The Examiners: Sharon Levine on Municipal Distress

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

Chapter 9 can be devastating for public sector workers and retirees. Unlike single-employer private pension funds that are backstopped by the federally provided insurance through the Pension Benefit Guaranty Corp., or multi-employer pension funds that protect retirees even if one of the employers withdraws, participants in public retirement systems lack any protection or safety net in the face of pension cuts. Some current or former municipal employees gave up Social Security benefits for a higher promised pension benefit. Many retired municipal employees rely exclusively on these now at-risk pension benefits, essentially deferred wages and foregone current benefits. If an employee or former employee loses benefits after or close to retirement, these individuals are often not in a position to re-enter the job market or otherwise make up this lost income.

Municipalities considering Chapter 9 as a tool to remedy financial difficulties need to consider whether Chapter 9 unconstitutionally shields elected officials from accountability for reducing pensions and other benefits by allowing elected officials to defer to the bankruptcy process as opposed to “owning” these difficult decisions. In Detroit, the city was allowed to take advantage of Chapter 9 without first establishing that it engaged in good faith negotiations with creditors, including retirees, prior to seeking Chapter 9 protection. Despite a direct requirement in the Bankruptcy Code for good-faith negotiations before a Chapter 9 filing, Detroit argued that it should be excused from this obligation as negotiations were impracticable due to the large number of creditors. So, while Chapter 9 may provide a fresh start to redevelop cities like Detroit, a collateral effect could be that elected officials find they can use Chapter 9 to cut claims, pensions and other benefits and obligations without directly confronting their constituents or trying first to solve these difficult fiscal issues through negotiations.

Sharon Levine is vice chair of Lowenstein Sandler LLP’s national bankruptcy, financial reorganization and creditors’ rights practice. She is representing the American Federation of State, County and Municipal Employees union in the Detroit Chapter 9 case.