Detroit Nears an official Exit from Bankruptcy, while Illinois Faces an Epic Pension Challenge

November 24, 2014

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The Municipally Costly Cost of Exiting Municipal Bankruptcy. U.S. Bankruptcy Judge Steven Rhodes could set an official date today for Detroit to exit chapter 9 municipal bankruptcy—officially confirming its ability to eliminate more than $7 billion in debt and reinvest $1.4 billion in services over the next decade after he receives an update this morning on the city’s efforts to complete its restructuring plan. At this morning’s hearing, Judge Rhodes is also expected to rule on whether to force the Motor City’s two public pension funds to submit their bankruptcy expenses for review by the fee examiner appointed to monitor bills during the case―the Detroit Retirement Systems were not previously subject to the fee-review process, because they are legally independent from the city; however, Judge Rhodes has determined they should be subject to fee examiner Robert Fishman’s review process, because the city may ultimately reimburse the pension funds for some of their expenses. Nevertheless, after the unions filed objections with the court, some believe Judge Rhodes might reverse his position. Part of the detritus of municipal bankruptcy is the extraordinary cost—cost that is additional debt (in Detroit’s case, those costs are projected to be somewhere between $150-$200 million) and that, more often than not, appears to go to attorneys and financial advisors who are neither local residents, nor taxpayers. Mayor Mike Duggan’s administration previously signaled concerns that fees could jeopardize the city’s financial position but later asserted that the mediation process would resolve those concerns. About 80 percent of the $146 million in professional services fees that a Detroit bankruptcy court mediator will review next week are already paid, and officials said odds are long that mediation will reduce the balance very much.

Pensionary Challenge. Even as the potential federalism challenges between the federal municipal bankruptcy law and the California and Michigan state constitutions appear less and less likely to be pursued in the 6th and 9th U.S. Courts of Appeal, Sangamon County Circuit Court Judge John Belz last Friday struck down Illinois’ landmark pension law, which the governor and state legislature had adopted to address the state’s $104.6 billion government retirement system debt. Judge Belz, however, declared the new law unconstitutional, likely leading to an appeal to the Illinois Supreme Court. Judge Belz wrote: “The state of Illinois made a constitutionally protected promise to its employees concerning their pension benefits…Under established and uncontroverted Illinois law, the state of Illinois cannot break this promise,” adding that it was “without question” that the law violates the state constitution’s provision that a public worker pension cannot be “diminished or impaired….The court finds there is no police power or reserved sovereign power to diminish pension benefits,” in voiding the legislation in its entirety and permanently barring not only the state from enforcing any part of it, but also making clear it extended to every local government:  “Membership in any pension or retirement system of the state, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefit of which shall not be diminished or impaired.” Illinois Attorney General Lisa Madigan said she will appeal the decision to the state’s high court, where cases go when a state law is declared unconstitutional. She will ask justices to expedite the appeal in order to seek resolution and “given the significant impact that a final decision in this case will have on the state’s financial condition.” For Illinois, it could mean going back to the legislative drawing board to address the state’s $111 billion pension deficit—an unexpected challenge for Governor-elect Bruce Rauner. For Chicago, the ruling is the obverse of R-o-l-a-i-d-s, as the Windy City faces a $550 million increase for police and fire pension funding in 2016 unless the General Assembly grants some relief. According to the grand wizard of municipal bankruptcy—and Illinois resident, Jim Spiotto, Illinois is one of seven states which has constitutional provisions which protect public worker pensions: “Labor and pension contracts under state constitutions and statutory provisions should not be interpreted as a mutual suicide pact…A recovery plan with reasonable adjustments to pension benefits to what is sustainable and affordable is the only path forward for all concerned.”

The Illinois-passed pension changes were aimed at shaving about $145 billion off state payments in the coming decades, including $1.1 billion in fiscal 2016, while bringing the system full funding in 30 years. About $21 billion would be, if the Illinois Supreme Court overturns the lower court, pared from the unfunded obligations’ tab. The legislation would limit cost-of-living increases, cap pensionable salaries, and raise the retirement age for some, while cutting employee contributions by 1%, shifting contribution calculations to a more actuarially sound method, and giving the pension funds enforcement rights over state payments. Much of the expected savings from the pension overhaul stems from the COLA increases annuitants now receive. Under the package, the state would shift to an actuarially based method that moves Illinois ‘system to full funding by 2044. State contributions are guaranteed and pension funds could ask the courts to compel the state to make the payments, although lawmakers can vote to change them.

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