The city of Detroit, Michigan filed for Chapter 9 bankruptcy on July 18, 2013. It is the largest municipal bankruptcy filing in U.S. history by debt, estimated at $18–20 billion, exceeding Jefferson County, Alabama's $4 billion filing in 2011. Detroit is also the largest city by population in the U.S. history to file for Chapter 9 bankruptcy, more than twice as large as Stockton, California, which filed in 2012. Detroit’s population has declined from a peak of 1.8 million in 1950; recently, the New York Times called the city “home to 700,000 people, as well as to tens of thousands of abandoned buildings, vacant lots and unlit streets.”
Detroit’s bankruptcy filing followed a declaration of financial emergency in March 2013 that resulted in Kevyn Orr being appointed as "emergency manager" of the city by Michigan Governor Rick Snyder. Orr’s subsequent negotiations sought to get creditors to willingly “take a haircut” on Detroit’s debt, and were ultimately unsuccessful.
On July 19, 2013, Judge Rosemarie Aquilina of the Thirtieth Judicial Circuit Court of Michigan ruled the bankruptcy filing by Detroit violated Article IX, Section 24, of the Michigan Constitution and ordered Governor Rick Snyder to withdraw the filing immediately. On July 23, an appeals court stayed the circuit court ruling pending future rulings on Michigan Attorney General Bill Schuette's appeal. On July 24, the Bankruptcy Court added its own, federal stay of the state court proceedings. On August 2, the bankruptcy court set a hearing date of October 23, 2013, for trial on any objections to the city's eligibility for Chapter 9 bankruptcy, and March 1, 2014, as the deadline for the city to file a bankruptcy plan. After a nine day trial on eligibility, the Bankruptcy Court on December 3, 2013, ruled Detroit eligible for Chapter 9 on its $18.5 billion debt. On June 3, 2014 the Michigan Legislature passed a package of bills to help Detroit avoid further bankruptcy proceedings. On the same day, Governor Snyder pledged to sign the package of bills.
- 1 Background
- 2 Bankruptcy filing
- 3 Reaction
- 4 Legal developments
- 5 State legislation
- 6 See also
- 7 References
- 8 External links
In April 2012, Detroit Mayor Dave Bing and the nine-member City Council entered into an agreement with Michigan Governor Rick Snyder that allowed for greater fiscal oversight by the state government in exchange for the state’s providing Detroit help with its finances. A financial review team was appointed in December 2012 to conduct a 60-day review. The team consisted of Andy Dillon, Thomas McTavish, Ken Whippel (Korn/Ferry), Darrell Burks (PricewaterhouseCoopers), Ronald Goldsberry (Deloitte Consulting) and Frederick Headen. In February 2013, Snyder announced that the Michigan state government was taking financial control of the city of Detroit, as it viewed that Detroit failed to meet deadlines set by the state government. In accordance with Public Act 72 of 1990, the state government's Local Emergency Financial Assistance Loan Board appointed Kevyn Orr emergency financial manager of Detroit following a declaration of financial emergency. As emergency manager, Orr was granted the power to rewrite Detroit's contracts and to liquidate city assets.
A report on the financial health of Detroit was released by Orr in May 2013. The report stated that Detroit is “clearly insolvent on a cash flow basis” and that the city would finish its current fiscal year with a US$162 million cash-flow shortfall. It also stated that the city’s budget deficit would reach $386 million in less than two months and that one-third of the city’s budget was going toward retiree benefits.
In June 2013, the government of Detroit stopped making payments on some of its unsecured debts, including pension obligations. In an effort to avoid bankruptcy, Orr sought to persuade some of Detroit’s creditors to accept 10% of the amount they are owed. White House Press Secretary Jay Carney said, during a press conference in July, that he knew of no plans by President Obama to bail out the Detroit city government similar to the bailouts in recent years of Detroit-area automakers General Motors and Chrysler. On July 17, just one day before the bankruptcy filing, Detroit’s two largest municipal pension funds filed suit in state court to prevent Orr from cutting retiree benefits as part of his efforts to cut the city’s budget deficit.
