the tide of declining revenues and rising debt and pension obligations, said at a press conference the two held at Wayne State University July 19. “This is the time to say, enough is enough.” Snyder July 18 approved Orr's recommendation that the city seek bankruptcy protection, and a petition was filed that same day.

“We're at the point where we simply can't kick the can down the road any further,” Orr said. The city has more than $18 billion in liabilities and has no way to meet its obligations, he said. The filing, he said, will give the city “breathing room” while it works to reach agreements with creditors. The city has reached an agreement in principle with a group of major banks--secured creditors--that frees up $180 million in casino revenue the city had owed, and talks with some other creditors are continuing, he said.


Challenge in State Court
The filing came as a group of unions and pension beneficiaries sought to fight it in Ingham County Circuit Court, on the grounds that the Michigan Constitution prohibits interference with public pensions (Gracie Webster v. Rick Snyder, Ingham Co. Cir. Ct., No. 13-734-CZ; Robbie Flowers v. Rick Snyder, Ingham Co. Cir. Ct., No. 13-729-CZ; General Retirement System of the City of Detroit v. Kevyn D. Orr, Ingham Co. Cir. Ct., No. 13-768-CZ; Mich. Ct. App. Case numbers unavailable, appeals filed 7/19/13).

Ingham County Judge Rosemarie Aquilina July 19 agreed and ordered Snyder to direct Orr to withdraw the bankruptcy petition, a finding that was “peculiar, to say the least,” Douglas Bernstein, a partner with Plunkett Cooney in Birmingham, Mich., told BNA. “I believe (Aquilina's) jurisdiction would have been divested as soon as bankruptcy was filed,” he said.

White House officials are “engaged in conversations about policy options and other ways that we can be of assistance to Detroit,” spokesman Jay Carney said at a briefing in Washington. Issues including insolvency are “something that local leaders and creditors are going to have to resolve,” he said, “but we will be partners in an effort to assist the city and the state as they move forward.”

Michigan Attorney General Bill Schuette (R) appealed Aquilina's orders to the Michigan Court of Appeals. “The trial court abused its discretion” by enjoining further action, as the bankruptcy filing automatically stayed all lower-court proceedings, Schuette said in his July 19 application for leave to appeal.

Orr said he tried to work out agreements with union and pension groups ahead of the filing, but “they decided to sue me,” he said. “I've got 18 months' time to do a lot of work,” he said. “We do not have time to run in place.”

Among documents filed with the bankruptcy court July 19 is a request from Orr that the court appoint a committee to represent city retirees in the bankruptcy process. Orr said he asked “some labor organizations” if they would take on that role, and “they said no.”

As of June 30, 2012, there were more than 23,500 city retirees, including more than 2,400 not yet receiving pension benefits, in addition to more than 9,700 active employees who expect benefits in the future, court documents show.


No Precedent
The issue of Michigan's constitution is just one of many that makes Detroit's case unique among the few municipal bankruptcy cases that have been filed, Bernstein said. None of them has been “on the scale of Detroit,” and “you really don't have much case law, so you don't have a lot of guidance out there,” he said. “We've been paying attention to what's been going on” in Stockton and Vallejo, Calif., and Jefferson County, Ala., “but none of the precedents which may be set in those cases are binding in a court here,” he said.

“Whether the state controls or federal bankruptcy law controls in the event the emergency manager is seeking to reduce the pensions certainly makes (the case) a high-profile matter with great implications,” Bernstein said. Likewise, the “treatment of bondholders has an impact upon municipal finance everywhere, especially in Michigan,” with talk that borrowing will be more difficult if the state gives the impression it “doesn't stand behind” its bonds, he said. “The money only goes so far,” and each side will claim it should get priority, he said.

The chief judge for the Sixth Circuit will assign a judge to the case, which may be heard in Detroit or elsewhere in the jurisdiction. The city must then prove that it is eligible to file for bankruptcy, with evidence that it is not only insolvent but has the authority to file and has made good-faith efforts to negotiate with creditors. All but the insolvency issue are likely to be contested, Bernstein said.

Michigan citizens may think the process will be as smooth as the bankruptcies of General Motors Co. and Chrysler Group LLC, which were accomplished in a matter of months with the backing of the U.S. government. “That's not going to happen here,” Bernstein said. Orr's hope that the matter is resolved by the end of his tenure is likely “wishful thinking,” he said.

Detroit's financial practices, such as the deferment of pension obligations, have been “at best, unorthodox,” Orr said. “I wish there had been a lot more outrage the past 10 or 20 years,” he said.


Detroit's bankruptcy petition is available at http://www.bloomberglaw.com/public/document/City_of_Detroit_Michigan_Docket_No_213bk53846_Bankr_ED_Mich_Jul_1. The Ingham County filings are at https://www.dropbox.com/sh/hxc77iql3renpkt/U-6a7aZlDt?n=112207733.

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