The City of Detroit filed a petition for Municipal bankruptcy protection under chapter 9 of the Bankruptcy Code on July 18, 2013.  Case No. 13-53846.   In a long anticipated decision, Bankruptcy Judge Steven Rhodes of the United States Bankruptcy Court for the Eastern District of Michigan held that the City of Detroit is eligible to be a debtor under chapter 9 of the federal bankruptcy code.  The following is a summary of the issues that the Court decided today.

Whether Chapter 9 of the Bankruptcy Code is Constitutional.

• Judge Rhodes held that the City Detroit is a “Municipality”.
• “The court concludes that it has the authority to determine the constitutionality of Chapter 9″ and the Emergency Manager Law.”
• “The popularity of a decision to appoint an emergency manager is not a matter of eligibility under federal bankruptcy laws.”
• Judge Rhodes rejected the creditors’ argument that Chapter 9 is unconstitutional because it gives permission to make cuts to public pension obligations.
• “The court concludes that Chapter 9 satisfies the uniformity requirement of the United States Constitution.”
• Outcome: “Chapter 9 bankruptcy is constitutional”.

Whether Michigan’s Emergency Manager Law is constitutional.

• The court stated: “There certainly was some credible evidence in support of the assertion” that the state Legislature attached a spending provision to the emergency manager law to prevent it from being overturned by referendum.
• Judge Rhodes stated that Gov. Rick Snyder did the right thing by refusing to attach a contingency to the city’s bankruptcy filing. “Any such contingency in the governor’s authorization letter and may have rendered the authorization itself invalid.”  (NOTE:  a reporter for the Detroit Free Press commented that this is a “Big win for the governor, who refused his own attorney’s advice. His attorney recommended attaching contingencies.”)
• Judge Rhodes stated that the City of Detroit meets the legal criteria of obtaining the state’s authorization to file bankruptcy.
• Outcome:  Michigan’s Emergency Manager Law is constitutional.

Whether bankruptcy law permits the City of Detroit to cut the pensions of public employees despite provisions in the Michigan Constitution that prohibit the government from doing anything to “impair”  or “diminish” pension rights.

• Judge Rhodes stated that the issue regarding the City’s ability to cut pension benefits is “ripe” for the court’s determination.
• “Resolving this issue now will likely expedite the resolution of this bankruptcy case.”
• “There is no functional difference or meaning between ‘impair’ — or ‘impair and diminish.”
• Judge Rhodes stated that the Michigan Constitution protects pension rights as a “contractual rights,” but bankruptcy law allows a debtor to impair contract rights.  “Moreover, where — as here — the state consents, that impairment does not violate the 10th amendment of the U.S. Constitution.”
• Outcome:  The court will allow the City of Detroit to present a bankruptcy plan of reorganization that proposes to cut pension obligations to public employees.
• However…. Judge Rhodes warned the City of Detroit that just because pension rights can be impaired, that does not mean his Court will approve a plan with steep cuts.  Judge Rhodes essentially said pensions can legally be cut in bankruptcy — but that he won’t approve pension cuts unless the entire plan of adjustment is fair and equitable.

Whether the City of Detroit is or was insolvent at the time it filed Chapter 9.

Judge Rhodes held the following:

• “The court finds that the city was generally not paying its debts as they became due.”
• “The testimony of Chief Craig (Detroit Police Chief) established that the city is in a state of “service delivery insolvency.”
• “Sales of city assets … would not address the long-term [issues of the city].”.
• Of rumors that the Emergency Manager may sell asset of the Detroit Institute of Arts (DIA):  “One-time infusions of cash won’t fix things and “The enterprise must take extreme care that the asset is truly unnecessary in carrying out its mission.”
• Judge Rhodes stated that witnesses for the City of Detroit proved that a sale of assets would not have solved the financial crisis, only delayed it.
• Outcome:  “The court finds that the city does desire to effect a plan” to reduce its debts(This is one of the key requirements of Chapter 9 bankruptcy)… The court finds that the city of Detroit was and is insolvent.”

Whether the City Negotiated with its creditors in Good Faith before filing Chapter 9?

• Newspaper reporters for the Detroit Free Press commented that from the perspective of a person in the courtroom, Judge Rhodes was not impressed with the City’s negotiations.
• Judge Rhodes stated of the City’s take it or leave it offer to creditors prior to filing for bankruptcy protections:  “Charitably stated, the proposal is very summary in nature… the creditors cannot be faulted for failing to offer counter proposals when they did not have enough information to evaluate the city’s initial vague proposal.” Allowing only a month to negotiate was not enough. “This calendar was very tight and did not request counter proposals… that amount of time is simply far to short that such a vague proposal of creditors.”
• Outcome:  The City of Detroit did not negotiate in good faith with its creditors before filing bankruptcy.

Whether the City filed the Chapter 9 Bankruptcy in Good Faith?

Judge Rhodes specifically acknowledged several of the Creditors’ arguments that the City’s bankruptcy filing was not done in good faith in his decision:

• “The City of Detroit’s bankruptcy was the intended consequence of a long-term strategic plan,”
• Judge Rhodes recited what he calls the creditors’ “composite narrative” — that the bankruptcy was fixed.
• Judge Rhodes acknowledged the argument that Detroit’s bankruptcy was a “foregone conclusion.”
• Judge Rhodes also acknowledged the argument that the state government was “starving the city of cash” to trigger the bankruptcy.
• Ultimately, Judge Rhodes stated:  “In some particulars, the record does support the objectors view” … but it’s not enough…Certainly the court must conclude that the bankruptcy filing was a foregone conclusion, at least in 2013.”
• Judge Rhodes determined that negotiating in good faith was “impracticable” and stated that “The totality of the circumstances” shows the city filed for bankruptcy in good faith.
• Outcome:  “[The court] finds that this case was filed in good faith and should not be dismissed.”

Regarding Appeals of his decision:

• Judge Rhodes says he will not issue a stay on the bankruptcy, meaning the case will proceed even if creditors file appeals.
• Appeals of bankruptcy decisions are usually made to the U.S. District Court for Eastern Michigan in Detroit, however creditors may wish to skip an appeal to the District Court and the law does allow an appellant to request a direct appeal to the next higher Court, the 6thCircuit Court of Appeals in Cincinnati, Ohio.
• Judge Rhodes held that any creditor or objector who wished to appeal directly to the 6th Circuit must file separate motions.
• The Free Press reported that the hearing concluded at about 11:34 a.m. and attorneys for the labor union, AFSCME,  wasted no time in filing its Notice of Appeal.   Court records show that AFSCME filed the first appeal this morning at 11:36:20 a.m.

If you have contracts with the City of Detroit or any city that has filed for bankruptcy protection, you undoubtedly will have questions regarding how the City’s bankruptcy case will impact you.  We strongly recommend that vendors and contractors contact a Bankruptcy attorney before making any decisions regarding their performance under their contracts with the City of Detroit or any municipality that has filed a Chapter 9 case.

To learn more, please schedule an initial consultation at the Bloomfield Hills law firm of Resnick Law, P.C., by calling 248-642-5400 or contact us online.  Our attorneys will explain the Chapter 9 Bankruptcy process, what the municipality can and cannot do and what other options might be available for you.  We can help you understand the Chapter 9 legal process, and assess the status of your current contracts and your ability to receive payment for amounts due on completed contracts.  You choose the course of action. We will provide the services and representation needed to achieve your goals. Contact us now via our online form or call 248-642-5400.