Federal Judge OK’s Detroit Bankruptcy

Union pensions could be slashed.

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The Fiscal Times
December 3, 2013

A federal judge ruled on Tuesday that Detroit can proceed with the largest municipal bankruptcy proceeding in history.

Steven Rhodes, the bankruptcy court judge, overrode vigorous opposition from union lawyers representing city employees and retirees who argued that state-appointed emergency manager Kevyn Orr didn’t do enough before filing for Chapter 9 protection to persuade creditors to negotiate a settlement.

“This once proud and prosperous city cannot pay its debts. It is insolvent. It’s eligible for bankruptcy,” Judge Rhodes said. “But it also has an opportunity for a fresh start.”

Related: Detroit’s 60-year Decline into Bankruptcy Hell

In order to prove that Detroit was eligible for bankruptcy protection, Orr and his lawyers had to show that the city was insolvent, that the state of Michigan approved of the bankruptcy application, and that city officials had negotiated “in good faith” with creditors before concluding that compromise was “impractical.”

Orr had no problem proving the city’s insolvency or that Republican Gov. Rick Snyder – who handpicked Orr for the job – had authorized the filing. But proving that Orr had bargained in “good faith” with bond holders and creditors before filing his petition in July proved more challenging.

Allowing only a month to negotiate was not enough, Rhodes said. "This calendar was very tight and did not request counter proposals," he noted. Still, he sided with Orr and the city in concluding that negotiating in good faith with the mass of city creditors was "impracticable,” and that “the totality of the circumstances" shows the city filed for bankruptcy in good faith.

Arguably the most contentious issue is the fate of the city’s pension program. Rhodes said today that pensions can legally be cut in a bankruptcy proceeding. But he added that he won't approve pension cuts unless the entire plan of adjustment is fair and equitable.

Lawyers for the unions also argued that Orr’s thinly veiled intentions to slash the pensions of 23,500 retirees would violate a provision of the Michigan state constitution. The judge’s ruling that pension programs are fair game in a bankruptcy proceeding may set a precedent for other cities and states struggling with massive unfunded pension liabilities.

Related: Detroit Bankruptcy Is Big Red Flag for Other Cities   

As a preamble to his ruling, Rhodes spent nearly 20 minutes reviewing Detroit’s tragic 60-year slide into bankruptcy, government dysfunction, declining population, rampant crime and one of the highest unemployment rates in the country.

“The City of Detroit was once a hard-working, diverse, vital city --  the home of the automobile industry and proud of its nickname the Motor city,” Rhodes said in the federal courtroom in downtown Detroit. “The city needs help.”

With a national spotlight on the case, Rhodes repeatedly admonished lawyers from both sides throughout the trial that every day they spent squabbling in court was another day that Detroiters were forced to live with a crippled city government, inferior city services, urban blight and an uncertain financial future.

Orr, appointed by Republican Gov. Rick Snyder last March to take charge of the city’s operations and finances, was not in the courtroom for Rhode’s ruling, according to The Detroit Free Press. With the legal challenge now at least temporarily out of the way, Orr will submit a “plan of adjustment” by Dec. 31 to cut its debt and restructure operations.

 Related -- Mismanaged State Pensions Bill Taxpayers for Shortfall   

It may have seemed inconceivable that Rhodes would rule against Detroit’s Chapter 9 bankruptcy petition when the city is saddled with an astounding $18 billion of short-term and long-term debt. But when the judge raised just enough tough questions about the city’s petition for relief during a nine-day hearing last month, he left Orr and other city officials uneasy about whether the case would be allowed to proceed.

“I frankly shudder to think” what would happen if the judge turns down the city’s petition and leaves it to fend for itself without immediate borrowing authority and a mounting operating deficit, Orr said on a Detroit Public Television program recently.

Motown needs the Chapter 9 protection to prevent 100,000 or more nervous creditors from coming after the city for payments before officials have time to work out a major restructuring of the city’s debt. Rhodes’ ruling now sets the stage for a bitter battle over pension reductions, the potential sale of assets including some of Detroit’s most valuable pieces of art, and proposed cuts to financial creditors.

Related: Will a Desperate Detroit Make a Huge Mistake?

Orr filed the petition last July. His goal was to seek simultaneously federal court protection from creditors while freeing up enough money to begin addressing Detroit’s dysfunctional city services, mediocre schools, high crime rate and widespread blight and abandoned buildings.

The petition was opposed by labor unions and city employees and retirees, who insisted that Orr  could have done a lot more before filing for bankruptcy to persuade banks and other creditors to take a haircut.

In early July, Orr took about 25 bankers on a tour of Detroit’s hardest-hit areas, to try to drum up support for a restructuring of the debt. “If they can see what it’s like for Detroiters, what they endure every day in this city, I think they’ll begin to understand what’s at stake,” he said at the time. But his pitch fell on deaf ears.

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Washington Editor and D.C. Bureau Chief Eric Pianin is a veteran journalist who has covered the federal government, congressional budget and tax issues, and national politics. He spent over 25 years at The Washington Post.