Detroit’s Bankruptcy Eligibility

U.S. Bankruptcy Judge Steven Rhodes late yesterday afternoon released his 143-page written opinion making clear that when “a state consents to a Chapter 9 bankruptcy, the 10th Amendment does not prohibit the impairment of contract rights that are otherwise protected by the state constitution,” and that the “residents of Detroit will be severely prejudiced if this case is dismissed.” Judge Rhodes wrote that last year, “38.6% of the City’s revenue was consumed servicing legacy liabilities. The forecasts for future years, assuming no new restructuring, are 42.5% for this year, 54.3% for 2014, 59.5% for 2015, 63% for 2016, and 64.5% for 2017.” Describing the city’s fiscal plight, he wrote: “The City cannot legally increase its tax revenues. Nor can it reduce its employee expenses without further endangering public health and safety.” At the same time, Judge Rhodes noted what he described as “the deeply held concern, and even anger that the State’s appointment of an emergency manager over the City of Detroit violated their fundamental rights of self-government.”

With regard to the fundamental federalism issue, he wrote:

The state constitutional provisions prohibiting the impairment of contracts and pensions impose no constraint on the bankruptcy process.

The state constitutional provisions prohibiting the impairment of contracts and pensions impose no constraint on the bankruptcy process. The Bankruptcy Clause of the United States Constitution, and the bankruptcy code enacted pursuant thereto, explicitly empower the bankruptcy court to impair contracts and to impair contractual rights relating to accrued vested pension benefits. Impairing contracts is what the bankruptcy process does. The constitutional foundation for municipal bankruptcy was well-articulated in Stockton:  In other words, while a state cannot make a law impairing the obligation of contract, Congress can do so. The goal of the Bankruptcy Code is adjusting the debtor-creditor relationship.

Every discharge impairs contracts. While bankruptcy law endeavors to provide a system of orderly, predictable rules for treatment of parties whose contracts are impaired, that does not change the starring role of change the starring role of contract impairment in bankruptcy.

It follows, then, that contracts may be impaired in this chapter 9 case without offending the Constitution. The Bankruptcy Clause gives Congress express power to legislate uniform laws of bankruptcy that result in impairment of contract; and Congress is not subject to the restriction that the Contracts Clause places on states. Compare U.S. Const. art. I, § 8, cl. 4, with § 10, cl. 1.

Addressing the fundamental issues of the pension contractual rights in the Michigan constitution, Judge Rhodes wrote that not only were those pensions subject to impairment in a federal bankruptcy proceeding, but also that where, as here, the state consents, that “impairment does not violate the 10th Amendment. Therefore, as applied in this case, chapter 9 is not unconstitutional:”

Nevertheless, the Court is compelled to comment. No one should interpret this holding that pension rights are subject to impairment in this bankruptcy case to mean that the Court will necessarily confirm any plan of adjustment that impairs pensions. The Court emphasizes that it will not lightly or casually exercise the power under federal bankruptcy law to impair pensions. Before the Court confirms any plan that the City submits, the Court must find that the plan fully meets the requirements of 11 U.S.C. § 943(b) and the other applicable provisions of the bankruptcy code. Together, these provisions of law demand this Court’s judicious legal and equitable consideration of the interests of the City and all of its creditors, as well as the laws of the State of Michigan.

Next Steps. One can now anticipate a dual track, with Detroit Emergency Manager Kevyn Orr on a fast track seeking to achieve consensus with the city 100,000 creditors on a plan of adjustment—whilst at the same time, Judge Rhodes’ decision will begin a lengthy process of appeals that could stretch all the way to the U.S. Supreme Court.


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