Since 1937, there have been over 600 other Chapter 9 bankruptcies in the United States of cities, towns, villages, counties, and special-purpose districts. The largest previous Chapter 9 bankruptcy happened in Jefferson County, Alabama, in 2011.
After several months of negotiations, Orr was ultimately unable to come to a deal with Detroit’s creditors, unions, and pension boards and therefore filed for Chapter 9 bankruptcy protection in the Eastern District of Michigan U.S. Bankruptcy Court on July 18, 2013. Snyder approved the filing by Orr in a letter attached to the court documents. Some of the named causes for the bankruptcy are the shrinking tax base caused by declining population, program costs for retiree health care and pension, borrowing to cover budget deficits (since 2008), poor record keeping and antiquated computer systems, that 47% of owners had not paid their 2011 property taxes, and government corruption. Two city workers pension plans had for nearly 25 years been paying out “13th month” checks.
Bankruptcies of cities, towns, villages and counties since the Great Depression are rare (about 60 since 1950, i.e. around 1 per year; special district bankruptcies have been more numerous), and how Detroit will be affected is unclear. Detroit’s estimated long term debt was more than USD $14 billion and could be between $18 and $20 billion, far exceeding the $4 billion in debt of Jefferson County, Alabama, that had been the largest American municipal bankruptcy filing to date. It is also the largest city by population in U.S. history to file for bankruptcy, with more than double the population of Stockton, California, which filed for bankruptcy in 2012. State officials said that city services will not be affected immediately by the bankruptcy filing. Municipal workers with pensions are not insured by the federal Pension Benefit Guaranty Corporation, since they work for a municipality and not a business, and some also had received pensions in lieu of Social Security benefits.
According to a Detroit area bankruptcy attorney, legal costs for the bankruptcy proceedings could cost Detroit "tens-of-millions to hundreds-of-millions of dollars." Orr hopes that Detroit can emerge from bankruptcy by late Summer or Fall in 2014; he says that the process is moving as “expeditiously as possible”. The City of Detroit is represented by lawyers from Jones Day and Miller Canfield, financial advisers from Ernst & Young and restructuring consultants from Conway MacKenzie. The Federal Guaranty Insurance Company hired Weil Gotshal & Manges to represent their interest during the bankruptcy. The Ambac Financial Group hired David Dubrow, a lawyer at Arent Fox, to represent their interests during the bankruptcy. Syncora hired Kirkland & Ellis; Assured Guaranty hired Winston & Strawn; and the National Public Finance Guarantee Corporation hired Sidley Austin. The Detroit Institute of Arts is represented by Richard Levin, a partner at Cravath Swaine & Moore. "Other large law firms, such as Brown Rudnick, Orrick Herrington & Sutcliffe, and DLA Piper, are involved in the case or looking for ways" to get involved in the bankruptcy case.
Orr has considered the sale of valuable city assets, but other arrangements or regulations make it difficult to sell some of them. For instance, valuable works at the Detroit Institute of Arts cannot be sold due to private and city agreements, as well as state law; other city assets that could be sold include the Coleman A. Young International Airport and the Belle Isle Park (see picture above). Mayor of Windsor, Ontario, Eddie Francis has said that his city would consider purchasing Detroit's half of the international Detroit–Windsor Tunnel if it is offered for sale.
Yields on bonds issued by the city of Detroit increased on July 18 to record highs, as investors considered the potential effects of the bankruptcy filing. Rates had already escalated when yields jumped from 8.39% in mid-May to 16% in mid-June of 2013. The credit rating agency Moody’s said that the bankruptcy filing was credit negative for Detroit and that it created an “unprecedented litigation scenario,” which could impact services city residents receive, as well as how much bondholders would recover from Detroit.
Business and labor leaders reacted to the filing. Detroit union leaders called Orr’s move to declare bankruptcy premature due to ongoing financial negotiations with creditors, unions, and pension boards, but also stated that employees will continue to work in a typical fashion. The only major U.S. automaker headquartered in Detroit itself, General Motors, said it “is proud to call Detroit home and ... (this is) a day that we and others hoped would not come. We believe, however, that today also can mark a clean start for the city.”
