Judge Rules Detroit Eligible for Bankruptcy

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Detroit Michigan is the first major American city to declare bankruptcy. Image by AcrylicArtist

Detroit Michigan is the first major American city to declare bankruptcy. Image by AcrylicArtist

U.S. Bankruptcy Judge Steven Rhodes ruled on December 2, 2013, that the Michigan city has met the requirements to declare Chapter 9 bankruptcy. Not surprisingly, the American Federation of State, County, and Municipal Employees is appealing the decision.

From the bench, Rhodes said, “This once proud and prosperous city can’t pay its debts. It’s insolvent. It’s eligible for bankruptcy. At the same time, it also has an opportunity for a fresh start.”

Detroit’s Decline

In 1950, Detroit Michigan had a population of 1.8 million people. The 2010 census calculated the population at only 713,000. At its apex, after the Second World War, Detroit was a thriving city, home to the booming automobile sector. But with misspent money and people fleeing the city proper, Detroit was left with a low population and many vacant and decaying buildings. The recent recession exacerbated the situation as did the large costs of retirees’ pensions for which the city was liable.

The city filed for bankruptcy on July 18, 2013. A nine-day trial led to Rhodes’ 140-page ruling. At the time of the filing, Detroit’s debts were estimated to be between $18 and $20 billion. In July, the city was using 40 cents of every dollar of revenue to service the debt.

Chapter 9 Municipal Bankruptcy Law First Enacted in 1934

Legislation allowing municipalities to file for and go bankrupt was begun during the Great Depression. Usually it was small municipalities that have taken advantage of Chapter 9 of the Bankruptcy Code although in 1994, Orange County, California filed for bankruptcy. That filing involved millions of dollars in debt.

Detroit is the largest municipality in the United States ever to seek bankruptcy protection.

The purpose of the legislation is to allow municipalities to reorganize their finances by extending the time the debt matures, reducing principal and interest payments, or refinancing some of its debt.

In these ways, a municipal bankruptcy is similar to the bankruptcy procedures governing businesses under Chapter 11. But there is a crucial difference—a municipality cannot be forced to liquidate its assets to satisfy its debts. It is believed forcing a municipality to sell its debts would violate the Tenth Amendment regarding state sovereignty.

To be eligible to file for Chapter 9 protection a municipality must specifically be allowed to take on debt either by state law or a government officer. The municipality must also be insolvent and wish to adjust its debts.

A further requirement in filing Chapter 9 bankruptcy is that the creditors holding a majority of the debt must agree, or there must be good faith negotiations with these creditors. However, when it is impractical to conduct these negotiations, the filing can still be made.

Rhodes found there were too many creditors, in excess of 100,000, for Detroit to enter into negotiations with them.

The Effect of Detroit’s Bankruptcy

Many art lovers are worried Detroit’s art collection will be sold off to help lower the city’s debt, something the city said it might do. But hardest hit by the bankruptcy will be the city’s municipal workers and retirees who expect to receive pensions in the future or who are receiving them now. The anticipated proceedings will likely have to include reductions of these pensions.

Under Michigan’s state constitution, pensions are specifically protected. But in his decision, Judge Rhodes made it clear that pensions are fair game in bankruptcy protection. He wrote, “Pension benefits are contractual and are not entitled to any heightened protection in a municipal bankruptcy.”

There are approximately 23,000 retirees currently receiving pensions from the city. Pensions of current employees would also be affected.

American Federation of State, County, and Municipal Employees Files Appeal Against Judge Rhodes’ Decision

Immediately after the ruling was handed down, the American Federation of State, County, and Municipal Employees filed a notice of appeal. The appeal of the bankruptcy court’s decision will be heard by the U.S. Court of Appeals for the 6th Circuit in Cincinnati but Rhodes, at least initially, refused to take steps that would have the appeal heard quickly.

Detroit Bankruptcy Decision May Be Difficult to Overturn

The decision may be difficult to overturn. The law is straightforward and Rhodes’ decision was based largely on facts, heard during the nine-day hearing. Findings of fact made by a judge are more difficult to overturn than are errors of law.

Rhodes refused to stay his decision so Detroit can now undertake negotiations with its creditors. But it may be difficult to resolve these matters as what could be a lengthy appeal process that could end up in the Supreme Court, leaves everything in a state of flux.

As Detroit is the largest city to file for bankruptcy, it is expected the appeals will be watched closely by other American cities.

Resources:

United States Courts. Chapter 9, Municipal Bankruptcy. (2013). Accessed December 4, 2013.

Washington Post. Judge declares Detroit eligible for Chapter 9 bankruptcy. (2013). Accessed December 4, 2013.

New York Times. Detroit Ruling on Bankruptcy Lifts Pension Protections. (2013). Accessed December 4, 2013.

Reuters. Analysis: Detroit bankruptcy expected to survive appeals process. (2013). Accessed December 4, 2013.

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