Detroit: Eligibility and Pensions

Two big rulings in Detroit's Chapter 9 bankruptcy today:  first that Detroit is eligible for Chapter 9 and second that it may impair its pension obligations in bankruptcy.  Both rulings were delivered orally from the bench and transcripts aren't yet available, so it's hard to really parse them other than through selected quotations in the media. With that major caveat, here are my initial thoughts on each issue in turn:

(1) Eligibility.  The eligibility ruling was no surprise.  The issue seems to have turned on whether Detroit was truly insolvent and whether Detroit attempted to negotiate with its creditors in good faith prior to filing as required by statute for eligibility.  For municipal bankruptcies, insolvency is defined not as a balance sheet test, but as an ability to pay debts as they come due. That seemed a fairly easy part of the ruling. As for the good faith negotiation, the Bankruptcy Code allows, in the alternative, that the debtor "is unable to negotiate with creditors because such a negotiation is impracticable".  That appears to be the grounds on which Judge Rhodes found the good faith requirement satisfied (technically, it is an alternative to good faith).

As characterized by the NYTimes, Judge Rhodes's impracticability ruling was based on "the size of Detroit’s debts and problems" which made it impracticable to negotiate concessions from creditors, and Detroit's union creditors' reluctance to concede what they believed were rights guaranteed by the state constitution made it “impractical to negotiate with a stone wall".  

If fairly reported, this seems like a reasonable enough analysis, but I wonder if it proves too much. Doesn't this mean that basically any city with lots of debts and problems doesn't have to make a good faith to effort to negotiate because it can shelter in the "impracticability" alternative? Isn't that the case for most debtors (and for most municipalities in financial distress)?  If so, it would seem that the exception swallows the rule. Shouldn't impracticability have to rest on some other characteristic, such as a time window for negotiations that is too short for negotiations to actually occur?  Impracticability surely can't mean the same thing as "it's tough" or "it's complicated." And maybe that's not what Judge Rhodes means, but that's my impression from the reporting.  I suspect it will be hard to get this ruling overturned on appeal.  I also suspect a lot will depend on the factual findings made by Judge Rhodes to support his conclusion, but at this point, I just don't know what those were. 

(2) Pensions.  Judge Rhodes also ruled that Detroit could impair its pension obligations. This is huge--it's a much bigger deal in general than eligilibity because this is the game for Detroit and for other cities that are watching in the wings. If Detroit can shed its pension obligations in bankruptcy, then bankruptcy enables municipalities to slough off decades of promises made to their employees. It also gives municipalities a lot more bargaining leverage outside of bankruptcy.  Chicago has already been (arguably illegally) squeezing its municipal retirees on healthcare benefits now that a settlement has lapsed.  Some municipal retirees saw their health insurance contributions rise 50% this past year, and more cost increases are on the way next way. The Detroit ruling is only going to embolden Rahm Emanuel. 

Judge Rhodes noted that “Pension benefits are a contractual right and are not entitled to any heightened protection in a municipal bankruptcy".  Well, yes, that's true, generically, but there's an added twist in this case: the Michigan state constitution prohibits the impairment of those pension benefits. The question, then, is what, if any, effect this state constitutional provision has in bankruptcy. One view is that the Supremacy Clause of the federal Constitution answers the question--to the extent state law conflicts with federal, it must yield.  Arguably there is a conflict between the state constitutional provision and Section 901 of the Bankruptcy Code, which incorporates into Chapter 9 section 1123(b) of the Bankruptcy Code, which authorizes a bankruptcy plan to "impair or leave unimpaired any class of claims..." and this provision is subject to section 1123(a), which requires designation of classes of claims and specification of their treatment, "[n]otwithstanding any otherwise applicable nonbankruptcy law".  If so, the state constitution doesn't affect bankruptcy. It might be interpreted, however, as making the State of Michigan a guarantor of all public pensions. Probably not what the state government wants. 

On the other hand, Article 9 can be understood as being the result of a the federal and state governments bargaining as co-equal sovereigns and a rare example of where the Supremacy Clause does not apply. If this view is correct (and I think there's historical support for it--we'll see if the article ever gets finished), then it makes sense to permit states to condition Chapter 9 bankruptcy. Given that states are allowed to control whether municipalities can file for Chapter 9 in the first place, it would be strange if they could prohibit a filing, but not condition it--the greater should include the lesser. 

None of this is going to get resolved in a blog post, but this is the sort of argument that is likely to have much more traction with a court of appeals than with a bankruptcy court, which is going to be reluctant to trim its sails in deference to the theoretical peculiarities of federalism when it has a real debtor with real problems before it. All of which is to say is that the pension issue in particular is far from decided at this point. Judge Rhodes' opinion was simply the kickoff for a much bigger fight.