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Judge Says Detroit Eligible for Bankruptcy Filing, Pension Impairment Is Constitutional

Wednesday, December 4, 2013
By Nora Macaluso

Dec. 3 --The City of Detroit may go forward with its plan to restructure under Chapter 9 bankruptcy protection, the judge overseeing the proceeding said, as the city met all the criteria necessary for eligibility (In re City of Detroit, Bankr. E.D. Mich., No. 13-53846, opinion 12/13/13).

In an hour-long explanation of a written opinion he said spans more than 140 pages, Judge Steven Rhodes Dec. 3 said key arguments raised by objectors -- among them the contention that the bankruptcy filing violated various provisions of the Michigan and U.S. constitutions -- did not hold up.

“The U.S. Supreme Court has already decided the question of whether the federal municipal bankruptcy act can be administered with the principles of federalism reflected in the 10th Amendment” of the U.S. Constitution, Rhodes said. United States v. Bekins and subsequent decisions show the court believes Chapter 9 is not in violation of the Constitution, as long as a state consents to a bankruptcy filing, and Chapter 9 must be voluntary, he said.

Pension Rights as Contract Rights
As for the argument that Michigan's constitution prohibits the impairment of pension rights, Rhodes said a careful reading of the constitution finds it refers to pension rights as contract rights, which in bankruptcy are by nature impaired.

“It has long been understood that bankruptcy law entails impairment of contracts,” Rhodes said. “Nothing distinguishes pension debt in a municipal bankruptcy case from other debt.”

Michigan's pension-protection clause, inserted into the state constitution in 1963, refers to pension benefits as “contractual obligations,” Rhodes said. If the intent had been to give more weight to pension obligations than to other contractual obligations, he said, that would have been spelled out. Rhodes said he did not intend that interpretation “to mean that this court necessarily will confirm any plan of adjustment that impairs pensions.”

Rhodes said the contention that Public Act 436, the state's emergency manager law that authorizes the bankruptcy filing, was illegal because voters repealed a similar law, was valid because there is no statute forbidding the legislature from enacting a new law.

Negotiations Not Adequate, But Impractical
Rhodes said the argument that the city did not negotiate in good faith with creditors has some merit. A proposal made to creditors in June did not provide enough information to unions and others, making it difficult for them to respond with counterproposals, Rhodes said. “Charitably stated, the proposal is very summary in nature,” he said. In addition, confidentiality requirements placed on anyone wanting to view city data “created an unnecessary hurdle for creditors,” and the timeframe for counterproposals was “far too short,” he said.

Yet while the city did not establish that it satisfied the requirement for “good-faith negotiations” prior to the filing, it nevertheless met the requirement that it would be “impracticable” to negotiate with all creditors, since there are more than 100,000 of them, Rhodes said. “The size of the debt and the number of creditors made pre-bankruptcy negotiation impracticable, impossible really,” he said.

Rhodes also found the city's filing to be made in good faith, even if elements of the path to bankruptcy may be seen as viewed by state officials as a foregone conclusion. The city “could have, and should have, filed for bankruptcy before it did,” he said.

“The residents of the City of Detroit will be severely prejudiced if this case is dismissed,” Rhodes said. “This factor is of paramount importance in this case.” The city is insolvent, services are subpar and revenues are not keeping up with debts, he said. “The city did not have enough money to properly care for its residents, let alone pay its debt,” he said. The “wisdom of bankruptcy law” is the recognition that individuals, businesses and municipalities “can't print money” and need an opportunity for a “fresh start,” he said.

Rhodes previously set a March 1, 2014, deadline for the city to file a plan of reorganization. Emergency Manager Kevyn Orr said the city will file a plan of adjustment “in the coming weeks.” At a Dec. 3 press conference, Orr said he hoped creditors, including unions, would work with city officials and submit a consensual plan.

Appeals Coming
The largest union representing city workers and its retiree chapter immediately filed a notice of appeal. Michigan Council 25 of the American Federation of State, County & Municipal Employees and its retiree group said they will ask the U.S. District Court for the Eastern District of Michigan to review Rhodes' decision.

The city's police and fire retirees also said they intend to appeal the decision regarding pensions. “The pensions clause of the Michigan Constitution absolutely bars any attempt by the city to cut or impair accrued pensions, no matter the reason,” the boards of the General Retirement System of the City of Detroit and the Police and Fire Retirement System of the City of Detroit said in a joint statement.

Michigan Attorney General Bill Schuette (R) said that while he was pleased with Rhodes' decision to clear the bankruptcy to proceed, he was “deeply disappointed” with the judge's decision on pensions and will “continue to aggressively defend” pensions as the case proceeds. When a plan is ready to be confirmed, “we can thoroughly review any plans for potential legal action involving pensions,” he said in a statement.

The city filed for Chapter 9 protection in July.

To contact the reporter on this story: Nora Macaluso in Detroit at nmacaluso@bna.com

To contact the editor responsible for this story: Jay Horowitz at jhorowitz@bna.com

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