Politicians have commented on the bankruptcy. Bing said that the people of Detroit “have to make the best of it”. Snyder stated that “I know many will see this as a low point in the city’s history,” “If so, I think it will also be the foundation of the city’s future—a statement I cannot make in confidence absent giving the city a chance for a fresh start, without burdens of debt it cannot hope to fully pay.” President Barack Obama said that he is following the developments and that he is "committed to continuing our strong partnership" with Detroit. Kentucky Senator Rand Paul stated that he will not allow the government to bail out the city, saying "He is bailing them out over my dead body, because we don’t have any money in Washington." Snyder also stated that he did not support a government bail out. "It's not just about putting more money in a situation," he said. "It's about better services to citizens again. It's about accountable government."
Detroit's debts included $369 million in unlimited general obligation bonds, bonds issued with the general backing of taxpayers, described by Florida bond finance director Ben Watkins as "[having] been the gold standard of the municipal-bond market". The offer by Kevyn Orr to settle these for less than 20% face value, and doubts regarding the willingness of Michigan to assume the debts, was predicted to drive up borrowing costs of nearby municipalities. This effect has been seen in regard to localities in Michigan. Three have so far had to postpone new bond offerings or face higher interest rates. However, this concern has not materialized on a wider scale, as investors have actually treated municipal general obligation bonds as safer than before the filing. Recent history from California "has shown that the fallout from a bankruptcy can dissipate quickly" in the bond market. Contributing to this is the fact that Moody's has fewer than 40 of the 7,500 local governments that it rates listed as below investment grade.
Soon after Detroit declared bankruptcy, it was reported that the city would continue with plans for a bond issue to fund a new $444 million arena for the Detroit Red Wings. Repayment of the bonds would be split between taxpayers and developers of the arena. Both Snyder and Orr acknowledged concerns raised about the expense, but stated that continuing the project makes good economic sense even with the context of Detroit's bankruptcy. With the arena, and additional retail, office, residential and hotel space the developer has committed to build as part of the overall project, it is expected to create about 8,000 construction jobs, with work due to start in 2014.
From bankruptcy filing to eligibility ruling
On July 19, 2013, Ingham County Circuit Court Judge Rosemarie Aquilina ruled, using a typed statement with hand-written notes attached, that the bankruptcy filing by Detroit violated the Michigan constitution by impairing pension payments and ordered Snyder to withdraw the filing: Snyder has appealed the motion, and Aquilina indicated she was sending a copy of her ruling to President Obama. While under Article IX, Section 24, of the Michigan Constitution, neither the state nor any of its "political subdivisions" are permitted to default on the accrued financial benefits of their pension plans or retirement systems, federal law may allow bankruptcy judges to renegotiate pensions of municipalities in bankruptcy. Many consider public pension benefits of existing retirees "virtually untouchable"; the clash between state constitutional protections of vested public pension rights and the general ability of the bankruptcy process to modify debt obligations has yet to be fully tested in any Chapter 9 proceeding.
On July 22, Aquilina delayed to July 29 her hearing on retiree funds request for an order directing Orr and Snyder to withdraw the bankruptcy filing and desist from any effort to reduce vested pension benefits in the face of their protected status under the Michigan Constitution. This legal move allowed the bankruptcy court to weigh in. Bankruptcy Judge Steven Rhodes scheduled a hearing on July 24, on the city's request that the retiree state court suit be stayed because of the pending federal bankruptcy case. Rhodes indicated that the bankruptcy court, not the state court, has the authority to resolve the dispute between the city and the retiree funds over the city's authorization to file the bankruptcy case.
On July 23, a three-judge panel of the Michigan Court of Appeals ruled unanimously to stay the proceedings in the state court actions, pending a resolution of the state's appeal of Aquilina's rulings directing withdrawal of the bankruptcy filing. In another development in the bankruptcy case, Rhodes indicated in a filing on July 23 his intent to appoint a mediator to work with the parties in the bankruptcy. Rhodes indicated that the mediator would be Chief Judge Gerald Rosen of the U.S. District Court for the Eastern District of Michigan.
