Detroit bankruptcy: City 'needs help,' can file for protection, judge rules

After a protracted legal battle, a federal judge is allowing Detroit to move forward with its application for Chapter 9 bankruptcy protections, and, in a blow to public sector unions, is allowing the city to seek a reduction in pensions.

“The city needs help,” US Bankruptcy Judge Stephen Rhodes said Tuesday. “The city no longer has the resources to provide its residents with basic services.… The city cannot legally increase its tax revenues, nor can it further reduce its expenses without further endangering health and safety.”

The ruling makes Detroit the largest municipality in the US to file for a federal bankruptcy.

Judge Rhodes noted the unprecedented factors that played in this case – the historic population loss over decades, the mismanagement of city funds, and its controversial public pension burden – that the state emergency management team says are collectively contributing to its $18.5 billion in long-term liabilities. In 2012, 39 percent of the city’s revenue was used to service legacy liabilities, he noted.

Michigan Gov. Rick Snyder (R) characterized the Rhodes decision as “a call to action.”

“We are confronting fiscal realities that have been ignored for too long. Today’s decision will allow Detroit to regain its financial footing and spark investments in key areas that will improve the quality of life for all residents and encourage growth and investment,” Governor Snyder said.

To seek federal protections for relief, the city needed to prove that it was insolvent and that it filed in good faith with its nearly 100,000 creditors, which include most of its public sector labor unions. The unions testified in the nine-day trial that the state team, led by emergency financial manager Kevyn Orr, was trying to use the federal bankruptcy court to destroy the public pension protections guaranteed by Michigan’s constitution.

Rhodes agreed that the city did not negotiate in good faith. He said Orr’s June 14 proposal to creditors only allowed 30 days for a counter-offer, and was “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,” he said.

That behavior will not stop the bankruptcy from moving forward, Rhodes said, because the pre-filing negotiations were burdened by “the totality of the circumstances,” which made them “impracticable.”

Randye Soref, a bankruptcy attorney at the Los Angeles business and litigation law firm Polsinelli, says Rhodes determined that negotiating in good faith was not possible in this case because of the 500 lawsuits aimed at the city, among other issues.

“Detroit has been paying legacy debt for years, and as a consequence of that, if you simplify it if you are always paying it, you’re never going to catch up and that’s the reality of it,” Ms. Soref says. “Faced with what they were faced with, did they [negotiate] the right way? They did it in a way that Rhodes could find some component of good faith.”

Rhodes also said Orr was allowed to seek relief through pension cuts, saying that a ruling was needed “to expedite the resolution” of the bankruptcy. His decision is a major blow to the unions, who argued that public pensions should be considered separate from other debts because they are protected under the state constitution. Rhodes disagreed, saying that there is no violation.

He warned that just because Orr now has the right to cut pensions, he will not approve a plan with steep cuts.

While appeals are assured, they are not likely to impact the bankruptcy from moving forward. “The ruling is appealable. Will it stop anything? No. This case will continue,” Soref says.

Orr now must submit a massive restructuring plan for the city by the end of December. This will likely include a sale of assets, including billions of dollars worth of art at the Detroit Institute of Arts, proposed privatization of the city’s water and sewer departments, and renegotiated offers to creditors, retirees and labor unions.

Soref estimates approval of the plan will come in the spring. 

Labor organizations expressed outrage by the decision. In a statement, Jordan Marks, executive director of the National Public Pension Coalition in Washington, said, “the modest pensions” of city workers “could be all but wiped out.”

“This is a dark day for people of Detroit who worked hard, played by the rules, and are now at risk of losing everything,” he said.