Now that the city of Detroit has been given the green light to proceed with restructuring under the protections of Chapter 9 of the U.S. Bankruptcy Code that governs municipalities, possible large-scale cuts, including pensions for the city retirees and big losses to unsecured creditors are probably the order of the day.
Reading aloud a prepared text for more than an hour, US bankruptcy judge Steven Rhodes ruled on December 3 that Detroit is officially eligible for bankruptcy because it met the specific legal criteria required to receive protection from its creditors. As a result, Detroit now holds the title of ‘the largest bankrupt city in American history’.
Detroit is $ 18.5 billion in debt and says retiree benefits and retiree health care account for half of its liabilities with $ 5.7 billion in debt coming from retiree health care and an additional $ 3.5 billion in liabilities. of unfunded pensions.
Although Rhodes ruled that the city did not “negotiate in good faith” with its creditors, it called those negotiations “impractical” as many of the more than 100,000 creditors were unable or unwilling to negotiate in the first place.
As part of the restructuring, Rhodes also decided that the city could cut pensions, ruling against an earlier argument by Detroit’s 23,500 retirees that Michigan’s constitution allows special safeguards that protect health care benefits and pensions from retirees being cut back. While Michigan’s constitution protects public pension benefits as contracts, those contracts can be affected in a municipal bankruptcy, Rhodes determined.
However, Rhodes cautioned that his court would not necessarily confirm any adjustment plan that harms pension rights, and said that the restructuring plan must take into account all creditors, including retirees, and weigh that against what is more. judicious for the city.
The 25th Council of the American Federation of State, County and Municipal Employees (AFSCME) filed a notice of appeal alleging that the judge erred in ruling that federal bankruptcy law takes precedence over enshrined public employee pension protections in the Michigan constitution. Michigan Attorney General Bill Schuette called the judge’s decision disappointing and said he will present amicus briefs to the court reaffirming his support for pension protection. Detroit’s other labor groups and pensions are expected to be attractive as well.
Rhodes refused to stay bankruptcy proceedings as appeals begin to proceed through the courts and said that all motions to appeal his decision must first be filed in bankruptcy court. He previously suspended all state court actions in the case.
Now that Detroit has been declared ‘eligible’ for bankruptcy, Detroit emergency manager Kevyn Orr is finalizing a “readjustment plan,” which will be presented in early January. Before the bankruptcy judgment, Orr’s initial proposal, which offered shares of unsecured creditors on a $ 2 billion bill in exchange for $ 11 billion in unsecured debt, could be modified.
Other financially distressed municipalities with unfunded pension liabilities will keep a close eye on future developments in Detroit. Unlike employees who work in the private sector, public pensions are not protected by the Federal Corporation for the Guarantee of Pension Benefits.
Although some analysts predict that the arduous process of proving bankruptcy eligibility alone will prevent most municipalities from imitating Detroit, the ruling provides a model that other cities may try to follow in the future.
Quoted in a Reuters article on December 3, 2013 on the bankruptcy ruling, Richard Ciccarone, president of Merritt Research Services, said that this decision “could create more bankruptcies because it is a way out of pension contracts.” Pressured and stressed creditors with inherited liabilities will have to consider the option. “
Robert Novy-Marx, associate professor of finance at the University of Rochester’s Simon School of Business, calls the judge’s decision “enormously important” in a Detroit Free Press article on December 3, 2013. “In terms of the big picture. legal, clarifies the fact that even pension benefits can be affected, “he said.
“That changes a lot the conversation that workers and municipalities have in the future,” said Novy-Marx, who has a background in public pensions. “Until now, the workers have said that they are going to pay us whatever happens. We are not going to negotiate.”
Rhodes’ ruling also means that the Detroit Institute of the Arts (DIA) is not exempt from restructuring. The city-owned collection, which includes paintings by Vincent van Gogh and Henri Matisse among other prized possessions, is being evaluated by Christie’s auction house, as some 500 pieces could be affected by bankruptcy, according to the emergency manager. from Detroit, Kevyn Orr. Auction house Christie’s preliminarily estimates that artworks purchased by the city for the museum’s collection are worth up to $ 866 million.
Detroit is not the only city in the United States facing huge pension obligations. Chicago faces a $ 20 billion pension shortfall, while the state of Illinois has the dubious distinction of being the worst-funded public employee pension system in the nation with nearly $ 100 billion in unfunded pension liabilities. Illinois passed a long-awaited public pension reform on December 4, 2013, which was signed by the governor and is being challenged by the unions.