Dec. 12 --Judge Steven Rhodes' ruling that Detroit pensions are contractual obligations subject to modification in bankruptcy, notwithstanding a Michigan constitutional provision protecting them, may spur other municipalities with pension funding problems to resolve them sooner rather than later, attorneys watching the case said.
Rhodes' decision on pensions was part of a Dec. 3 ruling that found Detroit met all the necessary conditions to file for Chapter 9 bankruptcy protection, clearing the way for the city to file a debt reorganization plan (In re City of Detroit,Bankr. E.D. Mich., No. 13-53846, ruling announced 12/3/13).
“We have cases decided by the U.S. Supreme Court that have recognized that governments, for higher public purposes -- health, safety and welfare of a city -- can impair contracts,” James Spiotto, head of the special litigation, bankruptcy and workout group at Chapman and Cutler LLP in Chicago, told Bloomberg BNA Dec. 11.
“Also, as a practical matter, I think there's support for municipalities [changing pension terms] outside of bankruptcy for a higher public purpose,” Spiotto said. “It's not good for the workers, it's not good for the retirees, or anything else if you're crowding out essential government services in the funding of those, and when you do that, you end up with Detroit,” he said.
Rhodes' decision “points out the reality that you need to save the city for the sake of everyone, and points out clearly that in bankruptcy you can do this,” Spiotto said. “I think we're going to see more municipalities, hopefully working with the unions and the workers, say to workers, 'Look, we're going to pay you everything we can, but we're not going to sacrifice the future of the municipality,'” he said.
City retirees and workers are appealing the pension decision, and Rhodes has scheduled a Dec. 16 hearing to determine whether the case may be appealed directly to the Sixth Circuit Court of Appeals, bypassing federal district court. “There are no appellate court decisions in the municipal bankruptcy world,” Bernstein said. Because of that, there is a “tremendous risk to the party who loses,” he said. If an appeal fails, “then you've got a binding precedent,” he said. “It's a risk.”
States with constitutional pension-protection clauses had “better pay attention,” Bernstein said. “If there are issues with the funding level, that's something that should be addressed sooner rather than” later, he said. The ruling “gives them an indication it would be wise to be proactive rather than reactive,” he said.
Illinois is already doing that, with new legislation aimed at bringing the state's five public pension systems to full funding in 30 years and reducing long-term pension obligations by $160 billion. Los Angeles, Philadelphia and Oakland, Calif., are among other jurisdictions thought to have “heavily unfunded pension liabilities,” he said.
Rhodes is the first judge “to tackle the pension issue head on and come to this conclusion that it's a contract,” Bernstein said. While the decision is not binding on any other court, “Rhodes is a widely respected, long-tenured bankruptcy judge,” and in the absence of any other guidance, “you'll pay attention to what he has to say,” he said.
Detroit filed for Chapter 9 protection in July.
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