On July 24, the bankruptcy court held a two-hour hearing on the city's request for a stay of the pending state court proceedings against Snyder and Orr. Rhodes then granted the federal stay and ruled that Orr is a validly authorized officer to act for the city in the bankruptcy. Rhodes ordered that three suits filed by city employees, retirees and pension funds in State Court be halted. He made it clear that all legal battles will be fought in the Federal Bankruptcy Court Rhodes emphasized that he was not on July 24 deciding whether the city met the statutory criteria for eligibility for a Chapter 9 filing, nor the effect on the bankruptcy case of Michigan's constitutional protection of vested public pension benefits.
On July 27, Michigan Attorney General Bill Schuette announced that he would enter an appearance in the bankruptcy case for the purpose of defending Michigan's constitutional protection of vested public pension benefits. Scheutte said that in doing so he would be acting in his role as "the people's attorney." Scheutte acknowledged that there is no action currently pending in the case related to public pensions, but he stated that by filing an appearance he “will be able to defend the state constitution if and when this does occur.” Scheutte's office also represents Snyder, who favors cuts to Detroit's public pension plans as an element of restoring the city to financial stability. Scheutte's spokesperson said that his office would continue to represent the governor and other state agencies in the bankruptcy; different sets of attorneys in the attorney general's office will represent these divergent positions. A spokesperson for emergency manager Orr said that Orr “respects the attorney general’s concern for Detroit’s pensioners. This is an important issue that will be decided, appropriately, by a federal bankruptcy judge."
On August 2, the bankruptcy court held a status conference, set an initial schedule for the case, and made several initial rulings. The court set August 19 as the deadline for any party to file objections to the city's eligibility for Chapter 9 bankruptcy, and October 23 as the hearing date for trial on such objections. The court set March 1, 2014, as the deadline for the city to file a plan of adjustment for its debts. The court ordered the appointment of a fee examiner to review the fees incurred by attorneys and other professionals for the City, and invited comments on naming an appropriate person to fill this role. The court presented a proposed order establishing a mediation process aimed at facilitating settlement of disputed issues that will arise in the case, and inviting comments on the naming of an appropriate mediator, with the court having initially proposed Chief Judge Gerald Rosen of the U.S. District Court for the Eastern District of Michigan. The court ordered the Office of the U.S. Trustee to appoint an official committee to represent retired employees of the city, with the U.S. Trustee to select the members to serve on this Retiree Committee. The professional expenses of the Retiree Committee will be paid by the city, which consented to do so. When a fee examiner is appointed, the professional expenses of the Retiree Committee will also be subject to the examiner's review. On August 19, Rhodes appointed Robert M. Fishman, an attorney with the Chicago law firm Shaw Fishman Glantz and Tobin, as the fee examiner. Fishman's own fees are charged at $600 per hour. Another attorney who has served as an expert witness in fee matters commented that, while the fees will no doubt be large, legal fees are always a small percentage of what is at stake in a bankruptcy of this magnitude.
On August 13, Judge Rhodes, after receiving input from various parties in the bankruptcy, confirmed his appointment of Judge Rosen of the District Court to serve as a mediator in the Chapter 9 case process. The mediator may bring parties together for "facilitative mediation" on any issues that Rhodes chooses to refer to mediation. Any mediation proceedings held will be confidential, except for the terms of any settlement that may be reached and presented to the bankruptcy court for approval. On August 21, Rosen - as permitted by Rhodes's order appointing him - appointed additional mediators to assist him. As Rosen said, mediation in this case will amount to a monumental task, involving "thousands of claims and issues." The additional mediators are: U.S. District Judge Victoria Roberts, a Detroit native who is also an adjunct professor at the University of Michigan Law School; U.S. Bankruptcy Judge Elizabeth Perris of the District of Oregon, who has served almost 30 years as judge and has been a judicial mediator in the Chapter 9 bankruptcies of Vallejo, Stockton and Mammoth Lakes, Calif.; Senior U.S. District Judge Wiley Daniel of the District of Colorado, a former Detroit resident; former U.S. Bankruptcy and U.S. District Judge David Coar, who has also served as a private mediator in large bankruptcy cases, including the Mammoth Lakes, Calif., Chapter 9; and Eugene Driker, also a Detroit native, who is "considered a leading mediator in Michigan."
