The Examiners: Marshall Huebner on Municipal Distress

As Detroit nears a crucial point in its restructuring, what lessons does the city’s historic bankruptcy offer troubled municipalities?

Efforts by municipalities to execute consensual restructurings outside of bankruptcy invariably present difficult collective action problems. Dozens of differently situated parties must be part of the attempt to reach consensus, but counterparties are usually unwilling to make concessions unless they view it as their only option and they feel that other stakeholders are also making appropriate concessions.

This process has been playing out on a large scale in the Detroit restructuring. The so-called “grand bargain” pits two sets of parties against each other. On the one hand, Detroit’s pensioners and unions, if they accept the city’s plan of adjustment, will join with the state of Michigan and certain foundations that have pledged to provide support to the city’s pension systems in exchange for the preservation of the Detroit Institute of the Arts. On the other hand, certain financial creditors, including some large holders of “certificates of participation” and monoline insurers, strongly oppose the city’s plan because they view it as providing unequal treatment to similarly situated creditors.

Importantly, the grand bargain came together only after the city had filed for Chapter 9 and the debtor and supporting creditors could break various stalemates by threatening and using the powers of the Bankruptcy Code. This template—of substantial additional contributions from the state and other entities via a Chapter 9 plan—may make municipal out-of-court workouts less likely, as stakeholders may be more incentivized to hold out until analogous grand bargains—with outside funding—come together in the crucible of Chapter 9.

Marshall Huebner is a partner with Davis Polk & Wardwell LLP in New York and is co-head of the firm’s insolvency and restructuring group.