The Examiners: Richard A. Chesley on Municipal Distress

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

When Detroit tumbled into bankruptcy in July 2013, it became the largest municipality (by a factor of five) to seek protection under Chapter 9. Detroit’s issues were legendary and massive; urban and economic flight had reduced the population by nearly 70%, which had eviscerated property and income tax bases. With revenues declining by over $250 million, the city could not meet its expenses, despite drastic spending cuts, which had further destabilized Detroit. With this and the city’s $18 billion debt, Detroit was hopelessly insolvent.

The bleakness of Detroit’s financial situation was only matched by the likelihood of any success during the early days of the Chapter 9. Constitutional challenges and eligibility litigation consumed considerable time and resources, and this only portended the anticipated skirmishes between the myriad constituencies in the Detroit case over a vast array of issues, ranging from defaults under the swap contracts to retiree pension benefits to the availability of the city’s art collection to satisfy creditors. Yet despite these nearly insurmountable challenges (and still others that lie ahead), Detroit is on the verge of what many thought impossible.

How did this happen and what are the lessons learned? First and most critically, Detroit confirms that if properly managed, the Chapter 9 process works. Through the prudent use of a mediator and the economic reality that consensual agreements (while never perfect) are far better than years of uncertain and costly litigation, an increasing number of essential agreements with lenders, bondholders, unions and others have now been reached.

Second, no Chapter 9 will succeed absent the political will to push through difficult choices. Both Detroit and the state of Michigan with its recent support of the “grand bargain” have aptly demonstrated that will.

Finally, Detroit has reaffirmed that when confronted with challenges, stakeholders can craft breakthrough agreements. The recently announced hybrid pension plan and the philanthropic/public partnership will not only greatly pave the way for Detroit but have the ability to aid other municipalities as they struggle with similarly harsh economic realities in the future.

Richard A. Chesley is the co-chair of DLA Piper’s restructuring practice, focusing on bankruptcy transactions both in the United States and internationally. He is based in Chicago.