On August 19, the deadline set by the bankruptcy court, 109 objections were filed to Detroit's eligibility for Chapter 9. Among the more prominent objectors were the Retired City Employees Association and Joint Retired Detroit Police and Fire Fighters Association, the UAW, the AFSCME, the city's General Retirement System and Police and Fire Retirement System, the Detroit Fire Fighters Association and the Detroit Police Officers Association (and two levels of associations of higher-ranking police officers). Numerous individuals were also among those filing objections, including some in the form of handwritten letters. Attorney General Schuette filed a statement that his office does not contest Detroit's eligibility for Chapter 9, but does object, and will continue to object, to Detroit's ability through the bankruptcy process to diminish its retiree pension benefits in light of the Michigan state constitutional prohibition against impairment of these vested obligations. Notably, bondholder representatives and municipal bond insurance companies chose not to file an objection to eligibility. This is despite Kevyn Orr's stated intention to treat approximately $2 billion of general obligation bond debt as unsecured, which would likely result in substantial losses to the bond parties. Frank Schafroth, director of the Center for State and Local Leadership at George Mason University, commented that the choice not to object on eligibility reflected lessons learned in the Stockton, California, Chapter 9 case. There, bondholders and bond insurers did wage a months-long litigation effort to have Stockton declared ineligible. But this expensive and time-consuming effort proved unsuccessful. An attorney for some of the bondholders in Detroit's case commented that they felt it was better to have the bankruptcy judge as a referee rather than to deal only with Orr on the terms of his severe pre-bankruptcy proposal to the bond groups.
Judge Rhodes ordered that initial argument on the purely legal issues of Detroit's eligibility for Chapter 9 be held on October 15–16, rather than the October 23 date of the full trial on eligibility. Rhodes declared early consideration of the purely legal issues, such as Detroit's authorization under state law for the bankruptcy filing, would expedite determination of eligibility under the Bankruptcy Code. At the same time, Rhodes reserved issues requiring factual determinations, such as whether Detroit negotiated in good faith with its creditors before filing the bankruptcy case, for the October 23 trial.
- $11 million to law firm Jones Day
- $4.59 million to Conway MacKenzie, a Detroit area restructuring firm
- $4.17 million to Ernst & Young, accounting firm
- $1.5 million to Plante Moran, accounting firm
- $1.2 million to Miller Buckfire, investment banking firm
Orr used $95 million earmarked for unsecured bond debt and pension payments to Detroit's restructuring initiatives, which caused Detroit to first miss bond payments in June 2013.
On December 3, Judge Rhodes ruled Detroit eligible for bankruptcy protection. In his ruling the judge determined that Detroit is insolvent, and that the city could not have practically negotiated on a plan of adjustment pre-bankruptcy with its thousands of creditors. The judge declined to find that the city had negotiated in good faith with creditors pre-bankruptcy, based on the testimony at the eligibility trial; he noted that the meetings the city held with creditors leading up to the bankruptcy filing did not meet the statutory good-faith requirement. However, he found the city eligible for Chapter 9 on the statutory alternative ground of impracticability of negotiating with so many creditors. The judge also found that the city could potentially impair the pensions of city retirees through a plan under federal bankruptcy law, despite the Michigan state constitutional provision protecting such pensions from impairment.
