7.22.13

How is a municipal bankruptcy different than a corporate bankruptcy?

The simplest answer is that in a corporate bankruptcy (chapter 11) is that the corporation immediately shuts down, the keys to all its assets , as it were, or to all the goods are simply handed over the bankruptcy court to divvy up amongst the creditors.  Not so for a municipality. In Detroit, for instance, the city’s largest corporations, General Motors and Chrysler, completed their chapter 11 bankruptcies in a mere 39 days. (It also helped that  in the case of these two Detroit-based corporations  the federal government stepped in with massive federal  bailout assistance. The federal government devoted some $24.9 billion of the $700 billion bank bailout fund, providing $17.4 billion for Chrysler, $1.5 billion for Chrysler Financial, and $6 billion for GMAC. In a chapter 9 municipal bankruptcy, the process can take years, as we have witnessed with Jefferson County.

Of course, an additional, critical, difference is that when a corporation files for bankruptcy, it may immediately cease doing business. That is not an option for a city or county. First, it may only seek such protection if a) it is authorized by state law, and b) can prove to a federal bankruptcy court that it is insolvent. But critically, a municipality must continue to provide essential services:

  • Shortly after filing for chapter 9 in the U.S. Bankruptcy Court, Detroit Emergency
  • Manager Kevyn Orr met with all city department heads and e-mailed nearly 10,000 of the city’s employees to  make sure they understood the city would operate without interruption to provide essential services. To the public, Mr. Orr stated: “We’re open for business.  Your garbage truck is going to come. Potholes are going to be filled  –hopefully better than the past.”
  • The single most critical purpose of municipal bankruptcy is to ensure that a municipality may provide uninterrupted, essential services.

What are the  intergovernmental differences and aspects? Will federal law or the state constitution prevail?

Unlike a corporate bankruptcy, a municipality may only file for federal chapter 9 bankruptcy protection if authorized by state law. Chapter 9, therefore, is a  federal statute that walks a federalism tightrope between the federal government and state laws.  How that tightrope works has been tested, to some extent, in Jefferson County, Alabama, where the City of Birmingham, brought suit to challenge the county’s petition for federal bankruptcy. A more critical intergovernmental challenge is happening now in both California and Michigan—where there are conflicts between provisions in the respective state constitutions versus the federal law. So, for instance, less than 24 hours after Detroit filed for federal bankruptcy protection with the U.S. Bankruptcy court in Michigan, Ingham County (Michigan) Judge Rosemarie Aquilina ruled that Michigan Governor Rick Snyder had violated the Michigan constitution (Section 24 of Article IX of the Michigan constitution provides that the “financial benefits of each pension plan and retirement system of the state and its political subdivisions…shall not be diminished.”) and ordered that Mr. Orr “immediately withdraw” the Detroit bankruptcy filing.

In her opinion (Webster and Thomas v. The State of Michigan, Ingham County Circuit Court, #13-734-CZ, July 19, 2013), Judge Aquilina wrote:

  • PA 436 is unconstitutional and in violation of Article IX, Section 24 of the Michigan  Constitution to the  extent that it permits the Governor to authorize an emergency manager to proceed under Chapter 9 in any manner which threatens to diminish or impair accrued pension benefits; and PA 436 is to that extent of no force or effect;
  • The Governor is prohibited by Article IX Section 24 of the Michigan Constitution from authorizing an emergency manager under PA 436  to proceed under Chapter 9 in a manner which threatens to diminish or impair accrued pension benefits, and any such action by the Governor is without authority and in violation of Article IX Section 24 of the Michigan Constitution.

Judge Aquilina, in handwriting at the end of her opinion wrote:  “A copy of this Order shall be transmitted to President Obama.” In a number of states, public pension and post-retirement benefits are defined as contracts and protected by state constitutions. Chapter 9 not only contains no such provision, nor any stipulation with regard to state constitutions, but rather specifically defers to  consideration of a plan proposed by the receiver to enable the municipality to exit bankruptcy.

Problem: As Detroit nears insolvency, it will become more difficult each day to draw blood out of a stone whilst at the same time maintaining essential services. Moreover, the parallel proceedings in state and federal courts are and will consume immense fiscal and human resources that will reduce the capacity for the city to be able to regain its feet.

How will the federal government help?

When asked last Friday, Vice President Biden responded: “We don’t know.” What we do know is that, due to the sequester, HUD will be shuttered today. White House officials have indicated any federal government intervention—as was provided to New York City in the 1970s when it was confronted with a serious fiscal crisis and possible municipal bankruptcy, is unlikely.

What we do know is that there will be significant reductions in federal assistance next year to Detroit in key programs, such as CDBG, K-12 education, etc., and that the House of Representatives has passed legislation to eliminate food stamps. (There are 264,209 households in Detroit, and 91,204, or 34.5% receive food stamps; the same legislation has provided 14 members of the U.S. House of Representatives $7.2 million in federal subsidies over the last four years, according to Politico.).

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