Judge Rhodes followed the announcement of his ruling in open court with a 143 page written memorandum opinion providing the bases for the ruling. The memorandum discusses in detail the financial status of the city. It reviews the statutory criteria for eligibility and indicates those the city satisfied, and finds that the city met the minimum criteria for eligibility. The memorandum discusses in depth the major objections raised by various parties to the city's eligibility, and finds that the objections are either unfounded in law or insufficient factually to deny the city eligibility for Chapter 9. The judge concluded the memorandum with a reminder to all interested parties that eligibility is only a preliminary step in a Chapter 9 case, and that the "ultimate objective is confirmation of a plan of adjustment....the Court strongly encourages the parties to begin to negotiate, or if they have already begun, to continue to negotiate, with a view toward a consensual plan."
Appeal of eligibility ruling
Judge Rhodes declined to stay the effect of his eligibility ruling while any potential appeals are decided. He also indicated that he would consider permission for an appeal to proceed directly to the U.S. Court of Appeals for the Sixth Circuit, rather than the regular route of an appeal first to the federal district court, in a separate motion. AFSCME immediately filed a notice of appeal of the ruling. It is expected that the independently managed pension funds for city workers will join in the appeal. Detroit’s teachers' union will appeal the bankruptcy ruling according to Randi Weingarten, national president of the American Federation of Teachers. On December 16, 2013, Judge Rhodes granted motions by AFSCME and the pension funds permitting direct appeal to the Sixth Circuit. The permission includes the ruling on eligibility for Chapter 9, and the ruling that the city can impair vested public pension benefits through a Chapter 9 plan.
City's plan of adjustment of debts
After the Chapter 9 eligibility ruling, emergency manager Kevyn Orr said the city will seek to file a plan for adjustment of its debts under bankruptcy law by early January. Orr said that negotiations with unions for the city's workers on the terms of a possible plan were continuing.
Judge Rhodes has set a trial on whether the City's proposed plan should be confirmed for late-July through August 2014. The judge is designating a neutral expert to advise the court on the merits of the plan and its financial feasibility. Federal judges are empowered to make use of such independent expert witnesses.
Assets available for distribution
One of the issues facing litigators is which assets belong to the city outright and are available to creditors in order to satisfy liabilities. For example the Detroit Institute of Arts holds 66,000 valuable pieces; however, only five percent of this collection were bought with city money. Judge Rhodes will have to decide if the other 95% of this collection can also be monetized in order to satisfy the claims of the bankruptcy creditors.
In May 2014, Michigan House of Representatives Speaker Jase Bolger announced the formation of a special committee, House Committee on Detroit's Recovery and Michigan's Future, to help Detroit settle the bankruptcy while protecting Michigan taxpayers statewide. The committee introduced legislation giving Detroit's retirement systems a $194.8 million lump sum. As well, legislation was passed to create an oversight commission to aid Detroit's recovery.
Bolger also called on unions to make contributions to help in the Detroit settlement. Bolger requested unions to make a material contribution that is reflective of other parties involved in the settlement. Speaker Bolger's request did not come without opposition, the Detroit Free Press wrote an editorial suggesting that Governor Rick Snyder should convince Bolger to drop his request of labor unions, or the governor should bypass Bolger. Other critics wrote that Bolger's request would imperil the settlement. On the other hand, the Detroit News editorial board wrote in support of labor unions contributing, but noted that the likelihood was slim. Bolger held firm to his request, and beginning with the Michigan Building and Construction Trades Council, some unions did agree to make material contributions towards health care costs to help with the Detroit bankruptcy settlement. After unions agreed to contribute money towards the settlement, the Michigan House passed legislation with major bipartisan support. Governor Snyder called the legislative package an opportunity to change the direction of Detroit. Upon passage, the Detroit News called the final legislative package a "grand piece of work," and the Detroit Free Press opined that the deal showed lawmakers "get it."
- History of Detroit
- Partial list of chapter 9 bankruptcies of the United States.
- History of New York City (1946–77): During the 1970s, New York City received a federal loan to avoid filing for bankruptcy under the administration of President Gerald Ford.
- Flint, Michigan financial emergency
- Municipal bond
- Saving Detroit's DIA and worker pensions
- Financial emergency in Michigan
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